France’s heterodox economists

Back in June, The Current Moment blogged about a manifesto written by a group of “dismayed economists” in France whose critique of free market orthodoxies was beginning to gain ground. This past weekend, a long interview with one of the original signatories of this manifesto, the French economist André Orléan, was published in Le Monde. Focusing on the role of financial markets in macro-economic policymaking, Orléan makes a number of excellent points.

He notes that historically, the role of specific economic interests, such as those of finance or of specific sectors of the real economy (export industries, domestic farming interests etc.) have been contained by the wider concerns of governments. The universality of the general interests holds sway against the particularities of individual groups. He makes the good point that this battle has often been fought through national central banks. They have been the main tool used by the executive power to pursue the interests of wider society. This gives us a rather different perspective on what is often assumed to be the narrow partisanship of politically-controlled central banks. In the mainstream economic literature, independent central banks are the guardians of the public interest; central banks directed by national executives are prisoners of political short-termism. This may be the conventional view today but Orléan reminds us that the historical record supports the opposite view: politically-controlled central banks were the vehicles for the articulation of the public interest. The primacy of politics over economics, as Orléan puts it, has had as one of its main tools the power of the central bank. This might shed a different light on the Orban government in Hungary: attacked for its anti-democratic ambitions, one of Orban’s proposed reforms was to curtail the independence of the Hungarian central bank. Rather than welcome this as an attempt to regain political control over macro-economic policy, Orban was criticized for his nascent authoritarianism. In fact, the more powerful assault on the democratic control of macro-economic policy has been waged over the years by the European Court of Justice, particularly its attack on the notion that national public sectors should be shielded from the competitive pressures of the private sector.

Orléan also has an interesting reflexion on the nature of finance. Contrasting it with the market for goods or services, he notes that finance has a “directly collective dimension”: it is concerned not just with individual sectors but with the economy as a whole. He gives the example of the infamous downgrading of France’s triple A rating by the agency, Standard & Poor’s. In its report, S&P referred to the EU’s new fiscal compact agreed upon in December 2011 (which the UK and the Czech Republic are today refusing to ratify), which it judged inadequate to meet the demands of the Eurozone debt crisis. Orléan notes that it is exactly this kind of very general judgement that is typical of the financial sector; and yet such generality does not pass through – as with democratic decision-making – a system by which a variety of different views are confronted via the freedom of the ballot box. This curious combination of its very narrow representative claim along with its interest in the economy as a whole can go some way of explaining the rise of technocratic governments in Europe today: they express the same peculiar combination, with individual technocratic leaders such as Italy’s Mario Monti having a history of very close relations to the world of finance.

Orléan’s views on the way out of the current crisis are based around a reassessment of the idea of value in the economy and of value creation. He argues for a much greater focus on the creation of value within the real economy, as this is ultimately where jobs and growth are created. He suggests that a new law should be introduced that firmly separates savings banks from investment banks, an argument included in the French Socialist Party’s programme. There is nothing radically new in Orléan’s arguments but his attack on conventional assumptions in economics is both powerful and welcome.

Interview with Arthur Goldhammer

As part of our ongoing series of interviews, we have today responses from Arthur Goldhammer. Art runs the excellent French politics blog, is on the editorial board of French Society, Politics, and Culture, and chairs the Visiting Scholars series at Harvard University’s Center for European Studies. He is a writer and translator of more than 120 books from French to English, including a translation of Alexis de Tocqueville’s Democracy in America. He has written and commented on both the US and European dimensions of the recent financial crisis, and we have asked him to elaborate his views.

What are the stories right now that you think people either aren’t paying enough attention to, or about which we have the wrong view?

I think we need to pay more attention to how the expansion of lending was financed by what Hyun Song Shin, Joe Danielsson, and Jean-Pierre Zigrand call “passive investors,” namely, household savers, value-oriented money market funds and pension funds (see here). Ben Bernanke called attention to a “global savings glut” due to the US-China trade imbalance, but Shin points out that the Chinese by and large did not buy risky mortgage-backed securities. Instead, he notes the existence of a “global banking glut,” as passive investors provided cheap financing that allowed European banks to expand their lending dramatically during the early 2000s. It was this intermediation of US funds through global European banks that fueled both the US mortgage bubble and the various bubbles that occurred in Europe.

