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Monday, October 20, 2014

Does The Secular Stagnation Theory Have Any Sort of Validity?

In a number of blog-posts (Paul Krugman's Bicycling Problem, On Bubble Business Bound, The Expectations Fairy) I have examined some of the implications of the theory of secular stagnation. But I haven't up to now argued why I think the hypothesis that Japan and some parts of Europe are suffering from some kind of secular stagnation could well be a valid one.

Strangely, while I would suggest the most obviously affected countries are those mentioned above, most of the debate has centered around the US economy. Since it is not at all clear that the US economy is actually suffering from either a liquidity trap or secular stagnation at this point, this has lead many to question whether the idea might not be ill-founded. The Economist, for example, in a revue article (Fad or Fact) of Teulings and Baldwin's Vox e-book  on the topic conclude the concept "remains a baggy one", one which is "arguably too capacious for its own good".

Viewed in this light the concept does at times appear vague, and lacking in clear definition. In part this is because Alvin Hansen's original idea was made up of two components, a technological and a demographic one. Naturally if there is a slowdown in the rate of impact of technological innovation then this would be felt equally across those economies which are operating near the technological frontier. But the phenomenon which is being described today as secular stagnation isn't being witnessed equally across all those countries. Economies in both the UK and the US appear to have responded differently to those in Sweden, the Euro Area and Japan, a phenomenon which is obvious to the theory's critics. Thus the Economist author goes on to argue, "it is hard to avoid the conclusion that many of the euro area’s difficulties result from a dysfunctional monetary union rather than a susceptibility to secular stagnation." And it would be hard to disagree with the writer on this count, except... except ....except that there is the awkward little case of what is happening to Japan, a country which as it happens doesn't use the Euro, or in Europe itself to countries like the Czech Republic, Sweden or Hungary that don't use it either.

Which brings us nearer to the demographic part of the argument. Is there any pattern emerging in the way symptoms which look like those which would be presented in cases suffering from secular stagnation  are showing up? Well, I would argue there is. I think it is generally accepted that the first affected country was Japan.  It was in Japan that a slowdown in GDP growth (not GDP per capita growth) was first noted.

Japan was also the first country were working age population started to turn negative (in 1997) and where the correlation between declining growth momentum in this group and creeping deflation first started to be noticed.

Here's what movements in EU working age population look like.

And here's why I don't think considerations of demography can really justify the secular stagnation thesis in the United States context at the present time.

EU working age populations started to decline in the years between 2009 and 2012. They will now continue to decline for many years to come. In the United States however, while the rate of growth in this population segment has slowed in recent years, it is about to start accelerating again. As Calculated Risk's Bill McBride pointed out, the US Census Bureau now reports that Baby Boomers aren't the largest US cohort anymore, and that the prime working-age force is expected to start growing again in a few years. In other words, in terms of the demographic outlook, the dynamic points to stronger, rather than weaker, economic growth.  By 2020, eight of the top ten largest cohorts (five year age groups) will be under 40, and by 2030 the top 11 cohorts will be the youngest 11 cohorts. (see the marvelous animation Bill has at the end of his post).

Not All Europe Is The Same

Naturally, demographic dynamics are not the same in every country across Europe.  The two oldest countries on the planet are Japan and Germany with median population ages of around 46. Then comes Italy with with one of 45. I have recently written about the possibility Germany is bogged down in some kind of secular stagnation process. The Economist writer argues that what Europe's economies need are structural reforms, but it isn't clear if he also thinks Germany needs another swathe of these.  Long term growth is low in Germany, and inflation pressures are weak. It is not clear, however, that Germany is stuck in any kind of any kind of balance-sheet-recession-type liquidity trap. Loan growth is low, but this may well be a function of the age structure of the population.

It's no big secret really that Italy is suffering long term growth stagnation (which many, like the Economist and Beppe Grillo simply attribute to Euro membership).

And Italy has recently begun to have negative inflation levels.

Next on the list come countries like Austria (median age, 44), Finland (43,2), The Netherlands (42.1), Switzerland (42) and Sweden (41.2). It is striking that both Finland and The Netherlands have recently been suffering from very weak growth and almost constant recessions, while Sweden and Switzerland have an ongoing problem with a deflation threat.

If we fan out a bit, and move over to Eastern Europe, where working age populations are almost universally falling, the sharp fall in growth rates between the years before and the years after the crisis is also pretty noteworthy. 

Before the crisis annual growth rates were in the 4% to 6% range, now they are in the 1% to 2% range, and these are all emerging economies with levels of GDP per capital well below the EU average, countries who should in theory be experiencing strong "catch up" growth.

