Ukraine – two years on

 

If the murder of Navalny has made one thing clear it is that Putin has no interest whatsoever in backing down from his murderous campaign against his enemies within and without Russia. As the second anniversary of his invasion of Ukraine nears, it still seems that too many in the West have still not realised that Ukraine is not just defending itself but the whole of Europe against an expansionist and murderous regime. The America-First or Putin-wing of the Republican party seems not to have learned anything from history, in the best case assuming that a broader conflict in Europe will not affect US economy and security, in the worst case, sympathising with the ‘strongman approach’ to international relationships. Left and right extremists in Western Europe, in the best case, are naïve believing that Putin will simply stop at the Western border of Ukraine and that once he gets the parts of Ukraine he wants plus the rest of the country as buffer zone, everything will go back to the status before the war; in the worst case, they are simply paid by Putin.  

 

Western Europe is in a war, even if bombs 'only' fall on Ukrainian cities and 'only' kill Ukrainian civilians. Pretending otherwise is a dangerous illusion. For us, it is an ‘easy’ war to fight: send military equipment and money. Yes, there is an economic cost, but as much as we benefited from a peace dividend over the past 30 years, we will now have to pay a war tax. Not paying it and not supporting Ukraine will be even costlier in the long-term. I simply cannot understand the hesitation by many European governments to be more forceful in their support for Ukraine’s fight, which is also our fight. Slava Ukraini! 

23. February 2024



A note on Israel and Gaza

 

Last year I came out very strongly in favour of Israel defending itself against the Hamas terror group, even if this included a full-fledged invasion of the Gaza strip. The events over the past 4 months or so, have seen exactly this. While at the beginning, there might have been some attempt at minimising civilian casualties, it has become clear that this is no longer the case. Even if it is hard to disentangle civilians and Hamas militants, the Israeli approach seems brutal and inhumane, with the suffering of the Palestine civil population horrific and unbearable. To add insult to injury, excesses by Jewish settlers in the West Bank seem to have only one aim: humiliate and deprive Palestinians.  

 

From the viewpoint of some in Israel, their brutal approach in Gaza might seem justified in the short-term; in the long-term, however, it is self-defeating, as the Palestinians will still be there after Hamas is hopefully gone (unless you follow the same maniac and murderous idea of Hamas of ethnic cleansing as some extremists in Israel do with respect to Palestinians). The vicious cycle of violence (in this round started by the terrorist attacks by Hamas on 7 October) will simply continue.   This is short-sighted and wrong!

 

The current brutal and short-sighed approach seems driven by the interest of Prime Minister Netanyahu to stay in government as long as possible without thinking about long-term consequences. He has made himself a hostage of extremist settler parties for purposes of political survival, putting his own interests above that of the country.


As mentioned before, Israel is the only functioning democracy in the region; one can only hope that there will be sufficient pressure to change the current approach, not only to reduce the suffering of the Palestinian civilians but also to the benefit of future Israeli generations.  So far, the conflict between Hamas and Israel has not escalated into a regional conflict, with many Arab governments holding back in spite of pressure from their population. The risk is that as the destruction of Gaza continues, this will not hold much longer.

19 February 2024


Capital market union – a reset?

 

I recently participated in a panel discussion on the capital market union, organised by the Portuguese regulatory authority CMVM and CIRSF, conducted under the Chatham House Rule. Here are some take-aways (building on my own remarks and others’ comments) – certainly a topic that I will write more about in the coming months, also because I am co-organising another such event in Florence on 14 May in the context of the EMU Lab. The background for these discussions is that ten years ago there was a big push for such a capital market union; while some progress has been made in terms of legislative efforts, there seem to be limited progress in actual outcomes.

 

First, drawing parallels between the banking and the capital market union is wrong and counterproductive. The banking union (or at least what has been put in place) was the result of a crisis and has focused on banking stability. There are clear elements (SSM, SRM and EDIS), with broad consensus on what has to be done, though not as much political willingness to also undertake the final steps. The capital market union, on the other hand, is a much broader project, focusing on a variety of markets and institutions, focusing on the sustainable development of different segments of the financial system, both through legislation and regulation, but also creating new authorities.

 

Second, Europe urgently needs to diversify away from a bank-based or bank-biased financial system towards a stronger role for non-banks and capital markets. This includes both public equity and bond markets, but also non-bank intermediaries such as venture capitalists and equity funds. There is sufficient evidence that a bank-based (or bank-biased) financial system is not only bad for growth, but also for stability (given the more procyclical nature of bank lending).

