Skip to content

The Trouble In Spain

August 28, 2012

Of all the Eurozone countries, Spain laments its miserable macroeconomic performance.  As this Wall Street Journal article demonstrates, Spain is in its “moment of deepest decline” in terms of GDP.  Students of macroeconomics will note that while exports are helping the economy grow, the other spending sectors are declining more severely.

” (H)ousehold spending fell by 2.2% on annual basis compared with a 1.5% contraction in the first quarter. Also, government spending dropped by 3% in the second quarter, compared with 3.6% in the first quarter.”

Adding to their tale of woe is an unemployment rate that has reached a dangerously high 24% in recent months.  This is nearly three times the normal rate, and is considered “depression”-level joblessness by any modern EU standard.  That’s “depression” as in the Great Depression, when the global economy tanked completely in the 1930s, and when Europe sought out radical (fasicst and communist) solutions to its economic problems.

If shown on an AD/AS diagram, the scenario would most likely resemble this below.  Led by decreases in consumption and government spending, AD in Spain is moving backward.  As the amount of output/income is reduced from Yfe to Y1 and then Y2, the number of workers needed to produce that output is reduced as well.  This is causing major cyclical unemployment (unemployment as a result of fluctuations in the business cycle).

Image

So clearly, things are going badly in Spain.  What should be the solution?  As my IB and AP economics students are growing to understand, there are a variety of responses at the command of a government facing recession.  After the Great Depression, the traditional response for most governments is to increase their spending and to lower tax rates.  This will result in a budget deficit, the government paying out more than it takes in, which is normally viewed to be irresponsible.   Why is this the standard response?

Keynes called it “spending against the wind.”  In this case, the wind is the overwhelmingly pessimistic economic conditions.  What business would attempt to expand or develop when their customers are unemployed (or worried about being unemployed and saving their money)?  Few would rationally invest at this time.  As for consumers, with 1 of every 4 Spaniards out of work, everyone knows someone who’s jobless, so there’s a real worry that “I’m next.”  So, therefore consumption is drying up.  (For example, a friend in the European car industry told me that private auto sales are dead right now.  Only fleet purchases, by businesses for company cars, are holding steady.)

This is what makes Spain’s reduction of government spending (-3%!) so baffling.  Why cut spending, and seemingly make the recession worse?  If the government is the only actor capable of pushing Spain out of depression, why cut spending?

Welcome to Europe in 2012.  Spain’s part of the club of countries that has already borrowed so heavily that it can’t afford to borrow (and spend ) their way out of this recession.  Spain owes so much in public and private debt (to banks and governments) that the ECB and Europe’s creditor countries, led by Germany, have insisted on an “austerity” plan for Spain to pay back its old debt.

Now.

During the New Depression.

Critics of this policy cite the old idea that to borrow is to be beholden to someone, but to lend significantly to another is to become obliging to the borrower.  As the article notes, if Spain does not grow, it will have even less tax money to pay off its debt.

What can Spain, and the other debtor countries of Europe, hope to do in this case?  We’ll consider the other options in future posts.  For now, suffice it to say that Spain is set to endure significant economic pain over the next couple of years.  This is causing unrest, even violence as Spaniards protest the austerity measures that have been adopted.

Check your understanding:

  1. Identify the four sectors of spending in the AD model, and explain the current status of each sector in Spain.
  2. Explain, using a diagram, how the AD has moved in response to these events.
  3. Show, using a diagram, how a traditional Keynesian stimulus program would help solve the recession.
  4. Identify the reason why Spain is not able to enact a Keynesian stimulus program at this time.
Advertisements

Greek Tragedy? The Perils of Partial Integration

November 9, 2011

The saga of Greek debt has been a regular source of discussion for many months now.  In fact, whole IB cohorts have graduated passed through my classes as the tale has dragged on.   Greece’s public and private debt add up to somewhere between 120-140 billion euro.   How did this happen?  As is common knowledge now, many countries over-borrowed in the “good years” of 2000-07.   The question is why did investors lend Greece so much when it was a small economy?

Many investors failed to distinguish between the Eurozone countries issuing bonds priced in euro.  Greek bonds were consdiered as credit-worthy as German and French ones.  And so Greece was able to borrow at much lower rates than they would have if their relative risk was factored in.  Thus Greece was able to borrow (issue bonds) to a much greater degree, and and much lower rates, than it should have.

This article from the Economist shows how bad the debt problem in Europe is, using gdp/debt ratios.

