Europe chooses more bailouts and undermines future growth (update)

After a week-end immersed on fiscal policy studies I woke up to an article from Bloomberg that starts with the following:

“The euro rose against the dollar and yen, Standard & Poor’s 500 Index futures gained and commodities climbed a fourth day after German and French leaders pledged to devise a plan to stem Europe’s debt crisis in three weeks and as the U.S. showed signs of sustaining its economic recovery.”

The article goes on to say: “German Chancellor Angela Merkel and French President Nicolas Sarkozy will deliver a plan to recapitalize European banks and address the Greek debt crisis by the Nov. 3 Group of 20 summit. Belgium will buy part of failing Dexia SA and provide security for depositors.”

Although not a surprise it saddens me. This is the sheer proof that 2008 came and went without any impact on policy makers. More importantly, I am getting more and more convinced that governments accuse markets of irrational behavior only to take more control of the markets and mask own irrationality.

Europe had a chance to strengthen the euro zone by adopting radical fiscal reforms. One such reform would have been adopting a common fiscal policy for the euro zone. Instead, EU policy makers chose the short term solution and much more expensive in the long run. In the same time it could be the solution that has sealed the fate of EURO few years down the road.

I expect markets to react very positive on the actual announcement of the bailout. We might see the same kind of rally as on the announcement of TARP. The effect of this decision should keep markets calm for few months.

Just remeber there is one more bailout to be done: heavily indebted European countries. Once this is taken care of markets should have few quarters of positive return.

All the world will have to deal with then will be higher taxes and low growth for years to come. But let’s wait to see the details of the bailout plans.

Here is The Economist on the same topic.

And ZERO HEDGE shows a list of the safest banks in Europe after the new round of stress tests. No comment here.

Source: THE ECONOMIST

From John Hussman on how bailouts affect growth:

The skewed distribution of wealth in the U.S. is worsened by policies that misallocate capital and divert public funds to bail out investments that have already gone bad.

Background: If you think about the “standard of living” in a country, you can roughly define it as the amount of goods and services that individuals are able to consume in return for their work. If you think about the “productivity” of a country, you can roughly define it as the amount of goods and services that individuals are able to produce for their work. Clearly, over the long-term, the productivity and the standard-of-living of a country go hand in hand. The best way to create both, over the long-term, is for an economy to build a stock of productive capital (inventions, new technologies, plants, equipment, public infrastructure, etc), and human capital (labor skills, education).

Still, even a generally productive economy can produce a skewed distribution in the standard of living enjoyed by its citizens. In a competitive and undistorted economy, the distribution of wealth is determined by the ability of each individual to a) provide a useful service, b) distribute the services they provide over a large number of “units”, and c) maintain the scarcity of what they provide.

So for example, professional football players earn more than teachers not because playing football has more virtue, but because professional football players are among a very small group, and distribute their “services” over millions and millions of spectators, each which implicitly pays a few cents to each player per game. Mark Zuckerberg at Facebook is able to distribute his services across hundreds of millions of users, each which implicitly pays him a tiny amount by viewing advertising. Bill Gates distributed his services over every computer that ran Windows, while the factory workers who built those computers were each able to distribute their skills over a smaller number of units. Teachers represent a large professional group, but are typically able to distribute their services over a limited number of students, each which implicitly pays a portion of their family’s income to the teacher. One-on-one aides tend to earn less, despite often being extremely skilled, because in order for them to earn a high income, their earnings would have to capture much of the income of their single student’s family.

The distribution of wealth has become increasingly skewed as trade has become more globalized and technology has allowed the innovations of a single person to be spread across millions of consuming “units.” At the same time, the economic emergence of China and India has brought forth literally billions of new workers who dilute the scarcity of the existing labor force. An economy where capital is scarce, protectable, and can easily be distributed over numerous units, while labor is plentiful, homogeneous and can only be applied to a smaller number of units, is an economy that is prone to an enormously skewed distrbution of wealth.

This process takes on a grotesque character when it becomes possible for a company to distribute its impact over a very large number of units, and government policy protects that ability even when the impact of the company reflects not skill but ineptitude. This is essentially what has happened with the “too big to fail” institutions. Despite inflicting massive damage on the economy, they are afforded a protected status that allows them to extract “rents” that don’t reflect the cost they have imposed. From that standpoint, the Occupy Wall Street protests are a welcome reflection of public frustration over Washington’s slavish coddling of reckless financial institutions.”

14 thoughts on “Europe chooses more bailouts and undermines future growth (update)

  1. It’s that too big to fail thing again. It’s odd to see how a country which bailed out it’s banking system, namely Ireland is doying much worse than a country which faced with the same issue didn’t (Iceland). Due to this decision + fiscal austerity and the lack of a currency, Ireland is at this time one of the most troubled countries in Europe.

    That’s likely to happen again, but at a much larger scale.

  2. I don’t like this guy, sorry🙂.

    “At the same time, the economic emergence of China and India has brought forth literally billions of new workers who dilute the scarcity of the existing labor force. An economy where capital is scarce, protectable, and can easily be distributed over numerous units, while labor is plentiful, homogeneous and can only be applied to a smaller number of units, is an economy that is prone to an enormously skewed distrbution of wealth.”

