Postcard from Northern Ireland
As I am spending a few days in Northern Ireland during half-break term, it might be time to catch up a bit on Brexit, given that this part of the Irish island continues to be at the centre of the ongoing conflict between the UK and the EU. As widely noted, Northern Ireland has not suffered from the same food and fuel shortages as Great Britain (and yes, I can confirm this from own experience), given that it is still integrated into the Single Market. East-West trade has become more difficult and North-South trade has therefore increased significantly, a not surprising consequence of the Irish Protocol that the UK government had signed up for, as part of the Withdrawal Agreement, in 2019. The controls envisioned by the European Commission might initially have gone beyond what was strictly necessary; after extensive consultations with Northern Irish businesses, the Commission has now made proposals to ease these controls. The UK government, on the other hand, is looking for symbolic fights, such as the right to exclusively use imperial measures. Most importantly, and impossible for the European Union to accept, the British government wants to eliminate the role of the European Court of Justice, in the name of complete sovereignty, even though this seems to have no importance for businesses on the ground in Northern Ireland. There are now indications that even if the British government will eventually back off, they do not consider this issue settled but will bring it up again in the future. Thus, a continuous conflict with the European Union, something that Brexiters promised to end after Brexit, but seemingly cannot let go.
In this context, the government has now all but officially confirmed that it signed the Withdrawal Agreement in bad faith, never planning on complying with its part of the Northern Ireland Protocol. Perfidious Albion is raising its ugly head!
And as the problems in Brexitland are mounting, the argumentation by the government that labour shortages (i) do not exist, (ii) do exist, but have nothing to do with Brexit, (iii) are actually caused by Brexit but are a benefit of Brexit is becoming more and more absurd; not sure whether to call it Orwellian or Trumpian. And the itching of some right-wing media figures for a trade war with the EU to rekindle the Blitz spirit of World War II stands in odd contrast with the fear of government to impose any Covid restrictions as the population will not be able to take it.
As ridiculous as Brexiters look from outside the UK, as naïve looks the ‘re-join’ the EU movement. Completely illusionary, they imply that all they need is a majority in parliament or some referendum to re-join the European Union in a few years. Well, the 27 member countries of the EU beg to differ. While careful with predictions, I would dare to predict that I will not see the UK re-joining the EU in my lifetime (and I currently have no indications nor wishes that I will pass on shortly 😊). All 27 current members of the EU have to agree and many of them will have their specific demands and objections. More importantly, the absence of the UK might have facilitated recent movements towards a fiscal union. And the looming conflict with Poland will make the EU even more reluctant to let back in a country that is not exactly known for its constructive role during the last decade of its membership. So, EU membership is off the table for the next couple of decades, at least with the current structure of the EU. The best the re-join movement can hope for is a Swiss-style alignment with the EU that re-establishes closer links between the UK and the EU in specific policy areas. Even Single Market membership is far away and not easy to achive, as explained here.
So, both Brexiters and the re-join movement are stuck in their respective bubbles, with one trying to divert attention from the damage Brexit is doing to the UK by fuelling constant conflict with the EU and the other blaming any problem on Brexit and promising the end to all problems once the UK re-joins the EU (sounds familiar?). Being in Northern Ireland, one is reminded where ideology and religion-like purity tests can lead to, with the two camps living in their own world; while in Northern Ireland they are also physically separated, in England, they live intellectually in their own respective bubbles. With calls that certain positions in the BBC have to be occupied by pro-Brexit journalists, the UK is moving closer and closer to the US model where the two bubbles no longer talk with but only at each other.
25. October 2021
Bundesbank – ready for change?
After 10 years of fighting the windmills of lose monetary policy, Bundesbank president Jens Weidmann leaves the stage. There are two reactions in Germany (and across Europe) towards the appointment of his successor. Some lament the possible end to a hawkish Bundesbank that is focused primarily on inflation angst and sees any loosening of monetary policy and the slightest increase in inflation rate as the possible start of a hyperinflationary downward spiral. Others see the appointment of a new Bundesbank president as chance to finally move away from a sometimes confrontational approach towards unconventional monetary policy under Draghi and Lagarde. Whatever side one takes, it is clear that Weidmann has been in the minority in the ECB’s Governing Council over the past decade and has had therefore limited influence. At the same time, one can argue that his position has contributed to the increasing hostility of media and public in Germany vis-à-vis the ECB.