At the same time inflation, which was previously a significant problem, has all but disappeared and in fact deflation risk is pretty general across the region. Normally CEE countries have median ages of around 41, much older than say Ireland with a median age of 35.7, or the United States with one of 37.6.

So we seem to be observing the following pattern: working age population growth approaches zero and starts to turn negative, growth slumps to about 1% a year and falling, and inflation weakens to the point of becoming deflation. If this rough correlation is reasonably valid the next countries where we see secular stagnation setting in are South Korea and China, since working age populations are now in the process of turning there too.

A Simple Mechanism

So how do secular stagnation work? What's the mechanism? Well so far we have been offered two, one from Paul Krugman.

"To have more or less full employment, we need sufficient spending to make use of the economy’s potential. But one important component of spending, investment, is subject to the accelerator effect: the demand for new capital depends on the economy’s rate of growth, rather than the current level of output. So if growth slows due to a falloff in population growth, investment demand falls — potentially pushing the economy into a semi-permanent slump."
A slowdown in the rate of increase in domestic demand leads to a slowdown in investment, and this double slowdown pushes the economy into a dependence on exports and very weak GDP growth. The first place this "underinvestment" phenomenon showed up was in Japan.

Then we have seen it in Germany.

And now the "German" phenomenon has spread to the rest of Europe.

 The second pathway through which demographically driven secular stagnation operates was described by a group of IMF economists in a recent research paper:  "Is Japan’s Population Aging Deflationary?" Lower demand from older populations (less credit growth) leads to oversupply and deflationary pressure. The first part of the paper abstract runs as follows:

    "Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need."

So while there is no definitive answer at this point to the question whether or not what we are seeing is a creeping process of secular stagnation which will gradually spread from one economy to another as the respective working age populations start to contract, there is strong prima facie evidence that  there may be, that the theory is worth examining and that the hypothesis should continue to be tested.


The above arguments about why the Euro Area countries may have entered some sort of state of secular stagnation are developed in detail and at far greater length in my new book "Is The Euro Crisis Really Over? - will doing whatever it takes be enough" - on sale in various formats - including Kindle - at Amazon.

Saturday, October 18, 2014

Open Letter to the Economist on Catalonia - J'accuse

Those who have interest in neither Catalonia nor the issue of journalistic standards will probably find this posting long, tedious, and not especially interesting. Perhaps you might like to stop at this point. Those of you who are interested in one or other of these, well, I invite you to read on..... 

 To The Editors Of The Economist

I am writing this missive addressed to you as I am outraged, nay scandalized, by the level of your reporting on the Catalan question. The source of my discontent are two recent pieces - both signed by one GT - the first of which appeared on the Charlemagne Blog (Getting to “sí”, 19 September 2014), while the second was published under the rubric The Economist Explains (Catalonia’s independence movement,14 October 2014.)

Of the two, I consider the second much more reproachable since it purports to be an informative document, and not a mere opinion piece. My issue with your journalist is not his opinion - to which any journalist is entitled - but that he attempts to pass off opinion as fact.  My view is the that the level of journalism being demonstrated is  not what you should be seeking in a publication with your high level of international prestige.

At the end of the day, of course, whether this is the case or not is an editorial decision on your part. I fully understand why the Economist originally took the decision to publish non-editorial unsigned articles, but in the modern age I think this be a double edged sword as it leads to confusion about what is an Op-ed and what isn't. Personally I think the practice is now more trouble than it's worth, but again that's for you to decide.

In order to try and demonstrate my case I have gone to the rather tedious lengths of re-reading the two offending articles and identifying what I consider to be factual inaccuracies (see below). 

 In a personal mail addressed to me, GT says he admires President Mas, and even describes the new Catalan "consulta" as a brilliant move. It is a pity he couldn't have brought himself to express such opinions in the articles. My reproach is not related to any one phrase or statement, but to a long history of the same over many years.

My feeling is that in the present context, and with so much for the whole of Europe at stake here in Spain both politically and economically in the coming years, what GT does verges on the irresponsible, especially in an article with the header The Economist Explains. Curiously for an article with such ambitions it is striking that the ANC (Assemblea Nacional Catalana) which is the key civil society organisation promoting the independence drive) doesn't get even a mention.

