Sunday, 25 December 2011

Merry Christmas and a Happy New 2012!

The new 2012 bears a lot of questions on the eurozone, UK, US, China and so on, but lacks to provide many answers. Unemployment is still at high levels and is likely only to rise. Output on the other hand, as well as investments, are likely to fall. Stagnation is upon us. The reports of the most prominent world institutions predict this, but they also predict a bounce back in 2013. This is a bias their models hold, since no one takes into account the possible reactions if the euro falls, or if the Chinese bubble finally bursts. The picture is gloomy and the politicians are realizing this more quickly than before as their election dates are closer. The current situation of postponing the necessary solutions is only pilling up the pressure on them and is increasing the dissatisfaction and antagonism among voters. Sooner or later, we will all have to face the necessary consequences and accept painful solutions. Balanced budgets and increased bailout funds will result only in more debt accumulation and won’t create a favourable environment for private sector growth. It may temporary restore investor confidence but the banks will still be reluctant to lend and the regulatory requirements will still raise costs for private sector enterprises. The upcoming year will eventually give us the answers on why the recovery is taking so long and why worldwide investor and consumer confidence is experiencing its longest low streak since the 1930s. We already know the welfare state is unsustainable in a productive-less and freedom lacking economy. Now we must find out how to fix it and find the proper remedy for an overblown and overdependent system. 

In the mean time, in these festive times let us enjoy the moment and celebrate the holidays, fearfully looking forward to the new 2012.

Thursday, 22 December 2011

The Great Mismatch between the labour market and universities

The ever high unemployment levels worldwide and particularly the upsurge of youth unemployment is getting more and more people worrying. The hardship of finding a proper job for a recent graduate has become next to impossible in 45%-youth-unemployed Spain or 42%-youth-unemployed Greece. Other countries aren’t far behind. Europe’s youth is locked in an unemployment trap and some go so far to call it a ‘lost generation’. I refuse to be that pessimistic as the amount of brilliant young minds created is increasing with the technological development, student ‘migration’ and widening exposure to new ideas and ways of thinking. However, the fact that they remain unemployed stands and the solutions are lacking. Although I won’t go in much detail on how to fix youth unemployment here (as I see the problem of unemployment being solved through restoring confidence and removing uncertainty in the economy in order to increase private sector investment and eventually hiring) I will touch upon the mismatch that has risen between universities and the labour market. 


Certain claims suggest that universities are not preparing the graduates good enough for jobs in the private sector, particularly for small and medium sized businesses. All those taking on apprenticeships are deemed too inexperienced and are turned down at job interviews. Unfortunately this is normal during a crisis. More experienced workers who lost their jobs will pick up the available ones. How can a graduate, no matter how impressive his CV is, compete with someone with 10 or more years of experience in the desired sector of work? This is why I find it strange why some advocate for government intervention in encouraging the employers to hire more young people, or better yet to encourage universities to offer a better skill-oriented program to graduates making them more competitive.

There are suggestions that universities should be encouraged by the government to provide more employability skills in order for the companies to be likely to hire and be more open to graduate students. This would be a wrong approach. Providing incentives to the education system to change will be costly and could produce unwanted results such as many below average schools taking in taxpayer’s money without using it in the right direction. Besides, how can the government verify whether the programs offered are any good, or helpful at all? The universities can always defend themselves that the program is new and it needs time for it to improve. By that time a lot of money will be spent and nothing will be gained in return. As a consequence the policy will result in squandering resources and without any real effect on employment or enhanced skills for that matter.

A much better approach would be to let the universities decide on their own whether or not to introduce such a program based on the experience of their students and the type of students they wish to attract. By offering a unique program a university will be able to distinct itself from others and attract more students. They will form their programs based on the demand signals they receive from the students. If there is a higher demand for more employment skills related programs, the universities who supply it will see an upsurge of applications and revenue. By offering what the students want they can charge higher prices and seize the rising demand, if there indeed is any. Today most students choose finance and economics programs hoping for a high return on their invested tuition. The majority of space and programs at the universities for those types of students simply shows that the universities are adopting the supply of their services. And it’s not that the universities don’t offer other, less attractive programs as well. They do, but since the demand for these is much lower, so is the supply.

The incentive for more hiring must go the opposite way. The businesses who wish to take on more apprenticeships or more graduate level students should advocate a need for more skills based programs. When the students notice this is important for them to get a job at a certain company they will look for universities which offer such a skill-oriented program. Upon observing an increase in demand for such programs the universities themselves will decide whether or not to engage in it and offer it to the students. It would be wrong to demand from the government to impose more skill-oriented programs onto universities so that we could increase the graduate hiring rate. There is no guarantee the businesses will react in the right direction and indeed start hiring more graduates. If they rather take in an experienced hire, no university program will make them change their minds. A government subsidy could change their mind, but then the problem is shifted towards a different angle – age discrimination and diversion of the firms’ resources towards a political market. The problem wouldn’t be solved, it would, much like in most government intervention programs, only be shifted away from one group to another.