Trying to stick to orthodoxy in monetary policy when the world around one changes seems at best naïve and at worst dangerous. First, it is important to remember that one important reason for the ECB to take a much more prominent, unorthodox role under Draghi after the onset of the eurodebt crisis was the refusal of ‘creditor countries’ (led by Germany) to give fiscal policy the necessary role in crisis mitigation. Second, monetary policy frameworks have to adjust to changes not just in economic structures but also in analytical insights. Over the past decade that I have been discussing monetary, financial stability and euro area policies more broadly with my fellow economists in Germany, I have noticed a clear shift away from orthodoxy to a more realistic approach, moving from ‘we show the rest of Europe how to do it properly’ to the recognition that Germany as anchor country of the euro has not only privileges (and big economic advantages) but also responsibilities. Third, the world has moved on from a view that money supply drives inflation and that monetary and prudential policies are independent of each other to the realisation that financial and monetary stability are inherently related with each other, which requires a much more broader central banking approach (reflected also in the fact that with one exception - Sweden – it is the central bank governors of the EU that have voting power in the General Board of the ESRB, the macroprudential coordination mechanisms of the EU).
So, what does this imply for the next president of the Bundesbank? Isabel Schnabel as member of the ECB Executive Board has given an important example, being a bridge between the ECB and often hostile, inflation-averse German media and public. The new president should see him or herself as being in the centre of the euro area system, being the representative of the anchor country of the euro in the Governing Council of the ECB and actively shaping ECB policies going forward. At the same time, (s)he should be a more active spokesman for the ECB towards the German media and public. The new president can draw on talented staff at the Bundesbank and an increasingly diverse and vibrant world-class economics and finance academic community in Germany. That’s an incredible opportunity and much more promising than tying oneself to historic orthodoxies.
22. October 2021
MPS – Europe’s banking troubles crystallised in one bank
La Repubblica Firenze has an agreement with EUI to publish op-eds by academics and this week it was my turn – to make the direct link to my new host region, I chose the never-ending saga of Monte dei Paschi di Siena, which for me is a mirror of where Europe’s banks, regulators and politicians have gone wrong over the past 20 years: a rapid expansion before 2008, followed by mounting losses, hidden from auditors and regulators; a government bail-out in 2013, which did not help turn things around and nationalisation in 2017. At the core of this drawn-out failure of MPS has been too close a relationship between politicians and bankers, which has prevented early and effective intervention.
What I see as critical mistake and would call the original sin of the banking union was the decision in 2014 to apply the new regulatory framework to a banking system still working through the aftermath of the Global Financial and Eurodebt crises and – in the case of Italy – a triple-dip recession rather than to address legacy losses and force an effective restructuring of European banking. Yes, supervision has been Europeanised, but banks’ connections with local and national politicians have kept the resolution effectively on the national level and bailouts are still the default solution. And while there is no immediate risk that the sovereign-bank deadly embrace will emerge again in the near future, the risk has not been eliminated because of these national and taxpayer supported resolutions.
To link back to MPS and my new host region – as there are concerns about the demise of MPS: Tuscany needs strong banks that serve the local economy and society. However, times have changed and the focus has to move from trying to conserve what is no longer sustainable to building effective and stable finance. Europe should not be seen as the enemy that robs Tuscany of its banks, but as an opportunity to create sustainable provision of financial services.
11. October 2021
The Demise of Doing Business - Goodhart’s Law in Action
The World Bank’s decision to permanently suspend the Doing Business project is the sad end to an initially very good idea! My latest Vox column discusses how we got from a research-based data collection effort as an important impetus into policy debate to a ranking exercise that undermined the usefulness of these data. A short summary:
20 years ago, the Doing Business project filled an important gap by providing detailed indices on specific institutions (e.g. credit registries) or specific business cases (enforcement of bounced check, registering a property of specific value). Over time, Doing Business has become by far the most successful data collection exercise and report of the World Bank, but also, as former World Bank chief economist Kaushik Basu (2018) stated, the most contentious publication. Controversies over Doing Business resulted in the resignation of Kaushik’s successor Paul Romer and have resulted in numerous inquiries and reviews, ultimately resulting in the pausing of the report in August 2020 and its permanent suspension in September 2021.
