Thursday, 20 December 2012

My article on Guardian: A strongly worded critique the Presidency of Demetris Christofias

I was asked to comment on the "Comment is Free" section of the Guardian on the public address of Demetris Christofias claiming that the whole issue of Cyprus is due to the banks and their failings.
Although I fully agree that long term issues of governance and the cosy nexus of bankers, politicians and the economic elite are part of the problem, this president has much to answer for how fast we ended up in this mess. My article in the Guardian is focusing exactly on this.


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Great news! The peace review article we co-authored is available on-line!



My father and mother have been a great influence in my life. My mother gave me the strength of character to fight, and my father the belief that through hard work life could be better for all in the future.

My father has worked in his own way tirelessly for the solution of the Cyprus problem for over 20 years. With no grand standing or show boating, Costas Apostolides has worked to bring peace in Cyprus, earning the respect from those Turkish Cypriot and Greek  Cypriot communities whose opinions on the Cyprus issue are not clouded by racism, hatred, or political expediency.

I would sometimes resent my father missing late nights working on the Cyprus issue while growing up, but by the time I reached university I started learning about the economics of a solution, and was intrigued. By the time I finished my PhD I was fully convinced by fathers argument that a solution is affordable and a "win-win" situation for all Cypriots that would also serve as a beacon of hope and progress for the Near East as a whole.

The past three years I was lucky to be involved in a UNDP-ACT funded project implemented by the Cyprus Chamber of Commerce and Industry, and the Turkish Cypriot Chamber of Commerce called "Economic Interdependence In Cyprus". I came in as a late member to the Peace Economics Consortium (PEC), an inter-communal entity that sought to bring together economists across the divide to work on common issues of economic interdependence. I learned so much by all, but especially from the Turkish Cypriot members, who gave me such a great understanding of the desires and aspirations as well as the problems of the community.

Eight reports were submitted, with the summary of the first being published by the UNDP. However some of the authors felt that a wider publication of the results were needed. As a result the parts written by Costas Apostolides, Erdal Guryay and my self (Alexander Apostolides) were extesivly reworked and submitted for a special issue of the Peace Review, which asked if a solution of Cyprus was possible.

Our take is positive: If you look at the economic interdependence rather than the politics there has been great progress, which proves the two communities can live together peacefully and prosper under a solution. More work is being done on this as we speak, which we hope to publish in the medium term: But the news are overall positive.


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Monday, 17 December 2012

The great liquidity crunch is starting to bite – Liberalise contract law and the financial market now!


 Until recently it was thought that the crisis in southern Europe largely affected only small and medium size enterprises: yet as the deadline for bank capitalisation of the ECB moves ever closer, the economy is feeling the crunch of the resulting restriction of credit. In Greece several medium enterprises, thought by many to be viable concerns, could not find the short term finance to survive. In Cyprus the largest supermarket chain (in terms of stores) is in dire straits as banks seem unwilling to bankroll it.

Economics warns that money supply is really created by the banks and not so much by the central bank: Banks receive deposits or capital, which does not receive any interest and hence it needs to be loaned out. In their efforts to make a profit they lend most of that to others, essentially expanding the money supply. As the money supply is linked directly with the GDP an expansion of the money supply can lead to an increase in income; a reduction will always certainly lead to a decrease in the nominal GDP and increase unemployment further.

The economist seems to be relatively optimistic that the retraction of banking will provide alternative ways for large and small businesses to receive financing. It argues that large and solvent companies can issue their own paper that would be eagerly bought by investors eager for safe interest bearing assets, while small companies can trade their invoices in a secondary invoice market in order to receive more liquidity.

Sadly neither of the two is possible in Southern Europe. The first obstacle is physiological. As the economic depression in the Southern Europe deepens, investors will be unwilling to raise debt for profitable and respectable large companies, as the companies’ future is certainly going to be affected by further decline in sales in southern Europe, and the general increase in taxation.

More worryingly the idea of lending in Europe was tied to the idea of banking. As a result contact law and bidding law has centred on banks and their specific provision of auxiliary banking services. For example companies are frequently asked for a bank guarantee (that proves the company’s solvency) as part of the bidding process, effectively tying up the company’s financing with the banking sector. However as banks seek to restrict their exposures there have been cases were they request that amount that the guarantee suggests should be tied in the bank until the results of the bidding process have been completed, which could take six to twelve months. The bank effectively holds your money without you having access to it until you have won the contract, effectively starving small companies the ability to compete in an EU wide level to survive.

How can this change? the legal framework is outdated and prevents innovation in financing. It is not clear if a third party has the right to claim an invoice without having significant restrictions and regulation that make the whole process too costly. The answer is clear: a liquidity shortage is inevitable: yet quickly deregulating the financial market and the laws relating to everyday business finance could help alleviate the gap. Sadly this is so far off the agenda it is not even discussed in the southern Europe. 

