Why these crash programmes to build houses won’t work

There’s any number of plans out there to create massive housebuilding programmes. There’s even that lovely Corbynite idea that the Bank of England should just print lots more money to pay for them: along with an insistence that this simply won’t be inflationary. Nope, not at all. Because there’s slack in the economy, you see?

And yes, there is most certainly slack in the economy. But spraying money around and the inflationary effects of doing so does rather depend upon whether there’s slack in that part of the economy that you’re spraying money at:

Two-thirds of British building companies have had to turn down work because they do not have enough skilled tradesmen, according to a survey by the Federation of Master Builders.
The trade body for construction firms said that 66pc of its members have had to refuse new business because of a lack of resources while almost half have been forced to outsource work.
The bosses of some of Britain’s biggest housebuilding companies have spoken out this week about the shortage.

Thus the problem in housebuilding is more of a structural one than a short term financing one. Meaning that just spraying money at the sector will only raise wages of those in short supply to do the work. And that is, erm, inflationary, isn’t it?

So perhaps it isn’t a very bright idea to simply print more money to firehose into this sector then?

The euro is driving Finland to depression

The Finnish economy has been hit by three shocks over the past decade:

  1. Nokia has more or less disappeared;
  2. The paper industry is in crisis;
  3. And recently the Russian crisis has hurt Finland’s economy too.

These have all caused a very significant change in Finland’s current account balance, which over the past 15 years has gone from a sizeable surplus (around 9% of GDP in 2001) to a small deficit (around -1% of GDP in past four years).

This would under normal circumstances require a (real) exchange rate depreciation to restore competitiveness. However, as Finland is a member of the euro such adjustment has not been possible through a nominal depreciation of the currency and instead Finland has had to rely on an internal devaluation through lower price and wage growth.

However, Finland’s labour market is excessively regulated and non-wage costs are high, which means that the internal devaluation has been very sluggish. As a result growth has suffered significantly.

three-finnish-depressions2

In fact, Finland’s real GDP level today is around 5% lower than at the onset of the crisis in 2008. This makes the present recession – or rather depression – deeper and longer than the Great Depression in 1930 and the large Finnish banking crisis of the 1990s. Rightly we should call the present crisis Finland’s Greater Depression.

European Central Bank policy obviously has not helped. First of all, the 2011 rate hikes from the ECB had a significantly negative impact on Finnish growth. Second, the shocks that have hit the economy are decisively asymmetrical in nature. This means that Finnish growth increasingly has come out of sync with the core Eurozone countries – such as Germany, Belgium and France.

Hence, Finland is a very good example that the eurozone is not an “Optimal Currency Area”, where one monetary policy fits all countries.

Concluding, the crisis would likely have been a lot shorter and less deep had Finland had its own currency. This would not have protected Finland from the shocks – Nokia would still have done badly, and exports to Russia would still have been hit by the crisis in the Russian economy, but a currency depreciation would have done a lot to offset these shocks.

To illustrate this, compare the pegged economies (in red in the graph below) of Finland and Denmark with the free-floating economies of Sweden, Iceland and Norway (in green).

five-nordic-countries

Should Finland leave the euro now? It’s hard to say, but it seems clear that Finland shouldn’t have joined in the first place.

Are there other options? Yes. Significant labour market reforms that weaken the power of labour unions and reduce non-wage costs would make internal devaluation easier. But such reforms are notoriously hard to implement politically and the discussion and the response from the Finnish government to the Greek crisis has shown the Finnish governing coalition is extremely fragile. This is hardly a government, which should be expected to be able to push through the needed reforms.

See also my three earlier blog posts on Finland:

http://marketmonetarist.com/2014/04/07/currency-union-and-asymmetrical-supply-shocks-the-case-of-finland/

http://marketmonetarist.com/2014/11/16/great-greater-greatest-three-finnish-depressions/

http://marketmonetarist.com/2015/07/23/peggers-and-floaters-the-story-of-five-nordic-countries/

Lars Christensen is a Senior Fellow of the Adam Smith Institute and blogs as the Market Monetarist.

Perhaps this isn’t really the Greek solution

friedman

The assembled professors of the Alma Mater have given us their collective wisdom on the Greek crisis:

The institutions have to agree to a relaxation of fiscal austerity, at least until Greece is on the recovery path. Austerity during a recession is the wrong policy as it deepens the recession. Continuation of the stringent austerity measures implemented by Greece is delaying recovery. More fiscal austerity could fail the creditors too, if recovery is so slow that the fiscal deficit increases. Public investment has collapsed completely and providing more funds for investment projects that can improve the infrastructure and create jobs should be given priority.
Although some progress has been made, further structural improvements are necessary, including pensions and VAT, anti-corruption, tax compliance, and institutional reform of product and labour markets. It is important that the Greek government acknowledges that there is still a lot to be done and comes up with credible proposals.
The Greek economy is not likely to recover as long as there is still significant uncertainty about the future and there is no credible path towards a situation in which the Greek debt is sustainable. It is essential to achieve an early agreement to get Greek debt levels to sustainable levels, even if it is to be conditional on progress elsewhere. Conditionality on structural improvements is a good way forward.