In order to maximise the impact of the data collection, the Doing Business report included rankings of countries based on Doing Business data. The report and ranking became part of a broader effort of the World Bank and other donors to assess countries’ investment climate and foster private sector development and thus growth in developing countries. Countries that moved up the most in the ranking were crowned reformer of the year, which in turn has been used by governments to attract foreign direct investment. However, governments that care about these rankings, might start gaming the system – rewriting laws with an eye on improvements in the Doing Business ranking rather than focusing on the most important constraints for private sector development.
Credit rating agencies face a conflict of interest if they rate securities while providing advisory services to the issuing companies. Similarly, the Doing Business team faces a conflict of interest if it collects data used for country ranking while at the same time offering advisory services to governments on how to improve their business environment and thus their Doing Business Ranking. This conflict of interest is not theoretical, but has been clearly shown in the Wilmer Hale (2021) report .
However, the conflict of interest is even deeper and cannot necessarily be remedied by introducing a firewall between data collection efforts and advisory services. Ultimately, the World Bank is owned by its member countries who are represented on the Executive Board. The (ultimately successful) attempt by certain governments to take influence on the ranking (and thus the underlying data) clearly speaks to this conflict of interest.
Beyond these conflicts of interest, there is a broader concern of whether the political targeting of the Doing Business ultimately undermines the usefulness of the index. Charles Goodhart stated in 1975 that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Originally, this regularity (known nowadays as Goodhart’s Law) was used in monetary policy, but it can be applied in any economic policy area. Marilyn Strathern (1997) summaries Goodhart’s Law in a discussion on the UK evaluation framework for universities: “When a measure becomes a target, it ceases to be a good measure”.
The events described in the World Bank report read like Goodhart’s Law in action. As rankings were published on an annual basis and as improvements in the ranking became political targets, so did attempts at influencing ranking and thus data. The conflict of interests mentioned above facilitated such influence-taking; all that was needed were persons in place that would be open to such influences. Beyond these conflicts of interests, however, it is hard to see how one can get around this more fundamental problem of declaring an index as policy target, without this index subsequently losing its usefulness.
Where do we go from here? The original idea of collecting data on the business environment in which companies across different countries (or even across different regions within countries) operate continues to be good and important – again for research purposes and to inform the policy dialogue (though not to pre-empt policy outcomes). In a previous VoxEU column in 2013, I called for moving away from rankings and to focus exclusively on data. Researchers do not need rankings, we need data. Policy makers need data and comparisons, while questionable rankings do not only not help a constructive reform process, but narrows it down to what are not necessarily the best reforms. Finally, Doing Business data should be regarded as one of several gauges of the business environment firms face, forming part of a more broadly-based approach that draws on multiple data sources and analyses. Such an approach might not hit the headlines as often, but might be more effective in driving policy reforms.
29. September 2021
Pay-out restrictions – going, going, gone
Important disclaimer: I am a member of the Advisory Scientific Committee of the ESRB. However, the views expressed below are exclusively mine and do not necessarily reflect the official stance of the ESRB or its member institutions.
The General Board of the ESRB decided to allow the revised recommendation on payout restrictions lapse at the end of this month, maybe not a surprising decision given the earlier decision of the ECB Supervisory Board in July. This brings to an end over 16 months of such ‘restrictions’, given that these were recommendations, the restrictions were soft, though it seems that at least in the banking sector, the compliance was high. Payout restrictions were controversial from the beginning; as discussed in this ESRB report (which was the basis for the first ESRB recommendation in June 2020) , there are good arguments on either side. Many felt that in spring 2020 the arguments in favour of such restrictions were stronger than the arguments against them: extremely high uncertainty (unknown unknowns) and an unprecedented degree of government support for the economy. The situation has certainly changed; there is a clear exit path from the pandemic; bank and corporate fragility concerns are lower than anticipated just a year ago and fiscal support is being phased out. On the other hand, the stress tests published in July have shown quite some variation across banks in terms of possible fragility and the fallout from the pandemic both in corporate and ultimately banking sector will not become clear until next year, the earliest. But importantly, profit distributions are an important part of the market process; a market-based process of bank restructuring and consolidation cannot take place, if equity holders are deprived of their property rights!
All of these arguments seem to speak clearly in favour of moving away from blanket (macroprudential) restrictions to more targeted (microprudential) approaches, in the context of the usual supervisory process. There will certainly (and hopefully) research being done in the coming years to assess the impact of these restrictions. The final word is certainly not spoken yet.
