Friday, 31 August 2012

A response to Protesilaos Stavrou’s “ is Euro area facing a balance of payments crisis”


I know and like Protesilaos personally for two years and I more often in agreement than not, but I must say that the following document (http://www.protesilaos.com/2012/08/euro-balance-payments.html) needed a response.

In the document Protesilaos criticised the obsession of many economists, including Krugman, of seeing the Euro crisis as essentially a balance of payments crisis that is made worse through the straightjacket of the Euro. He attacks the above by suggesting:
1) That the abstract of national trade is a statistical construct that is not very relevant to today’s G0 world of multinational manufacturing and services
2) That balance of payments are not linked to any socio-cultural characteristics
3) That imbalances within nations are frequent and they do not illicit such worries over the viability of a currency.

I disagree with all of the above.
a) This is not the first crisis that the EU has faced; in fact all European crises, whether triggered by exogenous factors (the oil price hikes in the 1970s) or by endogenous factors (Germany’s decision to keep interest rates high in the early 1990s) always end up becoming balance of payments problems as that is the essential weakness that underlines the European project. Although balance in trade was traditionally in surplus for the “core” of Europe and in deficit for the “periphery”, this was more than made up by the great migration of periphery workers to the core, whose remittances kept the balance. Where balance did not exist, nations would depreciative their currencies, hoping to remove balance of payment constraints, an option that is not available in the Eurozone. Depreciation was not necessarily a good option as it integrates a vicious cycle: “periphery” countries with limited raw materials found that a depreciation triggered another round of inflation (through the increase of the price of imported primary goods) leading to a further decline in competitiveness in the balance of trade, needing further future depreciations
b) No one claims that macroeconomics is not essentially an abstract idea, but its usefulness is not to be denied. National Accounts, trade statistics and others count what is going on in aggregate in an area defined by a set of rules where one authority holds power. It happens that we call this area a nation, and that since nations have their own set of rules for individuals, factories or companies, it is a very good summariser for economic vitality. Since a nation has substantial power over the individual then its decisions must be made while focused on the increase of the greater good – hence the need to think in terms of nations.
c) Just because there is a construct in creating a national level data the idea is still valid and useful. It enchases our ability to understand what is going on and perhaps find out what are the underlying causes a problem in a way that the microeconomics data might not be able to (people are not very good with data overload; machines are but are not very good on insight). Sure national data are a summary and as all summaries you lose detail but you gain insight – the long view. Yes the interactions of individuals across borders are not easily being pinpointed, but it is clear that if Greece fails to land a multinational firm making parts for a German auto company its balance of payments position will deteriorate over time, dampening the possibility of having economic growth (unless you have it on credit – and we all see the problems of that strategy).
d) Yes nations do have internal imbalances, and they rightly worry nations – they are not being as frivolous as Protesilaos suggests in ignoring their internal balance of payment problem areas. Italy is suffering from this problem through a North South divide, so in the US, and both have affected the political climate either through requests for limiting the national authority over the regional areas. Both countries a chucking huge sums of money on the problem, being aware that they risk having areas which are permanently in poverty who decide to undermine the national union.
e) I am afraid only with federation where they will be automatic aid to areas under deficit will the Balance of payment issues of the European Union will this problem cease to be so damaging to Europe, but since the mood in Europe is turning against a federation, I have to agree with Krugman and others that the Balance of payment imbalances between the “core” and “periphery” will remain one of the central weakness of the European Project.

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3 comments:

Protesilaos Stavrou said...

Thanks for the critique. I was looking forward to such a debate as I find it fundamentally important in how we understand economics. As a first general remark, I may say that what I stand for is methodological individualism in economics, which once expanded on the ethical and political level eventually leads to anarchism (but this is of course the logical extreme of my premises and need not be consider here). Now allow me to comment upon each and every one of your points.

Point a: Indeed there have been crises in the past and what you have referred to here does not contradict the crux of my argument: that the balance of payments is essentially a political problem and a monetary phenomenon over the long term.

In fact the permanent surplus of core countries is in large part the outcome of aggressive export policies which favor the export sector over the import sector, in that they impose all sorts of impediments to domestic consumption. In the periphery the deficits are the result of the unwillingness of governments to proceed to structural reforms in the internal market restrictions and most importantly in how they intervene in the economy. The need for depreciations which you mention, is exactly in line with what I argue about: that governments are not willing to face the political costs of objective restrictions.

Point b: I do not deny the usefulness of macroeconomics per se. But allow me to make to make a classification: the mainstream approach to macroeconomics is that the macro sphere is separated from the micro sphere; be it keynesian, monetarist or whatever, this approach suffers from the essential flaw of treating conceptual divisions are real ones.

My understanding of macroeconomics, is that of the austrian school where micro and macro are both established on the individual, on human action, and that there can be no real world distinction between the two. That is the main reason why I say that treating the nation or any other group as if it were an entity of its own is false. And since you make reference to the nation having power over the individual, my argument is that this power ought to be drastically diminished.

Point c: Yes collecting such data can be useful, but for what purpose? Ultimately it always comes down to how intervention will be formulated to fine tune all that is considered deviant from the arbitrary target.

If Greece fails to attract investments it is because it has in place a tangle of restrictions or because the political environment creates uncertainty. Greece had a chronic deficit because government interventions created it. The accession to the euro made things worse as it brought a tsunami of cheap credit leading to artificial prosperity.

In the long run a chronic deficit is impossible because at some point either individuals will have to change their spending patterns and/or because the government will be forced to revise its policies; otherwise they will simply run out of money and be extinguished – and since we accept that individuals are more or less rational or at least self-preserving, they will not continuously act against their very survival over a long period of time.

Point d: Of course all states take into account internal imbalances and that is why there are all sorts of programmes and subsidies regional development. All I meant in my hypothesis is that the imbalances are seen at arbitrary levels of authority, such as the national or the regional level. Why not apply the same tools to imbalances between neighboring villages up in the Troodos mountains or between neighboring streets etc.? Why should the fine-tuning be at the national or at least the regional level?

The only reason is that such an effort would be politically impractical; but this only means that the logic underpinning the balance of payments doctrine is flawed, as the inferences to be drawn from it effectively lead down the path of uneconomic self-sufficiency at the individual level.

Protesilaos Stavrou said...

sorry I am posting the last part of the comment because blogger prevented my from posting the whole thing in one part due to word limit

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Point e: A federation featuring a surplus recycling mechanism will indeed address the national imbalances if we are to accept that this is a problem in and of itself. But my take is that the imbalances are the symptom of interventionist policies and can be addressed through liberalization and the drastic minimization of state power. In monetary terms this leads to the conclusion that central banking is incompatible with a genuine free market; as macroeconomic imbalances over an extended period of time are essentially a monetary phenomenon.

Anonymous said...

Problem can be defined as Balance of payments if there is long terms assets against short term payment problem but this is not the case. PIGS have been given abundant loan and and with which they have bought say German cars. German economy is shown as booming. but in actual the buyers have no (intention ) capacity to pay and the Germans are just holding valueless paper.