 

Third, rebalancing of the financial system towards non-bank segments of the financial system is also needed for innovation and green transition. In a recently published paper, my co-authors and I show that liquidity creation by banks is growth-enhancing through the channel of tangible but not intangible investment, with the aggregate growth effect of banks’ liquidity creation turning insignificant in economies with a larger share of sectors relying on intangible rather than tangible assets. Ralph De Haas and Alex Popov show that market-based rather than bank-based financial systems are better positioned to fund the transition to net zero.  Why?  Banks generally do not fund innovation and intangible assets as they rely on tangible assets for collateral and companies’ track record (with innovative start-ups might not have); they are also reluctant to fund green transition as this might hurt their legacy borrowers.

 

The arguments so far make a general argument for fostering non-bank segments on the country-level, but why on the European level?  Scale economies matter in finance and even more so in capital markets, where network externalities are also important (as discussed and empirically shown in this paper). Larger countries have larger and more liquid capital markets (as shown here where we compare nascent stock exchanges – the most extreme comparison are the stock exchanges of China and Swaziland, established in the same year). There is also the issue of path dependence, as a vibrant financial centre also relies on lots of ancillary services (legal, accounting, auditing etc.), a reason why London continues to be one of the global financial centres.  So, moving towards a European Capital Market Union to benefit from such scale and network externalities is critical.  Does this mean that financial service providers have to be concentrated in one location?  Not necessarily, but it calls for close interconnections, merger of back offices etc.

 

What is needed to move towards such a Capital Market Union? One thing certainly won’t work is to ‘lure’ people into buying stocks with marketing campaigns and tax incentives alone. And if it works, it might backfire once people incur losses (remember the mis-selling of preferred shares in the runup to the 2008 crisis).  There is a debate on the importance of missing financial literacy as impediment to more households diversifying away from bank deposits; certainly an important factor though in the long-term not necessarily the decisive factor. Enforcement of fiduciary duties of sellers and of transparency standards is important. There is still not enough investor protection. There might also be a need for ‘industrial policy’ trying to aim for larger funds (again with the argument of scale economies and thus lower fees), although there might be competition concerns.

 

The most important question for me is who can drive this process. I think there is the clear need for a champion on the technocratic side – ESMA would certainly be in a good position. Upgrading ESMA’s position as supervisor across more segments of the financial system within the EU can also help in this context.

 

One important impediment are national political interests. The open competition to lure business from London’s financial centre after Brexit shows that there are limited interests in creating a truly European hub for financial services. Maybe rather than waiting for a compromise among 27 member states, with capital markets not at the top of the agenda, a ‘coalition of the willing’ is needed.


14. February 2024


Studying across Europe – the backlash from the locals

 

I spent five years at Tilburg University in the Netherlands, teaching in English and building up a banking research centre. Having moved subsequently to the UK, I have learned to appreciate the Dutch university system even more. One important strength of Dutch universities is that a large share of courses are taught in English, which makes it an attractive destination for non-Dutch students across Europe who have to pay the same (reasonable) tuition fees as Dutch students.  University education has thus become an important export industry for the Dutch, with the overall economy and society benefitting. Dutch students benefit from daily interaction with non-Dutch students and society benefits as some of the non-Dutch students might stay on and become part of the Dutch work force. Dutch universities have also managed to attract many foreign academics, not just because of a favourable tax treatment but also because of the international environment. Again, it is students who stand to benefit getting a broader and more global view in their education.  

 

All of this is now at risk.

 

The Netherlands seemingly has benefitted from Brexit as European students have shifted their focus away from the UK. Given the environment I described above, Dutch universities stand to enormously benefit from this trend; but this influx has also contributed to an increasing stress on the housing market, resulting in higher rents.  This has led the previous (and still acting) government to require universities to shift towards more teaching in Dutch, with the explicit objective to discourage foreign students.  One can think of few more short-sighted policies!  Rather than focusing on building more student housing, damage has to be done to the Dutch university system!  There might be a strong argument to limit the number of students, but doing so by reducing quality and global outlook?

 

It is important to note that it is not only diversity in the student body that will go down with this approach, but also diversity on the academic site. How many non-Dutch speakers will stay and start teaching in Dutch? How can you attract international talent if they find out that they have to teach in Dutch within a few years. While there might not be an immediate exodus, it will certainly hurt the university system and society at large. The Danish example (where a similar policy was introduced in 2021) shows that the damage can be actually done quite quickly.