A related discussion is whether macroprudential authorities should get formal powers to impose such restrictions to distribute profits during crisis times. I am somewhat sceptical on this. Macroprudential tools are designed for the financial cycle; the situation in 2020 was certainly not a financial cycle situation. Prudential authorities have ample tools to intervene into failing banks (the fact that they are not always being used is a topic for a different conversation), formal powers to suspend property rights across the financial sector seems a rather extreme step. There is certainly an important discussion to be had on the use of such a tool outside all but the most extreme economic situations and certain safeguards for the use of such instrument might be needed.
25. September 2021
German elections 2021
The German elections this Sunday are a game changer, not only because they will mark the end point of the Merkel era. As pointed out by many observers, this is the first time in modern German history that there is no incumbent chancellor running for re-election (all previous seven chancellors either (were) stepped down in between elections or lost re-election. A second novel feature is that the campaign started out with three serious candidates for chancellors (before the Green candidate tumbled). Hand in hand with this, there has been a trend away from the two-camp structure that has dominated campaigns (though less so governments) since the early 1980s – SPD-Greens on the one hand and CDU/CSU-FDP on the other hand, with two ‘Volksparteien’ (big tent parties) as anchors on either side. There has been an increasing Dutchification of German party politics, with no party getting more than 30% of the votes, a number of mid-sized parties and a number of smaller parties. This has resulted in more flexibility in government formation – so far only on the state-level, but now also at the federal level. There was already an attempt after the last election to form a government between CDU/CSU, FDP and Green party, which ultimately failed, but this time it is almost certain that there will be a coalition of three parties, with at least four different possible combinations. However, this also means that government formation will take much longer (to retake the example of the Netherlands: elections took place in March and there is still no new government in place).
But what are the challenges that the new government will face? Many of these coincide with challenges on the European level. This brings me to a podcast conversation that I had with Thomas Losse-Mueller earlier this year (in German!). This conversation was a broad tour d’horizon on topics I have thought and written about over the past decade, but several of these are directly relevant for the current political discussion in Germany and for the next German government: First, there has been a rediscovery of the role of the government both in aggregate demand policies and as insurer of last resort, as we have clearly seen during the current pandemic. Second, this applies beyond the national level to the European level, especially the euro area level. The pandemic has opened the door towards a fiscal union, first on the expenditure side, but in future also on the revenue side. There has been also a change in the German position, both among politicians and economists, with the realisation that the privilege of Germany as anchor country of the euro area (thus reaping a euro dividend) also implies certain responsibilities. Ultimately, the European economy can only recover if all countries recover with a similar trajectory, given their close economic integration. Third, it is critical that the heavy lifting is not left exclusively to the ECB as during the eurodebt crisis, where expansive monetary policy was offset by tightening fiscal policy in many core countries, including Germany.
One final comment on the hysterical inflation fears that are being raised during the current election campaign (minor ironic note: globally, hyperinflation is typically defined as inflation of more than 50% per month, in Germany apparently as above 2% per year). There is a narrative that Hitler’s rise to power in 1933 was driven by the hyperinflation in 1923 – you do not really have to be an economist or historian to see fallacy in this argument – Hitler’s electoral success started during the Great Depression and high unemployment it brought with it, while Germany suffered from deflation rather than inflation!
P.S.: there is one comment I made in this podcast where I certainly have changed my mind – vaccines: while the European “vaccine-union” might not have been successful initially and much slower than in the US and the UK, looking at the rollout from the current viewpoint, I think it has been a huge success, especially considering the counterfactual of purely national approaches.
23.September 2021
Fostering fintech for financial transformation
Today, the CEPR and the Korea Institute for Finance published a book, which I co-edited with Prof. Yung Chul Park, with the title Fostering Fintech for Financial Transformation. The motivation behind this book was an initiative by the KIF to draw on international expertise for specific policy lessons for Korean regulators.
The first four chapters draw on international experience and comparison, discussing the impact of financial digitalisation on the future structure of the financial system, providing a literature survey on the impact of financial digitalisation on the efficiency and stability of the financial system, focusing on innovations in money and payments, specifically the combination of new forms of digital assets with new forms of payment technology, and describing the regulation of cryptocurrencies across different jurisdictions.