In his mail GT tells me he is critical of Mr Rajoy, but frankly in his last two pieces this criticism is hardly noticeable. My "j'accuse" is based not on this factual inaccuracy (or superficial assessment) or that one, but on the fact that quantity eventually becomes quality. Despite claiming to admire Artur Mas the sum total of GT's "comedy of errors" makes the Catalan President look more like a character from Hotel Faulty, a sort of mediocre, run of the mill politician who was busying himself "ploughing another furrow" when the indy movement snuck up on him and forced him to try to "regain control". He is seen as a politician who is almost permanently under threat from the "Manuel" (or Sancho Panza) type character (Oriol Junqueras, leader of the openly separatist ERC - "my name is Oriol and I come from Barcelona") who is constantly threatening to wreak havoc with his best laid plans. Funnily enough there is a popular weekly satire programme on TV here which does something similar, but that programme, evidently, is just that, satire.

Getting to “sí

"On Friday Catalonia's parliament passed a so-called “law of consultations”, with a view to allowing Mr Mas to call a referendum on November 9."

This - that what the Catalan Parliament intended to enable under the "law of consultations" was the holding of a referendum - is just plain wrong. The law enables only popular consultations, and this was always its intention. Whether the vote called under the initial decree issued under the law was in fact a referendum is disputed, and vigorously so. The Catalan side argue it was an opinion-sounding vote, with no legal consequences, and have appealed to the Constitutional Court on just these grounds, against the Spanish government submission that it is de facto a referendum. The court has not yet ruled on this issue. When it does it is quite possible that it rule the law as such (possibly with some amendments) falls within the competences assigned to the Catalan Parliament under its charter, but that the question that was to be put is not covered by the law since it may be considered to constitute a referendum. But since the "with a view to"  words constitute an opinion about what was in the heads of the members of the Catalan parliament at the time of voting, all I can say is that there is no evidence to support this view.

Now, there is no harm in putting both sides of the argument, but I do think it is incumbent to put BOTH sides of the case. Also, it would be quite legitimate for GT to take the view it was a referendum by another name, but I do think he should make clear that this is his opinion. If you don't mention that the Catalans considered their attempted vote a "consulta" not a referendum - one without any evident legal consequences - then it's hard to make sense of everything that has taken place subsequent to the suspension, and especially it is difficult to explain how the new vote that has been called for the same day with the same questions differs from the suspended one. Apart from the legal framework in which it is to take place, to all appearances it doesn't.

"If Mr Mas obeys and cancels the referendum, his minority nationalist government, propped up by the separatist Catalan Republican Left (ERC), may fall."

Again, GT refers to "referendum" as if it was clear that this is what it would have been. As can be seen, President Mas cancelled the order authorizing the vote but his government didn't fall. It was never going to, and I think only people in Madrid ever believed this to be a  possibility. In order to understand why this was always going to be a highly improbable outcome maybe you do need to be familiar with some very simple "game theory".

"In the most extreme one, Mr Mas could stage an illegal referendum, with police moving in to remove urns and Madrid suspending the Catalan regional government's right to rule."

Well let's imagine that President Mas was to call an illegal "referendum" (not totally ruled out, but unlikely since he has continually insisted on his desire to work within the existing legal framework, or at least within his legal advisers' interpretation of it). The scenario GT depicts leaves me with one very basic question: where would these police come from? The number of Guardia Civil and Policia Nacional in Catalonia is very, very small. The vast majority of police in Catalonia are either local (municipal) police or belong to the body known as the Mossos de Esquadra, a Catalan police force under orders to the Generalitat de Catalunya. So this was a silly, unrealistic scenario. If the government in Madrid do move against the Catalan government, in my opinion,  it will be through the courts and through cutting-off finances. Maybe even trying to suspend the Statute of Autonomy under which the Catalan Parliament operates.However legal experts here question whether - despite the threats to do so that have on occasion been made - they in fact have the power to do this under the terms of the Spanish constitution. So it is possible that any hypothetical suspension of the "right to rule" may in practical terms need to involve some sort of suspension of the very constitution Mariano Rajoy declares he is determined to defend. That would be ironical, wouldn't it?

"Catalonia cannot negotiate to win more such powers from Madrid, for the simple reason that it already has them."

Well, again this is just an empty silly argument, since it is obvious there will eventually - as in the Scottish case - be third way proposals (maybe even a West Lothian question) as GT admit in his second article. There is no theoretical limit to the amount of devolution that can take place within a federal state. Especially if we start talking here about bi-lateral federalism for Catalonia. Again, he later points out, maybe many Catalans would vote for a new type of arrangement along these lines, and indeed this is why the consultation question is framed in two parts, so people can vote for the option of a (federated) Catalan state within Spain. If GT were to argue that maybe Artur Mas is ambiguous on this point, I would say that view is legitimate. As a democrat I suspect President Mas would go along with what he felt a majority of Catalans wanted. On the other hand I'm not sure I've seen any reference to the fact that there are to be two questions, or any analysis of the significance of this fact in any of his published material.