Now Greece is going back on its committments, in agonizingly slow motion.  The current deal offers a huge reduction of its obligations to pay bay investors, a discount of 50%.  This threatens all the banks bought Greek bonds, as well as the banks who lent to them– a domino effect.   So the EU (led by Germany and France) is setting aside hundreds of billions for rescue packages for the banks, as needed.  The Greeks, for their part, are being asked to agree to more severe budget cuts, cuts to public wages, pensions, and welfare payments.  In addition, they’re expected to pay higher income and property taxes.

Everyone suffers and the world moves on right?  Not so fast.  The Greeks may not go along.  Their dilemma is presented in the following articles:

Voting away your debts

and

Can Greece drop out of the European Union?

Some are aghast that Greece might reject the terms of the deal.  But, in one respect, can you blame them?  Everything our course presents about managing the economy says that during a demand-side recession governments need to enact expansionary fiscal policy, not raise taxes and cut spending.  More “austerity” for Greece is likely to deepen an already bad recession, making it more difficult to pay of their debt.

Finally, in the background, Italy’s estimated debt may be as high as 700 billion, and Spain’s up to $500 billion.  What happens with Greece may set a precedent for other big euro debtors.  But how can anyone imagine bailing out those two, with such extraordinary debt?  As one famous Italian banker put it: “Greece is too small to fail, and Italy to big to save.”

Extra:  This US radio commentator is urging Americans to be sympathetic to the Greek/EU cause.  Wrapped up in his discussion is a tidy historical perspective on the purpose of the EU.

1. How does the issue of Greek (and Italian) debt illustrate the problems of achieving only monetary union among many nations.

2. Why do you think the EU and IMF are forcing Greece to enact such a strongly pro-cyclical, anti-Keynsian policy?  Is this justified?

3.  Should Greece drop out of the Euro?  To what degree would this help or hurt the stability of the Eurozone?

4.  Explain what happens to the credit rating of countries who renege on their debts, as Greece is now doing.  How does this affect their government and companies plans to borrow money?

Roma Movement Tests EU’s Open Borders

November 7, 2011

While the Eurozone trembles and teeters on the brink of chaos with the situation in Greece, another underlying issue continues to challenge the union.  As Roma populations move across EU borders, largely from east to west, some EU countries are challenging the concept of open borders.   Led by France and Italy, they are trying to prevent Roma from entering from other EU states, and once there, trying to force them out.  The  New York times piece below partly explains why this is happening:

Roma, On the Move, Tests Europe’s Open Borders

Since 1993, more and more countries have joined what was then called the European Economic Community.  This form of a common market ensures the free flow of factors of production, including labor.  In other words, workers should be able to move freely about the common market, seeking the best wages.  With the addition of Eastern European countries in recent years, the number of Roma flooding into Western Europe has grown dramatically.   The allure of working in the west is obvious:  significantly higher wages, even if working illegally, and the opportunity to draw on comparatively rich social welfare programs.

  • “There is not much for us in Romania,” she said recently, watching her husband sleep. “And now that we are in the European Union, we have the right to go to other countries. It is better there.”
  • “What you see here these days is terrible conditions,” said Nicolae Stoica, who runs Roma Access, an advocacy group. “They have no hope of getting jobs. If they get 20 euros a month from collecting scrap metal, that’s a lot. How can we tell them not to go to France and beg on the streets?”
  • Twenty-eight Roma residents from Barbulesti were recently expelled from France. Among them was Ionel Costache, 30, who said he would return to France in a week or two.  “My son, who had eye problems, he got a 7,000-euro operation there that he would never have gotten here. And when you don’t have work, you can still eat with their social assistance,” he said. “France is a much better place than Romania.”

France has gone so far as to put Roma on planes, at some considerable expense, and send them back to their home countries.  Some have called the action bigoted, and possibly illegal under EU rules.

Discussion questions:

1.  Is the French deportation of Roma people a justifiable policy?  Explain.

2.  To what degree is this policy a discriminatory one, singling out the Roma rather than other immigrant groups (Poles, Czechs, etc.)?

3.  How does this situation reveal a structural problem with the common market, in that taxes and services are on a national basis, but workers can move to any country?

Life’s Opportunity Cost

August 29, 2011

In a break from our usual programming, let’s read a little poetry.  Our subject this week in my year one classes is opportunity cost, the sacrifice we make whenever we make a choice of any kind.  This can be demonstrated any number of ways, including production possibilities curves (hooray!).  But let’s save those for class, and instead discuss your life and decision making processes.

Frost’s poem can help us understand opportunity cost quite nicely.  This connection was first pointed out to me many years ago by Jim Spellicy, and extraordinary teacher at Lowell High School in San Fransisco.  I’m grateful to him for sharing it, and my students have enjoyed it ever since.

Let’s start with the poem itself.  By this point in your lives, you almost certainly have seen it before:

The Road Not Taken: Robert Frost

Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth.