Let’s turn to the Eurozone debt problem. The dominant view is that Greeks and Italians are corrupt, inefficient and lazy, and that is why they find themselves in this mess. What is your view of what is going on?

Low productivity and laziness are not the same thing. Greek workers in fact put in more hours per year than German workers, but they do not produce as much per hour of work because the German and Greek economies are radically different in structure. Given the low cost of government borrowing before 2009, however, the Greek government increased its purchases over many years, which drove up unit labor costs relative to Germany while putting money into the pockets of workers, encouraging them to buy imported goods. In other southern-tier countries, the details of the picture vary but the overall pattern is the same: wage-inflation in the south combined with wage-stability in Germany, where unions and management cooperated to foster export-led growth. Inevitably, this structural disparity reached its limit. To be sure, deficiencies in Greek and Italian governance contributed to the crisis, but they are not its root cause.

The standard recipe for the recovery from the Eurozone crisis is austerity and structural reforms in the peripheries, plus some recapitalization of banks. Do you think this is the right way to go?

“Structural reform” can mean many things. Too often it is simply a euphemism for “scale back the welfare state” and “make it easier to fire unwanted workers.” Clearly, a more far-sighted structural reform, oriented toward education, job training, and productivity-enhancing investment is needed to put Europe on a more balanced growth path. In the short run, austerity is harmful because it will reduce aggregate demand. The theory of expansionary contraction is wrong: business confidence will be undermined, not increased, by simultaneous fiscal retrenchment across the Eurozone.

What do you think would address the trade and debt imbalances between Northern and Southern Europe? Do you think it can be done within the European monetary order?

Germans need to consume more, save less, and agree to a fiscal union that will allow for transfers of wealth to poorer regions. Politically, however, the latter will not be easy to achieve, since Germans were assured when the euro was created that they would never be part of a “transfer union.” The German Constitutional Court might even veto any such proposal. This could doom the Eurozone. But German gains from the euro have been so substantial, and the costs of a collapse of the Eurozone would be so great, that it is possible to envision evolution on this point. I am not sure that it can come fast enough, however, to save the system, especially if the European Central Bank refuses to purchase sovereign debt on the primary market to keep Italian borrowing costs within reason.

The hegemony of the demand for austerity is striking. It is offered as the solution to the Eurozone crisis, as well as to the American situation – the US Congress even created a supercommittee to find savings. Yet it seems odd to have such agreement around austerity in the midst of a potential double dip recession. What is wrong with the demand for austerity? How do you account for the strength of this common sense?

It is not easy for people to think in terms of a general economic equilibrium. Politicians often fall back on homely household analogies: “a family cannot indefinitely spend more than it earns,” etc. Other simple homilies abound: “Debt got us into this mess, we cannot get out by piling on more debt.” The paradox of thrift is difficult to grasp. It is hard, moreover, for many people to place confidence in “the Keynesian solution,” because there is so much controversy over what it means. Keynesianism was only dimly understood during the Great Depression, and the immense deficits incurred in World War II were not taken on in virtue of an intellectual conversion to Keynesian ways of thinking. The so-called Keynesian demand management that took hold in the 60s is really a separate body of doctrine from Keynesian teachings about the liquidity trap, and demand management policies were discredited by the stagflation of the 70s. The economics profession itself is so far from consensus about Keynesianism in either normal times or liquidity traps that it would take a leap of faith for the average informed voter to countenance the vast deficit spending that some theorists say is necessary to restore growth. So things will have to get worse before practical men who believe themselves to be quite exempt from any intellectual influence are willing to put themselves deliberately into the hands of some defunct economist.

In the US, there is an influential view that we need to have continued expansionary monetary policy but contractionary fiscal policy. That seems to be the recipe of the moment, with the Fed even contemplating another round of quantitative easing. What do you think of this approach to inadequate demand and balance sheet problems?

I think that quantitative easing is helpful but that its operation is too slow and will eventually have to be supplemented by a more expansionary fiscal policy. The latter must be accommodated by monetary policy, but monetary policy alone cannot do the trick. Without growth, the Eurozone debt crisis will worsen, and “quantitative easing,” which has already occurred there, will have to take the form of monetization of the debt, which the ECB has thus far staunchly resisted. But the gallows will concentrate the minds of central bankers, unless political chaos erupts first.