The final chapter (which I want to talk a bit more about) focuses on Korea, taking stock of the current situation and drawing on international expertise for specific policy recommendation for Korean regulators. Fintech services have been regulated in Korea under a specific framework established in 2006, which has turned out too narrow. At the initial stage of fintech development, Korea's financial regulatory authorities chose to embrace a market-led approach to fostering the fintech industry in line with a general move towards financial liberalization. A decade later, however, a series of market failures and inefficiencies of the laissez-faire approach has begun to take its toll, with P2P lending platforms losing their credibility and reliability as they were shrouded in widespread fraud and deception of investors and borrowers, the number of fintech startups ballooning, but few of them being efficient, and the fintech industry developing into an oligopoly controlled mostly by financial subsidiaries of big techs.
The financial regulatory authorities have reacted to these problems with a law restricting entry and lending in the P2P sector, which has effectively driven all platform operators out of business. The FSC also plans to establish a "fintech assistance center" as part of the program arranging policy loans, business consulting, and startup support for small fintech firms. In addition, there are current discussions underway to reform the broader legislative and regulatory framework for fintech.
How can the regulatory framework support financial innovation without undermining financial stability? Based on international experience, there are no easy answers, though some general principles. One first principle is that it is not desirable to regulate the FinTech sector through legislation alone, but rather use legislation to establish general principles and then set forth regulation for details. This allows a more flexible and swifter regulatory response to developments in the rapidly changing FinTech sector. A second principle is a risk-based approach, which focuses on prudential regulation of financial intermediaries and applies a less rigorous approach to other non-intermediating financial service providers. However, this principle might ignore the critical position that some non-intermediating financial service providers have in infrastructure services (e.g. cloud services, clearance services). So, both business and market linkages have to be taken into account when deciding on a FinTech’s regulatory regime.
A third principle is to recognise that regulation of financial services has two opposing objectives. One is to enable efficiency and competition. The other is to protect investors and savers and avoid the failure of non-intermediating institutions to prevent stability risk for other institutions and segments of the financial system. Given that these two objectives can clash, it is important to define whether two different regulatory institutions should be in charge of these objectives or whether the financial regulator should obtain a secondary objective as in the Bank of England with the competition.
These opposing objectives on the FinTech industry regulation also imply that, on the one hand, a light-touch approach is called for in the case of novel products and services (in the form of a regulatory sandbox) or as long as new providers are not directly involved in intermediation and have not taken on a systemically important role in the overall financial system. On the other hand, it requires frequent review of the supervisory status of FinTech companies to see whether they have grown to a relevant size or into a systemically important role that would require including them in the standard regulatory perimeter (in return, requiring a banking license).
16. September 2021
Interesting forthcoming papers in JBF
One of the highlights of an editor’s job is to press the Accept button. Here are some of these highlights of recent months:
Andreas Haufler provides a theoretical explanation of why supervision is easier to centralise in a banking union than bailout decisions in “Regulatory and Bailout Decisions in a Banking Union”. Specifically, in a two-country model with different failure probabilities for banks centralized supervisory decisions will always be efficiency enhancing, as the two countries share a common interest to internalize the cross-border spillovers that arise from both successful and defaulting banks. In contrast, the overall efficiency effects of centralized bailout decision are ambiguous, as centralized bailouts reduce the total costs that arise from failing banks, but also exacerbate banks’ incentives to choose inefficiently high levels of risk-taking. In addition, with cross-country differences in the distribution of failure probabilities, a conflict of interest will necessarily emerge from an equal sharing of all countries in the costs of bank bailouts. For a simple calibration with foreign ownership shares and rates of returns collected from a sample of large European bank, the author shows that the equilibrium regime will feature a common regulatory policy, but maintain national bailout policies, i.e., exactly what we can currently observe in the European banking union structure.
Adonis Antoniades explores a variation on the bank lending channel of monetary policy in “Monetary Easing And The Lending Concentration Channel of Monetary Policy Transmission”, focusing on bank lending concentration. Specifically, he uses loan-level data on US mortgage loan applications to identify the effect of lending concentration on the pass-through of the 2008 monetary easing to the volume of lending. He finds that lenders eased credit conditions but less so in counties with higher lending concentration, consistent with theories predicting lower monetary pass-through for lenders with higher market power. Furthermore, within a county, the pass-through was lower for lenders with higher local market power. The channel is active also during the 2005 monetary tightening episode, where lending contraction is less in more concentrated counties.