 

Finally, it obviously also undermines the idea of Europe; yes, the student exchange programme Erasmus is not at risk yet, but a focus on domestic students is a clear step against the spirit of Europe!

10 February 2024


Are economists a tribal clique?  Sad, but true

 

ECB President Mme. Lagarde (herself a lawyer) recently called economists a tribal clique (see here, from minute 21 onward).  One might wonder whether it is wise to criticise the people that work for you, but I will leave this to others to judge.  Unfortunately, her statement seems quite correct and also confirmed by research, as reported, for example, here.  Compared to other social scientists, economists are less likely to quote papers from other social sciences and are more hierarchically structured. They clearly see themselves as more competent than other social scientists and see less value in interdisciplinarity. Calling this out is important! There is an older and more humorous description of life among economists here.

 

Having enjoyed an interdisciplinary environment over the past 2.5 years, I have learned to appreciate the opportunities interdisciplinary dialogue offers, especially after having spent eight years in an environment where interdisciplinarity was defined as a corporate finance and an asset pricing researcher having lunch together (I am not criticising my former employer for that as it was a the result of geographic distance from the rest of the university).  

 

How can interdisciplinarity help economists? Mme. Lagarde mentioned examples herself in her Davos remarks, related to climate change and supply-side shocks, but let me add some from my own experience. Take the example of banking union- last year, some of us economists joined forces with forces with legal scholars to explore options of completing the banking union within the legal constraints given by existing European treaties. When discussing options for banking union and capital market union completion, we economists (pretend to) know exactly what is to be done; learning from political scientists and historians how such reforms are actually put in place might not just make us more humble but also more effective.

 

In summary, Mme. Lagarde’s criticism might sound harsh, but rather than criticising the messenger it might be good for us economists to consider the substance of it and consider it carefully.

30. January 2024


Euro at 25

 

On 1 January 1999 the euro was formally launched (as accounting currency), thus 25 years ago.  Time for some reflections, including on two politicians who feature prominently in the history of the euro and passed away late last year, though one of them seemed to be more an accidental (and rather controversial) giant in the politics of the euro. Jacques Delors, president of the European Commission between 1985 and 95, implemented the Single Market and the Schengen Agreement and set the foundation for the monetary union. The European Union in its current shape owes a lot to policies and institutions created and implemented during his 10 years at the helm of the commission.  Free movement of goods, services, capital and people is today seen as the natural state of affairs, but was not just a generation ago. However, in creating the euro, there was also a, what today we would call minimalist approach, focusing exclusively on monetary union and ignoring all other policy areas, a decision that came back to haunt the euro area – more on this below.

 

Wolfgang Schäuble had a prominent role as German finance minister in the Eurozone. Following the Global Financial Crisis, which brought several European governments to the brink of overindebtedness and losing access to funding markets, the shortcomings of the euro governance structure became clear. While critics had not necessarily imagined this specific scenario, it was the lack of fiscal policy coherence across countries and a geographic mismatch between cross-border banks and national regulation and national interlinkage between governments and banks that made the currency union unsustainable without reforms. The solution proposed by Schäuble and others: austerity! And not only austerity in overindebted countries, but including in core countries such as Germany and the Netherlands, which had no fiscal problems to speak of.  This ultimately prolonged the economic slump throughout the euro area and put even more pressure on overindebted countries and the overall euro area.

 

Yes, progress was made in terms of a Single Supervisory Mechanism but we are far away from a functioning banking union and the bank-government deadly embrace is still very much there. And the new fiscal policy agreement, while more flexible than previous one, will still result in significant retrenchment in government spending. Overall, the role of Delors was that of driving integration, while the role of Schäuble was crisis-solution, but at a (too) slow pace and to a certain extent with wrong instruments as well as preventing deeper integration to address structural shortcomings. Ultimately, this reflects the difference between a pan-European approach, supposedly taken by the Commission, and the national approach, often ignoring externalities of domestic policy decisions (such as austerity) on the rest of the currency union.  However, one could also argue that Jacques Delors had an easier time as being not directly accountable to voters (though all important decisions of course were taken by national governments), while Wolfgang Schäuble was always accountable to national voters.