Debt, especially mortgages and student loans, have become a major issue over the past few years. What if anything do you think should be done about it? How should we understand the growing debt of American households in the past decades?

I think the housing market will correct itself but the damage to millions of lives could be limited if the government were to take a more aggressive line on mortgage modification. Student debt is another matter because expectations about the returns from education change very slowly. Too much hope is being invested in education, and inevitably many students will emerge with more debt than their future incomes can justify, imposing a durable drag on the economy. Law schools may have over-expanded, for instance, turning out more lawyers than the economy can remunerate at the levels students expected when their students took on heavy tuition burdens. On the other hand, the high cost of medical care might be alleviated if our medical schools produced more doctors, increasing competition and thus reducing fees for service, but unless there is a corresponding decrease in the cost of medical school, the burden will be borne by the students. But an over-indebted graduate is not like an underwater homeowner. The graduate’s freedom will be inhibited if she can’t service her debt, but the only appropriate bailout is sweeping social change.

One thing that seems to tie the American and European situation together is the considerable growth of financial activity. Is there anything to the view that the last decades can be understood as a period of financialization? If so, what does it mean to say the economy has become financialized?

There is no doubt that finance-related activities have accounted for a growing share of GDP and that much of this activity has been unproductive. But how much? It’s hard to know, because efficient economic growth does require intermediation between passive investors and active entrepreneurs. We have also learned that regulation of finance is not always helpful because it provides incentives for capital to seek unregulated niches in which to operate less transparently. For instance, the Basel II banking regulations appear to have contributed to the growth of the “shadow banking system” implicated in the mortgage financing debacle. Governments have nationalized banking systems in the past without always achieving more transparent or efficient financing. Nevertheless, I think increased public oversight of leveraged institutions is inevitable. And I’m not sure that there is any justification at all for hedge funds and other leveraged private equity firms operating largely outside the regulatory structure that applies to banks. Given the over-representation of financial operatives in the very highest income brackets, increased marginal tax rates on top earners, recently recommended in this paper by Peter Diamond and Emanuel Saez, might, if not curtail financial activity, at least yield revenues that could be put to alleviating the damage.

Related to that question, what do you think accounts for the ‘bubbliness’ of the US and European economies, and especially the scale of these bubbles? We have seen a number of different bubbles and credit crises – housing bubbles in the US, UK, Ireland, and Spain; sovereign debt events in Greece, Portugal, and Italy, perhaps even France. While there was the dot come bubble in the late 90s, and the East Asian financial crisis, those don’t seem to have had the magnitude and systemic character as the latest period. What is, or isn’t, different about what we’re experiencing now?

I think that the scale of the bubbles is related to the “banking glut” discussed above. There also seems to be a “herd mentality” at work in investment banking circles, perhaps owing to the way in which bankers are recruited, trained, and rewarded. But I don’t know enough about these matters to offer specific recommendations.

How optimistic/pessimistic are you about the ability of national democratic procedures to provide solutions to the current economic crises in Europe and in the US? What do you think of the recent proliferation of technocratic governments in Greece and Italy? Does the current crisis expose some basic tensions between capitalism and democracy? If so, how exactly?

I do not believe that so-called technocratic governments will survive for very long. The question of capitalism and democracy is larger than I want to take up here. To be sure, the crisis has exposed the power of financial institutions to insist on their due and to exert pressure on democratic institutions. But the money that has been lent includes the savings of millions of ordinary citizens, whose interests deserve protection as much as, if not more than, the interests of the borrowers, who after all have benefited from the use of the loaned funds over a long period of time. Our normal democratic procedures, which are intended to reconcile large-scale conflicts of interest of this sort, do not function well in an international context in which complicated technical issues are involved. We must not, however, throw up our hands in despair, lest the comprehensible rage of those whose trust has been abused give rise to some regrettable reaction.

What are your views of the nascent protests (Occupy Wall Street, Indignados) developing in response to the introduction of austerity packages in Europe and the US? Are these movements a continuation of or a break with the anti-globalization movements of the past? Are they likely to fundamentally change public perceptions and government policy or will they have only a very small lasting impact?