The only thing the government could do in terms of incentives is to reduce regulatory requirements and employment taxes that discourage businesses from hiring. The issue isn’t the lack of skills handed to the graduates, it’s the lack of motivation for hiring by the employers.

Friday, 16 December 2011

Graph of the week

This week we take a look at an interesting figure showing the target levels of the new eurozone treaty (signed last week).

Source: The Economist, Daily chart

As the Economist says, "this time we really mean it!" The level of insubordination of the eurozone countries is astonishing. While some were balancing around the target in pre-crisis times, trying to cope with it, others were outright irresponsible, particularly right about after the credit squeeze in 2009, when the debt levels and the deficits soared.
The debt levels are at an even worse state, knowing that the Maastricht target was 60% of GDP. How will the automatic punishments suppose to handle all of this and prevent further political mischief is still rather puzzling to me.

Monday, 12 December 2011

The path towards a fiscal union

One part of this post was published at the ASI blog, titled "Europe's road to serfdom"


The deal was struck. The EU and the eurozone are on a new path toward a more strict fiscal union. And with the deal, it is very likely a move towards a double speed Europe, or a union within a Union. Britain has isolated itself from the new treaty by a veto from its PM David Cameron. Whether such a move is good or not for the UK, only time will tell. It would be frivolous to make predictions now, as it is very likely that Britain will remain a part of the EU, only now left out of some main decision making and possibly regulatory standards. This isn’t necessarily bad, as Britain mostly suffered under various EU labour and financial market restrictions, but it is a question on how Britain might suffer politically. Loss of power and influence within the EU is certain, and it is left to see how this will impact Britain’s future motivation and public opinion regarding the EU.
The break-up of the Union, at least at the moment, isn’t likely, despite all the negative predictions. Neither will Britain exit, nor will the euro fall. The two-paced union was an unavoidable outcome ever since the euro introduction. The currency itself offered better economic conditions initially to all those who embraced it. It was the reason behind imbalances and it will be the reason for fiscal unity. All those who refuse to enter it, will remain outside like they did before. The UK can still benefit from trade treaties and a more open and flexible labour market (still only a theoretical assumption in most of Europe). It will enjoy less regulations and less fiscal constraint. It will remain to be independent and different than continental Europe, as it was before. I see no big differences in this apparent ‘break-up’ apart from the administrational ones. The euro needed a fiscal union, perhaps not in this form, but it nonetheless needed it. The loss of national sovereignty to the EU is the unfortunate but necessary outcome. It was never going to be the other way around.
The UK mostly did this to protect its money-maker – the City of London. It is encouraging they have finally remembered its importance, and they are finally showing support for once. They also realize that the FTT will present a huge negative impact on the City of London and the UK GDP in times of recovery. Britain finally got fed up with all the unnecessary regulation coming from the EU that was undermining its competitiveness. Introducing the FTT was the final drop, as London would lose its battle over the financial influence against Hong Kong, New York or Singapore. The “big bang” made London into the global financial centre it is today. The FTT would undo all that change and in return offer bigger equality in Europe? No thank you, say the Brits and who could blame them?
I don’t see a decrease of trade levels with the UK either. The EU does a lot of trading with the US, China, Japan and even Switzerland, and the fact that they are out of the single trade zone (well apart from the Swiss) didn’t result in negative outcomes for these countries, quite the opposite – it resulted in more specialization and more gains from trade worldwide.

The treaty agreement itself is much more a plea towards fiscal discipline and austerity. It lacks a long term strategy apart from hope that within a fiscal union there will be less scopes for irresponsible behaviour and everyone will have to act as Germans. If they were treated as Germans by the bond markets before, now they will finally have a chance to act like ones. 
The budgets of eurozone members need to be balanced or in a surplus. This will be introduced in each country’s legal system and possibly be overseen by the European Court of Justice. If any country breaches the 3% deficit ceiling (which was the initial requirement for the euro introduction; if only they had listened before) it will suffer automatic consequences and possible sanctions unless the majority of other nations oppose. I see room for political games once more.
The financial measures in place were designed to increase the firepower of the eurozone institutions to rescue the currency and its most endangered member states. There is a new rescue mechanism, the European Stability Mechanism which is to hold €500bn, and there is an additional €200bn to arrive through the IMF. According to some high numbers being called out before, it isn’t certain whether this will be enough.
The problem with the current plan is that it requires more and more bailouts, which essentially implies more and more debt accumulation. The socialist foundations of Europe are falling apart simply because they refuse to realize (or are unable to realize) that socialism and the welfare state are unsustainable, once you run out of other people’s money, that is. The dependency of peripheral nations is causing the highest burden on the eurozone. Its core members don’t have sympathy towards these countries, they require bailouts to save their own countries’ banks who plied up on peripheral debt due to Basel capital requirements – another example of European regulatory oversight that ended up increasing systemic risk of the financial sector rather than decreasing it. 
As long as the EU officials close their eyes on the only plausible solutions left – defaults that will end further bailouts and dependency (excellently summarized by Dan Mitchell of the Cato Institute), Europe will remain in dire straits. More socialism and more faulty policies that caused the current situation cannot be the answer to its problems. The response must come from a different perspective – just like it did in the 1980s. The question is how much longer will it take for the policymakers to realize they are on the road to serfdom. 