Modestus I. Nnadi and co-authors offer a new test of how political connections affect the costs of external finance in “Political Connections and Seasoned Equity Offerings”. Using a sample of seasoned equity offerings between 2001 to 2018 in the US, the authors find that politically connected issuers enjoy lower cost of seasoned equity issuance than their non-connected counterparts. SEO gross spreads are 36 to 38 percentage points lower when an issuer is politically connected (measured as having at least one board member who had important political offices and was a candidate for such). This result holds after controlling for issuers depending on government contracts and other factors. One wonders whether the benefit of such political connections has increased over time.
Ali Choudhary and Anil Jain explore the relationship between banks’ capital buffer and their willingness to recognise non-performing loans in “Corporate stress and bank nonperforming loans: Evidence from Pakistan”. Focusing on a sample of borrowers with multiple lender from the Pakistani credit registry, the authors show that banks with lower leverage ratios are both significantly slower and less likely to recognize a loan as overdue than other banks. This lack of recognition also impedes loan curing, with banks with lower leverage ratios reporting significantly higher final default rates than other banks for the same borrower, even after controlling for differences in loan terms. This is not due to these banks knowing their client better or trying to help them over bad times, as they reduce their lending to these firms compared to other lenders. Overall, a clear sign of zombie lending, triggered by low capital buffers. Maybe some lessons for Europe as well?
14. September 2021
Afghanistan
I decided not to blog or tweet on the chaotic Afghanistan withdrawal at the height of the events, as I do not consider myself an expert in military strategy or international relations in a broader sense. However, economics and social sciences, more generally, have something to say about the failure of state-building in Afghanistan. For the past two decades, there has been the illusion that with the right amount of money and the right strategies, the necessary institutions for economic and political development of Afghanistan could be built. And on the technical level, this might have had some successes, e.g., in central banking or pockets in public administration. But the building of broader institutions, such as democratic checks and balances, broad access to public administration and a functioning and accountable enforcement framework seems to have failed. Most importantly, the occupying forces turned a blind eye to the widespread corruption among the governing elite. So, while many in Washington DC held out hope that eventually there would be a self-sustainable democratic regime in Afghanistan, some observers were not surprised at all by its failure, as this article from 2017 shows.
But why did the regime collapse so quickly, contrary to the expectations of many observers (though not necessarily the intelligence services)? Here is a fascinating thread with links by Andrew Bennett, including on information cascades. Once it became clear that the Taliban would eventually win, why would Afghan soldiers try to hold out and simply delay their march towards Kabul, risking their own lives? Why would regional strongmen put up resistance if accommodation with the Taliban is safer?
Daron Acemoglu, one of the leading economists of the institution-growth literature has written on why nation-building failed in Afghanistan, pointing to the failure of top-down approaches. In addition, there is the issue of persistence; in a country with no functioning institutions or primarily extractive institutions, new rulers have limited incentives to build inclusive institutions and state capacity to support the broader society. We have seen this in many countries in Sub-Saharan Africa after independence, where the new rulers inherited and perfected extractive institutions; we could see this in Afghanistan where personal and political survival seemed to have been more important than any ambitions of state building.
What to do if nation-building turns out elusive? There are several failed states around the globe, Afghanistan only one of them. But there is not only an institutional dimension to it, but also an economic one – what Lant Pritchett refers to as ghost countries, countries that, if there were population mobility, would only have a very small fraction of their current population? What to do with such countries – trillions of development aid or – cheaper and most likely more sustainable – migration?
There is a lot of finger pointing about the failure of 20 years of Western intervention in Afghanistan. There are also fears of a new migration wave towards Europe. Hopefully, there will be a more serious debate on both nation-building and international migration in the future, beyond political point scoring.
12. September 2021
Brexit – and it just won’t stop
I have discussed in several occasions that the Brexit soap opera will never end, no matter that Johnson won the 2019 General Elections with the slogan Get Brexit Done! Brexit is an on-going process and given last week’s suggestion by Johnson’s government to renegotiate the Northern Ireland Protocol (NIP), one even wonders whether this is: Get Brexit Undone!