I think the protest movements have called attention to growing inequality, which excessive borrowing had in part masked. I believe that the movements are new and to a large extent independent of anti-globalization actions. They reflect a desire for increased voice, especially for the young, in democratic polities that had become overly focused on freeing markets, reducing taxes and preserving benefits for the old. If the movements are to have lasting impact, however, they need to influence the electoral process, and I am not sure that they have the numbers, leadership, or organizational skills to do so. Finally, the most recent protests are only one among many signs of a more general crisis of legitimacy throughout the democratic world. Elites have claimed too large a share of productivity gains and too great a monopoly of life opportunities for their children. Without reform, the center cannot hold. Even with reform it may be too late.

What, finally, do you think the appropriate political response is to both these crises and their aftermath?

Although there will inevitably be political responses of many kinds, what is really needed, I think, is an intellectual response to guide the politics: there is clearly something wrong with our understanding of economics, especially in the areas of monetary systems and macroeconomic stabilization. Until we achieve new clarity in these areas, politicians will flail at problems whose origins they do not fully grasp, and people will demand solutions that are incoherent and therefore potentially destructive. We must be wary of our own certitudes. As we saw in the Great Depression, statesman convinced of the virtues of the gold standard acted in ways they believed were right but that we know were wrong. We are similarly in the dark and should therefore proceed tentatively, experimentally, until we are confident that we are moving toward the exit. In the meantime, income must be redistributed downward and elites must loosen their stranglehold on upward mobility through education.

Why recapitalization is wrong

Recapitalization is the issue of the moment in Europe. It is almost taken for granted that it is the sensible next step. The question is less ‘if’ than ‘how’. Keen to avoid being seen as bailing out bankers, European governments are planning to impose upon Europe’s core banks a deadline of six to nine months after which these banks must have raised their core tier one capital ratio to 9%. In effect, banks are being asked to boost their reserves in order to be better placed to face down whatever losses will come about as part of the resolution to the Eurozone crisis. Predictably, as Patrick Jenkins recounts in his FT column, banks are resisting this move towards higher capital ratios: higher reserves means less lending and less lending means lower profits for the banks. In response, European governments are threatening to undertake recapitalization by force. The banks are upping the ante by saying that if they are forced to recapitalize, they will do so neither via shareholders nor via the state but by shrinking their balance sheets. This will mean a drying up of credit at a time when governments are trying to boost credit within the economy. Faced with this stand off, European governments may call in the banks’ bluff and force them to take state money.

There is something ironic about this round of bail-outs appearing as the victory of governments over the narrow interests of the banking industry. The reality is rather different. What is hidden by this debate about the modalities of recapitalization and the squirming of the banks over higher reserve requirements is the problem of recapitalization itself. We seem to have forgotten why Europe’s banks are in a weak position in the first place. The problem, as Mark Blyth explains very well, is the exposure of banks to the sovereign debt of peripheral Eurozone countries (Greece, Italy, Spain). This exposure is not the result of accident or misfortune. It comes from the determination of banks to make money out of the creation of the Euro. The peculiar features of the Eurozone meant that nations on the periphery were able to benefit from a credit rating identical to Germany’s. However, as Blyth points out, “while core/periphery yields narrowed there was still a spread, and if you were a core bank, you could dump all your boring low-yield German and Dutch debt, load up on periphery debt… and pocket the spread times a few billion exposures”. The banks’ current difficulties are thus the result of the risks they took previously in making profits off the uneven development of the Eurozone economy.

Instead of being recapitalized by governments, which will come with the bitter pill of higher reserve requirements, banks would rather the EU beef up its financial stability mechanism so as to avoid any sovereign defaults within the Eurozone. The alternative, namely recapitalization, still represents a dramatic subsidy from taxpayers to banks as it ensures that these banks are covered for the losses incurred as a result of their lending to peripheral Eurozone economies during the boom years.

These two alternatives – a bigger EFSF or recapitalization – are both significant wealth transfers from taxpayers to the financial sector and should be resisted for that reason. That these are the only two alternatives presently on the table shows how limited and narrow the debate on the current crisis has become.

The limits of Vickers

To much fanfare in the British media, the Independent Commission on Banking, chaired by Sir John Vickers, published its final report this month. Its interim report, published in April, had already attracted a great deal of attention and debate. This last report would – according to the BBC’s ever-excitable business editor, Robert Peston – be “hated” by British banks and promised to be “possibly” the most radical shake-up of banking in the UK ever undertaken.