Wednesday, 7 December 2011

Graph of the week

Here's a figure depicting the history of eurozone sovereign bond spreads vs. 10-year German Bunds, from 1990 to 2011. 


Source: FT Alphaville, original source: Pictet

It is an interesting proof to the propositions made here that the introduction of the euro equalized the risks across eurozone which gave the peripheral countries an opportunity to borrow cheaply. This opened the scope for excess borrowing and fueling domestic growth with consumption and government expenditure. As an effect all the peripheral countries experienced severe current account deficits

What is interesting in the figure is how the spreads were much more volatile before the euro and the rapid decrease of volatility (and hence risk) once the euro was introduced. It appeared that every eurozone country could borrow as if it were Germany. It is obvious that this was fiscally unsustainable. The US spillover effect can be seen in 2008, but the credit squeeze that came about in 2009 fully uncovered the eurozone's instabilities and led the bond markets to react the way they did - rapidly adjusting the risks of the eurozone sovereigns. 

Tuesday, 6 December 2011

Never fear, the Supercommittee is here?

Did anyone really believe that after the August US credit rating downgrade caused by political quarrels, stubbornness and instinctive self-preservation, a committee made of an equal number of Democrats and Republicans would actually reach a favourable conclusion? I didn’t think so.

After all the pleas for the Supercommittee to go big and seize the chance to create an impact and make a credible reform, in more than three months work, last week they’ve announced the inevitable failure.

I admit, on first sight it seemed like a good idea. Any form of political indulgence of the deal was removed. The Senate couldn’t use its filibuster power, there was going to be no amendments in the Congress; it was supposed to be a simple yes or no policy effective immediately. However, then I remembered that the topic was the US deficit and the actors were US politicians, the same ones responsible for the US debt downgrade and market panic in August this year, and I quickly came to realize any hopes of them coming up with a compromise solution was in vain.

The failure of the Supercommittee in the US results in several disappointing consequences. The first one is complete disgust of American voters over their politicians. I wouldn’t be surprised to see a record low turnout at the next Presidential elections. It is amazing to see that even when all obstacles are removed and when everyone is hoping for a credible solution, the nation’s politicians are unable to provide one. One signal is clearly sent to the voters – “remove us out of office”. 

Apparently the Republicans were reluctant to accept any tax rise (at least for the rich), while the Democrats refused to make cuts on various entitlement programmes (Social Security and Medicare). Once can see why each party was holding on stubbornly to its proposals as admitting defeat on one of the issues would automatically mean loss of reputation and voter support. But ironically, the inability to reach consensus is hurting them both even more. I would blame the two protest movements for this – the Tea Party and the Occupy movement are holding both parties to stick to their agenda and not let the other one get away with anything. The Republicans will not allow any taxation of the rich, something that the Democrats are very strongly in favour for. One couldn’t say the protest movements were a direct cause of the political lock down, but they definitely played a big role in shaping the opinions of each party’s representatives in Congress.

The second consequence is an inevitable fiscal contraction (Bush tax cuts will expire, so will the temporary cut in payroll taxes and unemployment benefits). The US will see an automatic $1,2 trillion deficit cut with half of that amount taken away from military spending and the other half from other areas such as education, housing, environment protection etc. It is questionable how the markets will react, since the ratings agencies welcomed the Supercommittee idea as a way for the US to prove its credibility for the AAA rating. Its failure increases uncertainty and prolongs any chance for a faster future recovery. Confidence in the economy cannot be increased under uncertainty. Next year will be particularly dramatic for Europe and more uncertainty coming from the US will only add to the gloomy picture the world economy is finding itself in. The political lock-down will last until the presidential elections in November 2012, which means that we can all anticipate a turbulent  2012, to put it mildly. 