If one feels that we have been here before, this is certainly the case – it is almost like Groundhog Day. I went back and checked what I wrote on my blog 25 October 2019, eight days after the agreement on the Withdrawal Agreement, including the Northern Ireland Protocol – most of what I wrote then applies to the current discussion – here are four points I made back then:
“First, the Brexit Trilemma is alive and kicking, with the UK wide backstop negotiated by Theresa May replaced with a Northern Ireland front-stop, taking NI effectively out of the UK customs union and internal single market.” As many more informed observers have pointed out, the Irish Sea Border is not an invention of the EU, it was critical part of the October 2019 agreement, addressing the Northern Ireland Trilemma. But here we are, with the UK government again threatening to break international law by walking away from the NIP, critical part of the Withdrawal Agreement that Johnson was so proud of in late 2019. And we are back at the same old discussion on border controls - as pointed out over and over and over again, only two of the following can hold: the UK leaving Single Market and Customs Union, no border control between Northern and the Republic of Ireland, no border controls between Great Britain and Northern Ireland. In true form, the Brexiters are revisiting all of their unicorns (including in the paper underpinning the request for renegotiation), ignoring the fact that the border has to be somewhere between the Single Market (i.e., the EU) and the United Kingdom. And while it is certainly true that there is lots of space to improve the functioning of the sea border between Great Britain and Northern Ireland, the UK government does not seem to want or able to engage in such a dialogue. Rather it has chosen yet again confrontation, asking for a complete revamp of an International Agreement it happily agree to less than two years ago. Now, one could draw a parallel to the replacement of NAFTA with USMCA, which was rather aggressively pushed by Trump, however, there are two important differences; one, USMCA replaced NAFTA after 26 years; two, the US is certainly a more powerful player vis-à-vis its two neighbours than the UK vis-à-vis the EU.
“Second, the utter incompetence of Tory ministers has been proven again, such as when not being able to respond whether or not there would be customs control between Great Britain and Northern Ireland” – ok, I might have been wrong here – it is either incompetence or simply lying by Tories. The arguments that the government is using to demand a renegotiation of the NIP (that it is creating unexpected problems) are obviously lies, given the explainer on the NIP published by the UK government in October 2019 (for further evidence, see here by Anton Spisak). Given the obvious trend towards rewriting history, it seems that the British government does not only want to renege on international treaties but also openly lies about its bad faith with which it signed these agreements. At the same time, it is asking for trust from the 27 countries that make up the European Union – as has been pointed out excessively, putting trust and Johnson in the same sentence is an oxymoron, As Dominic Cummings has made clear (and it seems rather plausible) is that Johnson simply did not care about the ‘fine print’ of his Brexit deal – yes, there were lots of warnings back then, but he signed up for the Withdrawal Agreement with the NIP simply in bad faith! So, why would the 27 countries of the European Union trust him now given that he has shown that his word is not to be trusted.
“Third, the idea that Brexit will help take back control” continues to be wrong – no, the EU will not throw more fuel on the Northern Irish bonfires if the Johnson government reneges on the Withdrawal Agreement, but it will put pressure on Great Britain with targeted trade sanctions; not immediately, but eventually. We can expect more EU bashing in the coming months – populists need a common enemy and for the Brexit press and the Tories it has been the EU for the past five years. And given that the UK is about to fall behind the EU in terms of vaccinations (not vaccinating below-18 for example), it cannot boast anymore about being so much better than the EU. So something else has to come up – the conflict on the Northern Ireland Protocol is thus timely for the British government. But obviously this does not mean that the UK has taken back control; it shows the lack of such control!
“Fourth, the idea that once Brexit has been ‘achieved’, it will all be done, the nation can find again together and the government can turn its attention to more pressing issues.” Well, I started this blog entry noting that this idea was wrong in 2019, it is wrong in 2021 and it will be wrong for many years to come.
In sum, not much substantial news: Brexit continues to be true to its nature as soap opera – new actions, new actors, but same plot. However, one interesting development in the past days was Dominic Cummings engaging on twitter, among others with David Gauke (one of the Tory MPs trying to prevent a no-deal Brexit and subsequently purged from the Tory party by Johnson) and Anne Applebaum – he seems to be taking as much joy as always from ‘owning the remainers’. His tweets have made clear that for him the referendum and the 2019 General Elections were all just a game – how to win, without thinking about the political consequences, referring to both the 2016 referendum and 2019 general election as ‘heist’. Now, in every political party, there are campaigners and policy wonks – it is just that the case of Brexit, the campaigners were really good (if not brilliant I would admit), while the policy wonks were nuts (and they still are). This, however, is a characteristics of populist movements – whatever slogan-based policy is being invented, there are always some people in the background who come up with the weirdest ideas to underpin these ideas (see unicorn ideas on avoiding the Northern Ireland Trilemma mentioned above).