Catalonia’s independence movement

"The regional government of Catalonia ..... was planning to hold a non-binding referendum on independence on November 9th."

Well again, this is a one side way of putting it (see above) the continual repetition of which brings into question GT's independence on the matter.

"On October 14th the Catalan prime minister, Artur Mas, announced that some form of "consultation", involving "ballots and ballot boxes", would go ahead anyway on November 9th, regardless of the Court's decision."

Well exactly, this is simply the earlier consultation without any decree behind it, since President Mas is gambling that without a decree the Madrid government can't go to the constitutional court to get a decree which doesn't exist suspended. As GT says in his mail to me, it's a brilliant stroke. Since the Catalan Parliament never considered the  9N vote a referendum, neither version could be considered to have legal consequences, the only force they can have is political, in demonstrating people's opinions. At the international level these political effects should not be underestimated, hence, I venture to suggest, Mariano Rajoy's desire that it not take place.

"The two motors of the new wave of separatism are Spain's economic woes and a 2010 Constitutional Court decision to strike out part of a renewed charter of self-government that had been approved at referendum."

This is undoubtedly true, but maybe it would have been helpful to have mentioned WHICH part of the charter was struck down - the declaration that Catalonia is a nation. This is especially relevant since it is at the heart of the current issue, and also in the light of his next comment. The fact that this little word was struck out following an appeal from the Partido Popular to the constitutional court after a "popular participation" protest which involved the collection of a large number of signatures is possibly also relevant. President Mas is simply repeating this performance in reverse.

"Many Catalans, who speak their own language as well as Spanish, believe their taxes pay for poor, lazy southerners to live off government hand-outs."

As well as the fact that they speak that language maybe he could have said a bit more, especially about how the Catalans now feel their language - which was of course banned during the Franco years -  is once more under threat. Recent developments in Valencia, the Balearic Islands, Aragon (where there are significant Catalan speaking communities) are seen as a clear sign of an intention to limit use of and familiarity with the language. The most recent Spanish educational reform which attempts to influence the quantity of teaching in Catalan in Catalan schools is also highly contentious and important in understanding the current strength of feeling.

In addition, the second part of his sentence is little better than an Andy Capp type caricature. The quantifier "many" often hides a multitude of sins. Many Germans think something of the kind about Spaniards in general, but I doubt it is a majority. The same is true of Catalans. What Catalans want is to be able to decide what to do with their own resources.

They also want to be recognized as a nation and not continually told there is only one nation - the Spanish one - of which (under the terms of the constitution) they are all compelled to form part (whether they like it or not).

"Mr Mas has been caught unprepared by this wave of separatist enthusiasm. He responded first by demanding new tax-raising powers from Madrid."

Well, this is one of the issues where I feel GT has things totally back to front. Artur Mas, like the ANC - who he somehow manages to avoid mentioning even once in what is supposed to be a background information article - and everyone else, was as he says surprised by the *size* of the 2012 demonstration, and this undoubtedly encouraged him to move forward more quickly with a project he was already working on - the Catalan "national transition" - and recognise the leaders of ANC and Omnium Cultural as legitimate leaders of Catalan civil society.

No man is an island, and President Mas himself had been evolving as part of this growing separatist feeling since 2006. It was around that time he first started talking about moving towards a "national transition". This transition was already conceptualized as creating the institutions necessary to move towards independence.  A declaration of some kind of statehood was always going to be the end point. So he was himself fanning the flames. He was  not simply a late opportunistic add-on to the developing idea that Catalonia had gone as far as it could within the terms of the 1978 constitution.

On the isssue of the tax proposal GT is just plain wrong: President Mas's tax proposal was not a hasty response to the arrival of a wave of separatism. It was an idea he had been working on all through his years in opposition. Certainly he seems to have been quite happy when Rajoy (perhaps foolishly) greeted this proposal with an outright  "no", since this meant he could then move on to the next stage in the project. I think the size of the separatist movement lead him to accelerate his plans, and shorten the time scale of the "national transition".That is all.