The moral hazard of having two strong parties deciding the fate of the country is showing its most adverse effects. A political lock-down is causing an economic lock-down. It is striking how the US politicians, on one hand calling European leaders irresponsible for not being able to tackle the crisis, and on the other hand causing the same contraction to their own economy, cannot see the irony in all of this. The double-dip, both in Europe and in the US, will be caused by political incompetence and their lack of perception of reality. Is there anyone to put the politicians down to earth? The voters can, but they, just like the politicians, are seriously lacking options. 

Saturday, 3 December 2011

Investment should be left to the private sector not the government

This blog post was also published at the Adam Smith Institute blog

Regarding the UK Chancellor’s last week’s autumn statement, if anyone had any doubts, one thing was made clear – the UK, much like the US, is embracing fully on a Keynesian path to recovery.  

The government took the plunge to direct private sector investment decisions. It is calling on pension funds to invest into infrastructure projects and even putting in some money by itself, it is calling on businesses to hire more young people (introducing an age boundary and a waiting list boundary) and offering them money to do so, it is calling on banks to lend more money to businesses by offering guarantees for these loans thereby setting a stage for another asset bubble, it is underwriting mortgages and driving the housing supply and finally it is doing all this in hope of satisfying narrow interests and in hope of ensuring political success.

The government is centrally planning the country’s development. And they are doing so through populist policies, higher spending and more borrowing, despite all the warnings from the Office for Budget Responsibility (OBR) on the adverse effect this will have on output. The call for cuts is still strong but so is the call for more spending and more borrowing. The deficit and debt goals are prolonged another 2 years than initially planned. No wonder, since the policies the Chancellor came up with will only widen the national debt and increase the budget deficit. What is the point of calling plan A (or plan A plus) austerity, when it is clear that the UK is using a fiscal stimulus.

It is worrying that the current government would rather resort to populism and cronyism to create a seemingly good picture of the economy then to keep its long term goals. The bond markets aren't punishing the UK yet, but they will do so soon enough. The policies imposed by the Chancellor resemble all those policies that led the peripheral eurozone nations into severe debt troubles. The UK is nothing like these economies some would say and would be right. But it is only a matter of time before it becomes like them if allowed to continue with a centrally planned investment and ‘growth’ scheme.

The worst outcome will be in the perception the UK government will create. Once it fails in its policies to restore growth, the Keynesian response will be it was because it crippled the recovery by cuts and that the plea towards austerity didn’t boost spending or the aggregate demand. The fiscal austerity aimed to reduce the national debt and budget deficit will be blamed for UK’s failure and a lost decade or two. But it will be exactly the opposite. Reckless spending in the Brown period and incompetence and lack of courage to change the public’s opinion on the welfare state and continuance with populist policies during the current government will mark the reasons of a lost decade in Britain. 

The lessons of the financial crisis in 2008 and the current eurozone sovereign debt crisis haven’t been learnt. The fallacy that a centrally planned economy can lead to prosperity and creating value still persists in the minds of the decision makers. Government steering of private sector investment leads to the creation of artificial demand and it leads to the creation of asset bubbles. The solution to these previously created problems cannot be applying the same policy as before, it must rest on other virtues, it must focus on creating value. And only the private sector can create value. Therefore, the government must do everything to clear the path for the private sector and remove any burdensome regulation and taxes in order to encourage the private sector to do so. Confidence in the economy is best restored if it’s a healthy, private sector led economy, not a government run behemoth. If the UK policymakers are unable to see this, they should resign with immediate effect before they poison an entire generation with dogmatic thinking.  

Thursday, 1 December 2011

Graph of the week

I will be introducing a new category on the blog, inspired by the economist's daily chart, I will randomly select and/or make interesting charts and comment them briefly. If it turns out to be popular, maybe I'll turn the category into 'graph of the day'. 

The first one is taken from the Economist's daily chart:
Source: The Economist, Nov 28th 2011.

It is the OECD GDP growth forecasts for the year(s) to come. It appears that 2012 will be the year of the double-dip recession. This will be particularly emphasized in case of a euro break-up. The European countries in the figure reflect this the most. On the other hand the US economy is expected to slightly increase growth to a steady 2%, while Japan is expected to rebound from its earthquake tragedy earlier this year. The developing economies will also be affected by the european slowdown as their exports are expected to fall. 
It is worth noting that the OECD have made the predictions based on the fact that the current status quo situation persists throughout the following year. Due to the dynamics of bond market reactions and political responses I believe that the road ahead will be rough and the growth forecasts will have to be revised a couple of times. Let's all hope they will be revised upwards if/when the credible solution to the sovereign debt crisis is found. If not, we're in for a depression rather than a recession.