So, here we are in Groundhog Day, reliving the same circle of grandstanding, confrontation and lies that has come to dominate British politics.
27. July 2021
Ieke van den Burg Prize 2021
This year’s Ieke van den Burg prize goes to Karsten Mueller and Emil Verner for their paper Credit Allocation and Macroeconomic Fluctuations and will be formally awarded on 1 October.
This is a paper very close to my own interests. A long literature has shown the positive relationship between financial development (often measured by credit to the private sector, relative to GDP) and economic growth but also the predictive power of rapid credit growth for financial crises. However, until ten years ago or so, we always focused on aggregate credit. In one of my lesser-known papers (together with Berrak Bahadir, Valev Neven and Feliz Rioja) we showed tentative evidence that it is enterprise rather than household credit that can explain the positive growth effect of financial development on economic growth. Atif Mian and Amir Sufi have argued that expansions in credit supply, operating primarily through household demand for credit, have been an important driver of business cycles. That’s where Karsten came in – during his PhD time, he collected detailed data on the sectoral composition of credit across a large number of countries over time. Emil and Karsten use these data to study the relationship between credit expansions, macroeconomic fluctuations, and financial crises. They find stark differences between different types of corporate credit expansions. In particular, while lending to the construction, real estate, and non-tradable sectors are associated with a boom-bust pattern in output and elevated financial crisis risk, similar to household credit booms, there is no such pattern for tradable-sector credit expansions, which are often followed by stronger output growth. There are thus good and bad credit booms! And who receives credit is indeed important for growth and stability! Ultimately, it is not simply about financial development, but the use of the funding by banks.
This paper is not only an important contribution to the literature on the role of the financial sector in macroeconomic fluctuations, but sets the stage for an important research and policy agenda. It reinforces the call for more micro-data and looking beyond aggregates. It also implies that macroprudential policy should focus as much on sectoral as on aggregate risks.
20. July 2021
Demography, inequality and inflation
Every year, the Florence School of Banking and Finance organises an Executive Seminar. This year’s (as last year’s) edition was shortened and virtual, but nevertheless fascinating. Many economists (including this one) see the current burst of inflation as temporary, result of market imbalances, of repressed consumption and forced savings during the pandemic and (maybe just maybe) generous support payments during the pandemic). Charles Goodhart and Manoj Pradhan disagree with this assessment, though focusing more on the medium- and long-term, arguing that demographic trends will lead to a long-term increase in inflation. They lay out their argument in the book “The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival” and presented a summary last Thursday in a webinar. Due to the ageing of societies across the globe, the share of working population has been decreasing and will continue to do so. Previous positive shocks the global working population (entry of women into the labour force in the second half of the 20th century and China’s entry into the world economy towards the end of the 20th century) had positively contributed to the dampening of inflation in the late 20th century – no such shock is on the horizon right now. And while the working population in some parts of the work (especially India and Africa) is still increasing, political constraints prevent them from reallocating where they would be needed most – in the ageing societies of Europe. A higher share of old population in turn requires higher government spending, both for pensions (unless the retirement age is pushed significantly than it is today) and due to higher medical expenses. The question on how to finance these expenditures is a politically sensitive one – higher taxes on wealth (which would hit primarily the older generation) is politically hard to implement (the triple lock in the UK, where state pension increases each year in line with the rising cost of living seen in the Consumer Prices Index (CPI) measure of inflation, increasing average wages, or 2.5%, whichever is highest, will increase pensions by over 8% this year and shows the political power of the older generations), and increasing income taxes on the working population could be growth dampening.
Remains the inflation tax and that is where Charles and Manoj see the inflationary pressures coming from. While the Covid crisis might have made these trends worse, the increase in debt due to the pandemic might ultimately turn out to be only a blip in the longer-term trends lines. The higher debt burden (and the deteriorating savings-investment balance) will tend to increase the long-run equilibrium interest rate (r*), increasing pressure on central bank independence. But even though central banks will feel compelled to keep short-term interest rates low, long-term rates will rise, with a steepening yield curve as consequence. I would add that this could play out even more aggressively in the euro area with its variation in demographic structure and debt-to-GDP ratios. Overall, a rather scary picture.
18. July 2021