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Friday, 7 December 2012

An alternative Neo classical solution to Europe’s Banking Crisis: Universal Default.


I am constantly amazed with the indignant way politicians and media claim that the deflationary and austere measures demanded by the “Troika” consortium are the epitome of “Neo-liberalism”. It is true that some policy-makers have decided that these measures should continue, despite failing to revive the economies (Ireland, Greece, Portugal) that are in trouble. There seems to be the idea that the lack of recovery is due to a lack of sufficient reduction of the price level, and as such they demand ever more austerity and wage and price falls as a method to restore competitiveness of the ailing economies. The result is a downward spiral of GDP disposable income and people in employment, and a weakening of the critical sector for the economy: Banking.

The issue is that idea that just more austerity works is as weakly based on economic principles as most other suggestions heard in the last three years – rather than being “Neo-liberal” and sticking to the Neo classical paradigm of economics, the policy-makers in favour of these ideas choose a pick and mix approach, that totally discredits their efforts. It is not “neo-liberal” economics: it is bad economics, as it violates one of the first principles set by Lucas for modern Macroeconomics: it should be based on solid microeconomic foundations (i.e. it should anticipate the reaction of each individual agent to changes in incentives).

Let look at the three major suggestions of the “Troika” consortium: Government should reduce expenditure, labour laws and prices should be liberalised and fall in order to restore competitiveness, and banks should increase their capital in order to be immune to the effects of a declining economy. Government should borrow to help the banks directly by providing cheap credit/support.  

Yet Neo classical economics has for decades proven that the combination of these three policies would be catastrophic. Irving Fischer wrote a paper in Econometrica in 1933 that proved that such a combination of policies is catastrophic. Although there are other reasons why the above policies are ruinous (which will be subject of latter articles) here we will focus on Fisher’s understanding of the problem and his solution: the real cost of debt and the idea of universal default.

Fischer pointed out that even if prices and wages are flexible and can fall, contracts written in the past are not. Some of the most rigid (and long term) contracts are loans to firms and individuals; although banks can change the interest they charge in most deposits (and face the risk of losing clients), debtors do not have the right to change the interest they get charged.

For Fischer a severe downturn can bring a reduction of prices and wages in an economy, leading to a dramatic increase in the real cost of an existing loan agreement. For example if I bought a house and I used 10% of my past salary to repay the mortgage, the reduction in prices and wages would mean now I have to spend 20% of my current salary to repay that loan. The house is now probably worth less than what I bought it for (and hence I am repaying a loan for more than its current value) and I need to sacrifice more of my shirking income to pay for it.

What are the implications of the above example? If I keep paying the mortgage then there is a large redistribution of wealth from the owner to the bank: the bank is gaining from the lower price level and thus the real interest rate it receives increases. If I stop paying, the bank will go bankrupt: forcefully getting my asset (the house) will not help the bank as the fire-sales of devaluated assets lead to the asset selling for a very low value.

What is Fischer’s policy advice: universal default! Fischer argues that all institutions and agents acknowledge that past contracts are unworkable and universally default and renegotiate to take account of the new wage and price level. Neo classically this idea is ideologically sound and it can be perhaps best explained with a joke:

It is a slow day in a little Greek Village. The rain is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit. On this particular day a rich German tourist is driving through the village, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night. The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher. The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer. The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel. The guy at the Farmers' Co-op takes the €100 note and runs to pay his drinks bill at the taverna. The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him "services" on credit. The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note. The hotel proprietor then places the €100 note back on the counter so the rich traveller will not suspect anything. At that moment the traveller comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town. No one produced anything. No one earned anything. However, the whole village is now out of debt and looking to the future with a lot more optimism.

Now some will argue that:
a)      Greece and Southern Europe have not seen deflation as measured by the Consumer Price Index (CPI)
b)      As loans as now estimated as a basis points above the ECB base rate, interest payment are flexible and thus there is no need to renegotiate contracts – interest payments of individuals will fall as their wages decline.
I argue that a) is false and b) is theoretically correct but stopped by the Troika measures.

In regards to a), although the CPI of Southern European countries is positive, this is mainly due to the effects on inflation though tax increases raising prices – thus a CPI minus tax increases is close to being deflationary. There is no doubt that the purchasing power of the average Southern European is falling rapidly and this is accepted even by the “Troika” consortium; they argue it is just not falling fast enough.  

As for b), the ECB interest rate is low but as banks are scrambling to gain capital and other secure assets, we do not see a decrease in the interest rate of lending to individuals; if anything we see interest rates to individuals remain at the same levels, while total lending is being dramatically reduced. But this is mainly is due to the policy of increasing banking solvency at a time of lean economic times, a policy agreed by some of the same policy makers which argue for increased austerity. Currently banks borrow from the ECB cheaply and lend to governments less cheaply, while no one is really helping those who defaulted on their loans: Fischer’s idea provides and alternative view, were homeowners and banks reach settlements through a defaults that is across the board.  I suspect the reason Fischer’s alternative idea is not even discussed has more to do with politics and interest groups rather than with economics.