"When they [the tax powers] were refused he called a referendum, knowing it was likely to be banned. It has not been enough to convince voters:"

What is the insinuation behind "knowing it was likely to be banned"? That it was all part of a carefully calculated plan - just another step towards the "elections as a referendum move"? Mas as Machiavelli? Or is GT suggesting that he was simply trying to throw sand in the voters eyes, to stall for time. The general gist of his argument leads towards the latter conclusion, so if he wanted to make the former point may I suggest that there are better ways of doing so. Like saying "this was also brilliant".

"Spain's conservative prime minister, Mariano Rajoy of the Popular Party (PP), has refused to call a referendum, which has only stoked support for one"

Mariano Rajoy, to my knowledge, has not been asked to call a referendum at any point, so he has not refused to call one. The Catalan parliament in the spring of this year asked the Madrid one  to authorize them to hold one - as had happened with the earlier referendum which was held over the new charter in 2006  - but this time the Madrid parliament refused. Once a referendum became impossible the Catalan parliament decided to go for a "popular consultation" - the legal aspects of the two - as I keep saying - are rather different. I suggest that the fact that GT didn't distinguish between referendum and "consulta" in the first instance leads to this kind of confusion. maybe he himself was confused.

"It [the Spanish government] also refuses to countenance the opposition Socialist Party's “third way” approach, which would involve constitutional reform to give Catalonia still more power and make Spain more federal. Polls show such reforms could bring support for independence below 50%."

See my point above, this is the reason more autonomy could clearly be offered, as happened in the Scottish case. And is indeed one of the few occasions on which GT criticizes Mariano Rajoy.

"Mr Mas's pseudo-referendum is still due to go ahead on November 9th, though it will have no legal consequence."

Well, we're back to the same old issue. What would have been the legal consequence of the suspended vote? None. What will be the legal consequence of the new vote? None. What's the real difference? None.

Essentially the two votes are one and the same - same questions, same date, same ballot papers, same ballot boxes -  and serve the same purpose, to find out what those who want to vote think. "No" supporters would not vote in either case, so we are only talking about getting a rough idea of who would vote "yes-yes" in a full referendum.

The use of the expression "pseudo referendum" irks somewhat here, since it sounds remarkably like the Catalan PP leader Alicia Sanchez Camacho's disparaging "refèrendum de costellada" (Sunday afternoon barbeque referendum). Pseudo (unlike say surrogate, or placebo) is normally used very negatively in English.

"The “no” side has either refused to engage or, where it has spoken up, been drowned out."

I dispute this. Both parts. Plenty of people have come to Catalonia from Madrid and other areas of Spain to argue in favour of "no". Both putting the constitutional case for "no" vote (rather than "no" in the vote) and arguing Catalonia is better off inside Spain. What hasn't existed is a "better together" campaign since there has been no third way offer to campaign for, and an assumption that there will be no vote. I also see no evidence of people being "drowned out". Plenty went to the Plaça Catalunya on 12 October (maybe 50,000) to show their support for staying in Spain. If  people think that more than a small minority actively oppose independence, then the best way to find out is to have a real referendum and see. Constant insinuation achieves nothing.

GT also misses the key point about the  elections as referendum proposal: this - in President Mas's opinion - is the only way to get the "no" side to actually campaign and vote - a key point in his international legitimization strategy.

"Mr Mas may now be forced to call early elections."

President Mas is not going to be FORCED to call early elections, as GT obviously knew since he explained to me he watched a video of the relevant press conference. The Catalan president is actively promoting them and sees these as the best way forward. In fact he is struggling with the other parties to get them to accept this idea and join a common list.

"The likely winner would be the radical ERC, which would lead a regional government encouraging civil disobedience, if the party sticks to its current position."

So again no, the likely winner wouldn't be ERC but the "yes-yes" vote. Mas has said he won't call early elections unless a common platform is agreed to.  His mandate extends to November 2016. He doesn't even need the support of any other party to pass the 2015 budget since he can simply extend the validity of this year's in the same way he did this in 2011 with the 2010 ones he inherited when he came to office.

You could, like Oriol Junqueras suggest he has electoral purposes in taking this stance. That is a matter of opinion. Think again about game theory and the prisoner's dilemma. The outcome of those elections wouldn't, in his opinion,  be an immediate UDI, but hey, guess what, Artur Mas's blessed national transition - which it is suggested would last 18 months - during which time an attempt would be made to create the institutional infrastructure necessary for UDI. In fact he has has an advisory body on the national transition at work since the November 2012 elections preparing all the documentation and strategy precisely with this in mind.

Naturally Madrid would probably not stand idly by - see comments above - but that is not what we are talking about here.