Some of the proposals in the report seem sensible and are improvements on the status quo. The main thrust of the report is about how to avoid UK taxpayers having to cover the cost of another financial crisis. By ring-fencing the retail part of a bank’s business, its investment activities are no longer meant to enjoy an implicit government subsidy (the result of bankers knowing that in a crisis the government will save the bank in order to protect savers). This would make it more expensive for banks to engage in investment banking activities but the Vickers-led commission rightly responded that this is only a case of making banks pay for the risks they are taking.

A few problems stand-out though, all to do with the role banking plays in the contemporary national and international economy. The idea of ring-fencing – which is a watered-down version of the more radical idea of dividing up banks entirely, investment banks on one side and retail banks on the other – might make some sense in theory but in practice it is difficult to see whether it would actually fundamentally change the way the government acts in a crisis. The investment arm of a bank might be expected to take a loss in line with its risky behaviour up to a point. But what if this would threaten the survival of a major British firm, dependent upon financing from a shaky investment bank? What if more than one major firm was threatened? Would the government not be obliged to intervene as before? The idea of ring-fencing rests upon the idea that investment banking exists in one sphere, the “real”, i.e. non-financial, economy in another. This is simply not true.

Another problem is that the report invests too much importance into identifying an ideal structure for the City of London. This suggests that if the institutional rules are the right ones, we will be free from future crises. Or, at the very least, the consequences of future crises will be severely constrained, unable to spill onto the innocent paving of Main Street. But there is little evidence to suggest that the structure of banking industries is the crucial variable in the ongoing financial and economic crisis. Today, debate rages around part-nationalization of French banks as shares of big French banks plummet. And yet French banking is different in many ways from the British banking industry. The smaller and regional Spanish cajas are also in great trouble today, with many suggesting they should be consolidated into a smaller number of bigger players, a move that would make Spain look more like… Britain. The issue doesn’t seem to be the structure of the industry as such but rather something deeper. To focus on banking reform is to present the structure of the banking industry as a main cause of the present difficulties and of the 2008 financial meltdown. Events since 2008 suggest that it is less cause than consequence.

A really radical move would be to trace in detail the causes of the 2008 crisis and the current global economic slow-down, situating the role of the banks within a broader study of a financialized global economy.

Sarkozy and the French banking sector

It was announced on the 27th June, by French president Nicolas Sarkozy, that French banks had agreed to a plan to rollover a large chunk of the debt owed to them by the Greek government. Le Monde reports that this was decided upon at the weekend, with aim of bringing the French proposal to an International Institute of Finance meeting in Rome on the 27th where around 400 financial companies would be present. Without giving up on debt repayment as such, in the French plan the banks agreed to extend new loans to the Greek government as existing loans come up for repayment. These new loans would be extended over a longer time period, giving Greece more breathing room. Originating as a German idea to force private investors to share some of the burden in bailing-out Greece, France and the ECB had been firmly opposed to the idea. Now, cast as a purely voluntary affair, France has struck a deal with its big banks remarkably quickly.

Reported in the financial press as an arduous process, likely to take weeks, the French government has announced a deal within days. How was this done so quickly? Part of the answer is of course the degree of exposure of the big French banks. By some way, they are as a whole more vulnerable than banks from other European countries.

Banks	Exposure (Billions of Euros)
BNP Paribas (Fr)	5
Société Générale (Fr)	2.9
Axa (Fr)	1.9
Dexia (Fr-Belgian)	3.5
Generali (It)	3
Commerzbank (German)	2.9
Royal Bank of Scotland (UK)	1.1

Source: Forbes

That said, these figures also show that exposure to Greek debt runs through the European banking sector. So how to explain the speed of the French plan? A hat tip to my colleague, Daniel Mügge, for the answer. The French government, whilst having divested itself of its share of the banking sector as with its share of public services in general in the course of the 1980s and 1990s, is still able to coordinate policy with the main banks. No longer a state-run economy, France nevertheless rests upon a set of remarkably close relationships between political, business and finance leaders. The French deal was brokered by a working group, with representatives of the French treasury, the ministry of finance and the secretary general of the Elysée palace, Xavier Musca. Three of the biggest French banks – Société Générale, BNP Paribas and Crédti Agricole – are reported to have made their proposal to the government but there was much pressure in the other direction too. In other countries, such as Germany, it is by no means clear that the government will be able to put a similar agreement together. This is not only because its banks are marginally less exposed than the French banks but also that the nature of the relations between government and the banking sector is different.