Despite the fact that I think many of the ideas of the “Troika” consortium are rubbish, I do not believe the economic ideas as expounded by SYRIZA can work. Those who accuse the “Neo liberal” policies and provide alternative heterox views also have a poor foundation in economic theory. As a result an implementation of such views will result to unpredictable and disastrous results. The “Troika” policy makers should stop hiding behind economics: the Neo classical worldview is incredibly mixed and varied, and offers alternative ways out of the current crisis which are not discussed due to political rather than economic considerations.

My thanks to Econtalk for the Fischer Article, and Demetris Halios who first asked me about the paradox hidden in the joke,  and the girl in Cave bar who asked me why does the bailout of Cyprus go to the homeowners rather than to the banks.--------------------------------------------------------------------------------------------------- Licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License. . You are free to copy content but you must link back to this blog and attribute the work to me (Alexandros Apostolides).. You cannot use my work for commercial purposes and you must share it under the same terms I do.

Thursday, 6 December 2012

Prices, Hurricanes and Rationing: Why prohibiting price increases can be a bad thing.

A petrol station on Staten Island after the Hurricane: Courtesy ITN 


Just as the Presidential Campaign was entering its final stages in the US, hurricane Sandy ripped through the west coast, creating extensive damage to the East coast. Republican New Jersey Governor Chris Christie was praised for his work both before and during the hurricane, as well as his close collaboration with the Democratic President Obama in the midst of elections.

The governor has stated publicly even before the hurricane made landfall that anti-gouging laws will be enforced to their fullest.  What are anti-gouging laws? They are laws that state that no business can take advantage of an emergency to charge higher prices for its product than it did before the emergency.  In fact the governor acted on his statement, sending lawsuits against many businesses that increased their prices, including petrol stations and other vendors of what were deemed essential goods.
But are such laws a correct way of tackling issues that arise from an emergency? What Governor Chris Christie and other politicians seem to forget is that a cap on prices does not ensure sufficient quantity: it ensures a deficit of products, causing additional hardship and social unfairness.  Let us take the case of petrol as an example. There is no doubt that the Hurricane created a Demand shock (sudden increase of the quantity demanded) and a supply shock (a sudden reduction in the ability to provide additional petrol). As a result the market clearing price would have to rise at substantially higher levels than previously. A price of 25 dollars a litre would not be unthinkable in such conditions. People used to paying less for petrol would be upset and demand action.

The governors of New York and New Jersey decided to enforce laws against rising of prices in an effort to make sure the people had petrol. The result was disastrous: there was a prolonged shortage of petrol in all New Jersey for substantial time after the hurricane hit; strategic reserves were released that did not alleviate the petrol deficit. Since there could not be a significant increase in prices the result was incredibly predictable: mass shortages, long queues and general unpleasantness.  

As a result of the anti-gouging laws there was no incentive for the petrol station owners to bring in more petrol; consumers on the other hand would not just buy how much they need but they would hoard, knowing that the price was lower that it should have been and that there was uncertainty of future supply. The governor of New Jersey tried to stop the selfish desire to hoard by rationing the available gas. New York decided to give gas for free and found itself overwhelmed by the people who wanted it. The intuition missed by the Governors of New Jersey and New York is serious and happens often by politicians – you just cannot use the price mechanism to introduce social values.

Economics has evolved its understanding of markets to form a general system for an economy, using general equilibrium analysis. The intuition is that consumers adjust to the changes of prices between goods; these price changes will allow the consumers and suppliers to make the best choice for them, but that choice will also lead to a socially efficient outcome. Thus allowing price of petrol to rise to $25 would achieve the aim the governors of New York and New Jersey found difficult to tackle: Consumers would self-ration, since they would be unwilling to spend so much of their budget on petrol and only take as much as they needed. Suppliers would bend over backwards to re-establish the networks that would supply them with more gas, rapidly reducing the price for petrol.

Does that mean that Governors should let consumers suffer in the hands of what are perceived as opportunists? There is an efficient way of alleviating the situation: but it is not through the price mechanism. It is through changing who owns the supply of petrol. An economist would not enforce the anti-gouging laws, but he would provide one litre of gas to each citizen and give them the right to buy and sell it as they chose. The result would be that consumers who wanted gas would buy it from those who did not want it, putting pressure of petrol station owners to lower their prices to the lowest possible. Social fairness has to be addressed through the re-distribution and the increase of competition and not though enforcing price law edicts.

My thanks to Econtalk which inspired this article, and my ECO 310 students who challenged me to find a theoretically robust way to stop gouging.
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