Monday, October 13, 2014

Eurocrisis Round Two, Blame the Germans Edition

"What strikes me, also, is the extent of intellectual confusion that remains." - Paul Krugman, Europanic 2.0

“The problem is that Germany has continued to maintain highly competitive labor costs and run huge surpluses since the bubble burst — and that in a depressed world economy, this makes Germany a significant part of the problem.” – Paul Krugman, German Surpluses: This Time Is Different

According to one fairly widespread (and recently much in vogue) theory about the Euro crisis, Germany bears a large part of the responsibility for the current mess. The view is met with a variety of responses inside the country, ranging from horror to amazement. Naturally, if the argument were simply about the way Angela Merkel has handled the crisis – no Eurobonds, no debt forgiveness, systematic fiscal austerity – then possibly some of it could be understood. But no, things go beyond that, Germany has been too successful, too competitive, and this has presented a big problem for its partners who simply haven’t been able to keep up.

This deeper “German bad” argument can take a variety of forms. The country is said to be obsessed with austerity even though all its partners are struggling to find air, it is thought to be guilty of running excessively large current account surpluses, it is accused of not showing sufficient solidarity with its south European partners by being unwilling to run higher inflation: what is more it is said to have benefited from a kind of vendor financing procedure during the good years and then complaining when the customers can’t pay. The list is a long one. The UK economist Simon Wren-Lewis even accuses them of having attained their hegemonic status simply by undercutting everyone else.
“Within the Eurozone, we have a problem created by Germany undercutting pretty well every other economy in the 2000-2007 period. I am not suggesting this was a deliberate policy, but the consequences were not appreciated by any Eurozone government at the time.” 
The questionable status of this version of events was highlighted once more last weekend in a blog post by Paul Krugman (who has been little short of prolific in his tirade against what he considers to be the bastion of theoretical stupidity in Berlin -  The Harm Germany Does, More Notes On Germany, Sin and Unsinn, France 1930, Germany 2013, German Surpluses: This Time Is Different, Germany’s Lack of Reciprocity, Europe’s Macro Muddle (Wonkish),   Germany’s Sin  ).

Personally, I think that behind this whole approach there lies a major misunderstanding about just what is going on in Europe (dare I use the word "confusion"). Why is the Germany economy falling back towards a possible recession?  Why does a country which recovered so rapidly from the global recession in need itself of stimulus? What we need to look at is why it is that Germany itself has problems. Why it looks so much like Japan, and not the extent which it could be blamed for the obvious economic problems in Italy and France. Instead of crying to the heavens about the country's current account surplus why don't we ask why domestic demand is so weak. Surely not because the country is living through a "balance sheet recession".

What worried me is that people are suggesting remedies - once which they admit might not even work - without getting to the heart of an adequate diagnosis. The nub of the problem is to be found in the following statement in PK's latest post:

"Draghi can try to get traction through quantitative easing, but it’s by no means clear that this could do the trick even under the best of circumstances — and in reality he faces severe political constraints on what he can do."

The argument we are being served up seems at best simplistic: Draghi is good, Schaüble is bad. That may be fine for those of you who like your world polarised in nice Manichean fashion, but would that things were so simple. I just spent a good deal of time writing a blogpost - The Japanisation of Europe - which tried  to argue that Mario Draghi is understating the extent of the mess Europe is in, and detailing the shortcomings in his knowledge of what actually happened in Japan. I am no admirer of the intellectual corner Herr Schaüble finds himself in, but I can't help feeling there is a significant element of "good cop" , "bad cop" going on here, with everyone defending the script they've been allotted, still if you like your stories nice and simple.....

What worries me isn't the idealisation of Mario, nor the demonification of Wolfgang, no it isn't that at all, it's those five little words Krugman uses: "it's by no means clear". This vagueness worries me since it rings a bell in my head about a phrase he used on an earlier occassion: Japan's "economy won’t always be in a liquidity trap, or at least it might not always be there." (Monetary Policy In a Liquidity Trap). For someone who wants us to draw the conclusion that it's the other side who are confused this vagueness is a bit rich. Does the policy he is advocating work or doesn't it? I think the guinea pigs have the right to know before giving their permission to the experiment?

You see, it wouldn't be so bad if there were strong grounds for thinking that full blown QE might shock the Euro Area out of its secular stagnation, but as I've been arguing for some time now (see my Paul Krugman's bicycling problem) the logic of Paul's argument (that secular stagnation is ultimately the result of long term fertility trends, and the long term natural interest rate may well be permanently negative) leads to the opposite conclusion: that it probably won't. And growing evidence from the application of Abenomics in Japan seems to confirm that view. To quote Martin Wolf again, "you can't print babies".