Well, yes, OK. Greece should do all of those supply side reforms, lower the relative wages and thus get the economy booming again. Or we could heed the wisdom of Milton Friedman in the quote there. Instead of having to have this internal devaluation, this heavy austerity needed to bring down sticky prices like wages, we could just have a change in one single price in the economy, the external value of the internal money. You know, a devaluation.

Amusingly, this is one of the times that Friedman agrees with Keynes, even with the New Keynesians of today: prices are sticky, notably downwards, and wages especially so. Thus an economic policy which depends upon pushing down wages is going to require a great deal of pain to work.

Better, by far, not to have had the euro in the first place.

Yes, your humble writer here is extremely biased on this subject. But also correct.

If you want to know why rule by the Great and the Good doesn’t work

Consider this from Simon Jenkins as an example of why rule by the Great and the Good doesn’t work.

But such is the political arthritis now afflicting Europe’s “technocratic” rulers that they ignored the fact. They concentrate on their one concern: somehow extending Greece’s repayments so German, French and British banks could have even larger loans underpinned. It is bankers, not Greeks, who are being “bailed out”. They want Greek taxpayers to go on paying interest even if the principal is as beyond reach as a tsarist bond.

No Sir Simon, just no.

Of Greece’s some €320 billion in debt a couple of percentage points is owed to foreign banks. That’s actually what the problem here is: there’s no bankers that anyone can go and steal the money from.

The debts are owed to: the IMF, which in effect means the governments of the countries that own the IMF. The ECB, which means the countries that own it (ie, the eurozone governments). The EFSF, which is guaranteed by the eurozone governments. Then there’s bilateral loans from …yes….the eurozone governments.

The Greek banks do own Greek Treasuries, both bonds and bills: and these are all pledged to the ECB as collateral for the cash they need to remain open. This is actually what the problem is in the negotiations. If there were any rapacious capitalists holding any appreciable amount of the debt then they would be haircut without anyone caring in the slightest. That near all of the money is owed to taxpayers of other countries is the problem.

This would have been a valid criticism of the 2010 to 2012 actions, where the banks’ debt holdings were largely unloaded onto those taxpayer guarantees. But it’s simply incorrect to claim that banks have anything beyond the most minimal exposure today. Whatever this is this isn’t a crisis about protecting bankers.

And that, of course, is why that rule by the Great and the Good, by the wise Solons, by a technocracy, doesn’t in fact work. For the obvious reason that all too many of them haven’t a clue about whatever it is that they’re supposed to be managing or making public policy upon.

This is not to say that they’re all idiots, of course it isn’t, but rule by the ill informed isn’t a great step forwards now is it?

Apparently the euro is a neoliberal plot: who knew?

The blame game for the Greek disaster is in full voice over on the left. Apparently it’s really all the fault of the neoliberals. Yes, that’s us, the people who argue for less government intervention, markets work and so on, we’re responsible for the idiocy that a supra-national bureaucracy has erected.

Here’s Georgie Monbiot as one of the cheerleaders for this argument:

The Maastricht treaty, establishing the European Union and the euro, was built on a lethal delusion: a belief that the ECB could provide the only common economic governance that monetary union required. It arose from an extreme version of market fundamentalism: if inflation were kept low, its authors imagined, the magic of the markets would resolve all other social and economic problems, making politics redundant. Those sober, suited, serious people, who now pronounce themselves the only adults in the room, turn out to be demented utopian fantasists, votaries of a fanatical economic cult.

So let’s look at what a real market fundamentalist, Milton Friedman, said about it all:

The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.

Friedman was of course far too polite to put it this way, but that’s clearly a claim that the idiot politicians are about to impose something that won’t work, either economically or politically, and something thus that market fundamentalists (or as we like to style ourselves, liberals) simply should not be supporting.

George’s basic problem here, as with that gathering chorus over on the left, is that they’ve got confused. They’re against neoliberalism, they know that. And they’re against the implosion of the Greek economy. At least one of those is a sensible thing to be against. But because they’re against both they insist that one is a facet of the other. When in this case, neoliberalism, market fundamentalism, has been saying all along (and some of us have been shouting this for two decades now) that the euro as constructed simply will not work. Because it doesn’t contain enough market, because it’s a political construct built without reference to sensible economics.

And we’re right of course. Far from neoliberalism being the cause here it’s the cure.