    This guy sounds like Hitler wanting to take the jewish out of his way. I find his way to express his view to be disgusting.

    Plus, more people doesn’t mean only more workforce, but also more capital, both of them will follow their own distribution in the medium and log run, with their normal departures from the mean, down the road. And of course the capital will always be scarce. DOH!

    I not a fan of banks bailouts, although I understand them, and I’m not sure that letting them down would be better in the medium run for all of us than bailing them out. But the guy didn’t find the best way to explain his pains.

    1. As an economist you have to be able to simplify things to factors of production even though when we talk about labor we talk about human beings with lives and families. You have to distance yourself emotionally or otherwise every policy advice will tilt towards left.

      1. From my point of view the problem is that many are still very, very poor, and not that more and more people are going out of the tent. This is something good for the future and for the humanity. But the guy didn’t put it this way. Is the problem of the developed world to structure their state and their fiscal policy so that to be able to compete internationally, not the problem of indians not to get into employment circuit.

        He’s talking like the poor people are some sort of competition, they appear in the horizon and they can get the american employee more and more poor. Which I don’t agree.

        And I strongly believe that not the bail out of the banks generates the job moving into china and india, from the US. With or without them, it will be the same, because the problem is somewhere else, not in the way we understand capitalism by bailing out banks, or in the way we keep 10 bad banks in the market place🙂. This is just an image, not an essence.

      2. You say “He’s talking like the poor people are some sort of competition, they appear in the horizon and they can get the american employee more and more poor. Which I don’t agree. ” Unfortunately this is true, labor intensive and low paying jobs have moved east. Only last week Romania felt the blow from Nokia leaving the country. This is not a question of fair or unfair it is a question of factor endowment, competitiveness and ultimately economic policy. If there is someone to blame for the current status of our economy, we only offer cheap labor, than it is ourselves. We elect our policy makers and we keep them there. This is the best they can do. And the same goes for China.

  3. I have no problem with your question, and with your refuse toward bailing out banks. I just don’t consider the guy found the right way to express his disagreement.

    Regarding the subjct. It depends also what sort of banks do we bail out, and what for. And, then, what could we make regarding their deposits, from millions of people who in the end have nothing to do with some bankster’s stupid decisions? And what should we consider the value of the deposits to be? I don’t know if bailing out in itself is the problem, or the way their are doing this bailouts. I’d be happy to see a bailout and a sort of changing in the business model for the banks, in the same time. Which I’m not sure I’m seeing, we seam to need a bailout every some 1-2-3 decades :))). ………

    1. I am also concerned about the depositors. We are the real victims. In fact we loose if the banks go bust or if the government increases taxes and inflation to bail out the banks. This shows the enviable position that banks have put themselves in: too big to fail. What I really want is for banks to be broken up and compete for our services. They are no good to the economy in the current design so I thin we will do just fine without few of them.

      1. This is something I can agree with. May be they should think at another model, which would permit the saving of deposits without a bailout. But I don’t agree with killing the idea of the deposit to be a safety need, I feel like we need this idea. I don’t have any deposit, I’m too young to use my little money for a deposit, I prefer taking risks, but I’m sure there will be times in my life when I’ll feel the need for a certain comfort, even knowing I don’t get much, or I loose in real terms.

        I totally agree with you on taxes, they suck! But I don’t share the view for inflation. And I also consider inflation to be necessary for progress, the companies can’t innovate enough to get extra profits only from cost cutting, and can’t increase our wages without profits. Although I don’t like high increases either. But I’m not sure these bailouts will generate much inflation, I will prefer to wait and see this with my own eyes🙂.

  4. Exactly, only any of us is to blame, this is why the China and India employees can’t be an argument for that idea of that guy. Is their problem if the jobs moved east, they should find solutions to hold them inside the country. They tend to search of a guilty in the east for their lack of jobs, production, and real wage growth. Which it doesn’t seam like capitalism, to me🙂. Get less health care, less contribution to the state, and lower the cost for units produced, to re get competitiveness, with our without China and India as part of the international employment.

    Like is our problem, and China’s problem, if we are not more than cheap labor for the west. Is our job to change our perspective. Is everybody’s problem to solve their issues inside their borders, not to have a mentality like: oh, we’re running out of jobs because of the guys from the east!🙂.

  5. @Inia So what do you suggest we do? For the last 10 years the world’s greatest minds have done either real-estate or made people click on ads on the internet. New technology mostly automates stuff, and makes stuff cheaper increasing productivity while requiring less manpower. There’s nothing on the horizon that would create millions of 100.000$/year jobs…

  6. @gheorghe

    I suggest we shouldn’t be short sighted and see just 10 years from 100, and, mostly, I’d never short human creativity🙂. May be in the beginning more and more jobs will go to robots, from people, and then they will see that less and less people afford buying what they are producing using the robots and they will think of something to be done by the unemployeed in order to get a wage and continue to consume, while they still improve their robots🙂. Anyway, the fear of high technology isn’t a reason good enough for us to go back in the tent, or something alike. I think the humanity should look forward, not behind. When we will indeed have a real problem, we will feel forced to solve it and we will regain the equilibrium🙂. Just like it has always happened, this is how evolution occurred.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s