There are lots of things wrong with the Euro Area and it's institutions, and much needs to be done, but sending 18 countries on an experiment with consequences that wouldn't be benign and might not work doesn't seem like exactly the best way forward if you're not sure about what you're doing.

Not Simply An Export Model, Germany is the most Japanised of Europe's economies.

This whole “German Bad” approach is fundamentally flawed in my opinion, since while the crisis has revealed many failings in the south European economies – book cooking, corruption and conniving with money hungry developers, the presence of large and systematic extractive networks who were basically living off economic rents  – the finger pointing towards their German counterparts smells all too much like saying something like  “why did they have to be so good at selling their products.”

Simply cutting wages in the south isn't the answer (although carrying through a more serious internal devaluation involving reducing both prices and wages might be if you want to hold the Euro together). But neither is making Germany less competitive.

Even the idea that Germany has done better than its partners simply by driving down wages doesn’t fit the facts. According to Eurostat, average hourly wages in Germany in 2013 were 31.3 Euros. In Greece they were 13.6 Euros (and 16.7 Euros in 2008), in Spain they were 21.1Euros (and 19.4 Euros in 2008), while in Italy they were 28.1 Euros (and 25.2 Euros in 2008). In fact Germany came 8th in the Euro 18 league as far as hourly salaries goes. The conclusion you should draw from this data is that Germany’s unit labour costs are low not because Germans aren’t paid much, but because they are very productive, and at the end of the day, despite all the bleating about the current account this is the model other members of the Euro Area (including France) not only need to but are compelled to follow: high pay and high productivity. Indeed Paul Krugman more or less admits this reality:

“So while it’s impressive that Germany can run a surplus despite quite high labor costs, and that’s a testimony to the quality of its stuff, ultimately the surplus reflects high savings relative to investment.”

High savings relative to investment is exactly the argument Krugman uses to explain demographically driven secular stagnation: there is insufficient capex as a result of weaker domestic demand. So German savings are a symptom of something, and that something needs adequate diagnosis.

Even a cursory examination of German growth rates – the trend is now down to around 1% - suggests that all is far from well, as do the constant relapses back towards recession. The country simply looks good because all its partners are doing so badly.

What southern Europe needs is a revolution in the mindset and more “better quality” stuff, and no amount of blaming Germany for the situation can get over that. The extractive networks who hold back growth need reforming out of existence.

At the same time the under-investment over-saving phenomenon that characterizes Germany bears a remarkable similarity to what has been happening in Japan, with the strange difference that these days Japan is normally sympathized with and not blamed for all the world’s ills.
The Japanisation of Europe is most evident in the creeping stagnation in the so called core, and above all in Germany. Germany could probably help more with its short term fiscal stance, as Mario Draghi is arguing, if the others had a clearer plan, but at the moment the reform impetus in countries like Spain - unemployment still around 27%, a 3% fiscal deficit in Germany won't shave much off that - is waning severely. Shock measures to address this "unacceptable" unemployment is being neither contemplated or nor even discussed.

But the idea that Germany is stagnating on a temporary basis is absurd. It has been sliding to where it is now for over a decade, and short term stimulus won't be any kind of game changer. Nor are structural reforms likely to make that great a difference, the country has already done a lot of those. They slowed the process down - which is what structural reforms can achieve - but they couldn't halt the inevitable.

You can either argue that Germany goes "full Japanese" and tries live on permanent fiscal injection steroids (which clearly the country never will because that is not what its citizens want) or you can accept that it will just have to try what Keynes recommended, and start learning to manage the consequences of population decline. Obviously there is more, much more, to be done in Southern Europe, but trying to look for the problem where it isn't won't help in that endeavor.


The above arguments are developed in detail and at far greater length in my new book "Is The Euro Crisis Really Over? - will doing whatever it takes be enough" - on sale in various formats - including Kindle - at Amazon.

Wednesday, October 8, 2014

Is Japan Back In Recession?

“People should seriously consider that Japan’s economy may have fallen into recession despite the weaker yen and a stock rally from the BOJ’s easing and the flexible fiscal policy by Abe’s administration,” said Maiko Noguchi, senior economist at Daiwa Securities. “Initial expectations that the economy could withstand the negative effects of a sales tax hike through a virtuous circle seem to be collapsing.”

"the risks are rising that the economy will later be determined to be in recession,” said Yuji Shimanaka,  chief economist at Mitsubishi UFJ Morgan Stanley Securities Co.