 

These issues are also related to the launch of the EMU Lab here at the EUI last week, with the first session being titled “The Euro is not what we expected it to be – discuss!”. There are much better summaries by  Martin Sandbu on the FT (here) and of Adam Tooze on his blog (here), but here are some of my take-aways:  First, it is important to remember the objectives for many countries in agreeing to a joint currency – to overcome the fragility of a fixed-exchange rate regime, such as became obvious in 1992, but not necessarily as first step into an ever deeper union. It can also be seen in the context of the just established Single Market; while the Commission has been in charge of avoiding government subsidies that give uncompetitive advantages to firms, a common currency would exclude competitive devaluations. Barry Eichengreen reminded us that the US did not get to a true fiscal union until the 16th constitutional amendment allowed Congress to impose an income tax in 1913. And as still the case in Europe, labour markets were not really geographically integrated in the US until later in the 20th century. So, taking the long, historic view, maybe we can see the first 25 of the euro project as relatively successful, after all.

 

One important discussion was on the role of Single Market vs. euro area: the recent move towards joint expenditures for post-Covid recovery and discussions on similar expenditures for Ukraine are on the Single Market level; similarly, the discussions on the capital market union are not limited to the euro area (unlike the banking union). Martin Sandbu made the very valid point that maybe the best way forward should be to focus on resilience and growth on the Single Market rather than the euro area level.

14. January 2024


Banking in Africa: Opportunities and challenges in volatile times


In preparation for the 4th edition of the Oxford Handbook of Banking, Bob Cull, David Mare, Patrizio Valenzuela and I have updated our chapter on African banking, this time sub-titling it: Opportunities and challenges in volatile times. In summary, our paper ”shows a picture of achievements, including stronger resilience, and challenges, including stubbornly high costs, with progress along some fronts but other challenges persisting even as new ones arise, including the turning of the global financial cycle in 2022/23 and increasing geopolitical tensions.”


When discussing banking and finance in Africa, one first has to remember the adverse conditions in which financial service providers operate: First, the small size of many economies does not allow financial service providers to reap the benefits of scale economies. Second, large parts of the economy and a large share of all economic agents operate in the informal sector and do not have the necessary formal documentation that traditionally has facilitated financial transactions, such as enterprise registration, land titles, or even formal addresses. Third, volatility increases costs and undermines risk management.Finally, governance problems continue to plague many private and government institutions


While shallow, concentrated, and costly, Africa’s banking systems have also proven stable and resilient over the past years. There is a focus on the shorter end of the yield curve, also reflected in the marked absence of liquid capital markets and low development of contractual savings institutions such as pension funds and life insurance companies in most countries. There has been deepening of financial systems, but developing countries in Africa are still behind developing countries in other regions of the world.


On the upside, the adverse characteristics described above have also provided a prominent role for technology and innovation. Mobile money providers using agent networks can overcome the size problems by minimising the cost of a physical infrastructure and reducing the necessity for formal documentation requirements. Mobile money also allows more arms-length transactions, reducing governance challenges. And the mobile money revolution has significantly contributed to a substantial increase in financial inclusion in several African countries, even though there is still some way to go. There has also been a rapid increase in lending platforms, although it is still at a very low level, compared to other segments of the financial system.


Turning to the performance during Covid, we make three observations: first, the banking sectors in African countries were less affected by international economic turbulence as they are not well-integrated with the rest of the world, as was also seen in the Global Financial Crisis. Second, COVID-19 had mild negative effects on African banking sectors, at least in part because it was a less severe health crisis in Africa. Third, the lack of policy space (fiscal, monetary, and financial) limited the number of interventions of governments in reaction to COVID-19.


So, while Covid-19 did not have as severe effects on African finance in spite of a less powerful policy response as in advanced countries, the shifting global financial cycle and geopolitical tensions have the potential to test the resilience of African finance. The rise in interest rates since late 2021 across major advanced economies has increased debt burdens across the globe. The increase in foreign debt over the past decade, partly underpinned by rising commnodity prices and not all of it made transparent at time of origination, and the economic losses due to the pandemic have brought many developing including African countries close to unsustainable debt levels and some are already beyond that threshold.And with the Russian invasion of Ukraine and the same Russia trying to expand its footprint in Africa, there is an increasing focus on aligning the system of global financial transactions with new geopolitical objectives. This might also affect the geographic footprint of global banks, in a way similar to the repercussions of sanctions against Apartheid South Africa in the 1980s.


A final and continuous challenge is that of long-term finance, as already mentioned above. While there is no scarcity in the need or in the necessary savings pools, there is a lack of intermediary capacity for long-term finance. A bit like the Capital Market Union in the EU, creating the necessary enabling environment, markets and institutions is a long-term process. First progress has been made with measuring the existence of long-term finance instruments across Africa (as also discussed previously on my blog), but much more is to be done.

11. January 2024


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