Worsening Picture

As noted in my post - Does Abenomics Work? -  (published 19 September) the tide of media opinion finally seems to be turning against Shinzo Abe and his economic reform plan for Japan known as "Abenomics". The degree of skepticism being shown only seems to have grown on the back of a slew of recent data confirming the impression that the recovery of economic activity from the post sales-tax slump isn't going to be as easy as either the Japanese government or the Bank of Japan initially thought it would be. As the authors of the Bloomberg report from which the above quotes are taken - Oops Japan Did It Again? Sales-Tax Spurs Recession Debate - put it: "Weak industrial production data from Japan today raises concern that the world’s third-largest economy may be back in recession, challenging Prime Minister Shinzo Abe’s growth strategy." In fact, output which was down 1.5% between July and August (and down 2.9% over August 2013) has fallen in three of the past five months.

Other indicators point in a similar direction. Household spending was down 4.7% year on year in August, and the coincident composite index, which consists of 11 key indicators, including retail sales and industrial production, fell 1.4 points to 108.5, according to the Cabinet Office this week. The August drop was the the first fall since June.

Even corporates  are becoming more gloomy. The latest Bank of Japan quarterly Tankan confidence survey fell back three points from June, the second successive fall since it peaked just before the tax hike.

As the FT's Ben McLannahan points out the Tankan numbers also suggested that "the recent drop in the yen – which fell more than 5 per cent against the US dollar in September – remains a double-edged sword for Japan Inc, pushing up profits for big exporters with extensive overseas operations while squeezing the margins of smaller manufacturers, which struggle to pass on the higher cost of imports." Unsurprisingly it is the small manufacturers who are most disgruntled about the impact of Abenomics.

The economy fell between April and June by an annualized 7.1% and even though the rate of decline will have been much slower from July to September all the indications seem to point towards the possibility that growth was negative, which would mean that at least technically Japan is back in recession.

 Abe is having more success with inflation, which is running at the highest level in nearly two decades.  Yet even the inflation – which is  at an annual 1.3%  once you strip out the effects of the tax hike – has largely been driven by the rising cost of imports, and there are serious doubts whether even this will be sustained if there are not further yen devaluations. The Tokyo University frequently purchased items index (obtained from supermarket scanner data) shows underlying inflation continuing to ease.

But even the inflation proves to be problematic in a country where wages constantly fail to rise significantly. The fact that non inflation adjusted monthly wages rose at the highest rate in I don't know how many years makes a nice headline, but the fact that real take home pay keeps falling due to the impact of inflation gives a more realistic description of the difficulties involved in trying to refloat Japanese consumption..

The theory that is being applied assumes that Japan is in some sort of "temporary" liquidity trap due to the presence of a balance sheet recession, but what if the trap is permanent rather than temporary - see my Paul Krugman's bicycling problem - and is the result of the country's demographic evolution. In that case what - apart from all participating in a mass Labour of Sysiphus - do we really hope to achieve?

A policy which is exclusively aimed at attaining a positive natural rate of interest when the natural rate may be permanently negative seems of dubious value at the least, and when this policy in addition proves unable to drag the economy stably out of recession and only benefits the 10% of the Japanese population who have financial assets and senior management in large global companies,  then in its application it seems almost to be noxious. A state of affairs which doesn't escape the attention of the average Japanese in the street.

Falling Popularity

The popularity of Prime Minister Shinzo Abe's cabinet was falling sharply going into the summer, forcing him to stage a reshuffle in September. The current approval rating is now back up at 64% but if the country's economic fortunes don't improve it will surely start to head back down again.  On the critical question of whether to go ahead with next October's second tax hike, some 68% of those interviewed in the most recent survey say they are opposed while only 28% supported implementation.

Most market participants assume that the Bank of Japan will react to further bad news by increasing the rate of Japan Government Bond purchases, but it is far from clear that this will happen. Indeed only this week Bloomberg reports that members of the governing Liberal Democratic Party's governing council are starting to call for the formulation of an exit strategy from the yen weakening process as the debate over the policy's pros and cons grows steadily more intense.

Meanwhile the Japanese government recently announced that the number of people over 65 reached 25.9% of the population in September – up 1.1 million from a year earlier. Tic-toc, tic-toc.


The above analysis is based on arguments which are fleshed out in much greater detail in my  "mini book" the A B E of Economics.

The book is available with Amazon as an e-book. It can be found here. You don't need to buy a Kindle to read this book. You can download a free app from Amazon.