Then took the other, as just as fair,
And having perhaps the better claim,
Because it was grassy and wanted wear;
Though as for that the passing there
Had worn them really about the same.

And both that morning equally lay
In leaves no step had trodden black.
Oh, I kept the first for another day!
Yet knowing how way leads on to way,
I doubted if I should ever come back.

I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I–
I took the one less traveled by,
And that has made all the difference.

Thank you Robert Frost, for keeping it simple: a choice between two paths.  That’s opportunity cost, because we really don’t agonize over all of life’s possibilities, just the tough decisions.  And opportunity cost involves the value of the next best alternative, not all of them. A rational decision maker sees two choices and weighs the alternative.  They know, also, the price of any decision involves linear time, the idea that they won’t really be able to do it over (“Knowing how way leads on to way, I doubted if I should ever come back.”)  Even if they returned, it would be later, and with the experience of having tried the other path originally.   So, in the narrator’s case, their opportunity cost is the road “most taken.”  What would life have been like…?

Application questions:

1. In your life, identify an experience where you made a difficult decision.

2. Explain the costs and benefits of each option.

3.  Briefly, explain the process by which you made the decision, using the language and terminology of opportunity cost concepts. (costs, tradeoffs, rationality)

Politicians Beware: Romania’s Witches Resent Being Taxed

August 28, 2011

This story about Romania taxing its witches, (and the witches fighting back), appeared in the Associated Press in January of 2010 turned into something of an internet sensation.   In many ways, it seems to be telling a unsurprising story: A desperate government seeks new sources of revenue.  Outraged citizens protest that their taxes will increase.    So, why all the fuss?   Most notably,  the outraged citizens are witches: self-proclaimed, proud, and sincere practitioners of what are called the “dark arts.”  Moreover, to show their outrage, they intend to curse the politicians who will tax them.

But first, a little background on the story is in order.  Romania’s government had recently experienced a severe budget crisis as a result of the Great Recession.  They, of course, were not alone: the UK, Ireland, Greece, Spain, Portugal, and Iceland, to mention just a few, experienced combinations of internal and external debt that threatened to bankrupt each country.  Romania, like others, requested loans from the International Monetary Fund.  The IMF, in turn, would only lend to Romania if it proved creditworthy, which meant slashing government spending (on the salaries of teachers and doctors, for example), and raising taxes, including the VAT.

It was then noted that some professions, like embalmer, driving instructor, and witch were left out of previous labor listings.  In other words, their jobs did not exist, according to the government, and therefore could not be taxed.  And so it came to pass that the government announced plans to add them to the rolls, and to begin taxing their income the following year.

Furthermore, as a resident of Bucharest, the tax on witchcraft appears to be a cynical attempt to appeal to anti-gypsy resentment, a feeling that runs high here.  It would be as if the US state of Louisiana were to suddenly start taxing the practice of voodoo, what happens to be a cultural and religious practice of the Creole people who have lived there for centuries.

TOK-related Discussion questions:
1.  Most government leave such activities to the “informal” or “parallel” markets.   Is Romania justified in levying this tax?

2.  One witch, quoted in the article, did not mind the ruling because it gives her profession some legitimacy in they eyes of the state.   Romania, as many countries do, offer tax exemptions for religious organizations.  To what degree could their profession qualify for tax exemptions in this fashion?

Application questions:
1.  Assume that the government chooses not to tax incomes but the services themselves with an excise tax.  For example, say the government taxed each “hex” placed on behalf of a customer at 20 RON (about 5 euro).  Using a diagram, show this tax on a diagram with an average price of 100 RON (abut 25 euro).  Show the respective producer and consumer burden, along with the area of deadweight loss.

2.  Assume that during an economic expansion, the demand for curses is strong because of competition between businesses (and perhaps politicians), and demand is relatively inelastic.  Explain how your answer to number 2 might change as a result

The Perils of Inequality: Boy Sells Kidney for Ipad

June 6, 2011

I had intended to inaugurate my economics blog with an article on taxation, but when this popped up in the news that had to be put aside.  This story, tragically, has it all:  dubious free market activity, another worrying result of more “perfect information,” and the effects of widening income distribution.

“A teenager in China reportedly sold one of his kidneys so he could buy an Apple iPad 2, according to reports from Chinese media.

Identified as simply Zheng, the 17-year-old took to the Internet to find a way to raise money so he could buy himself an iPad 2, according to Shanghai Daily.

“I wanted to buy an iPad 2 but could not afford it,” Zheng told the Daily. “A broker contacted me on the Internet and said he could help me sell one kidney for 20,000 yuan.”  

My students are currently studying the distribution of income, and the widening gap between rich and poor came to mind immediately.  China is famously producing more millionaires than any other country these days, and the article suggests that health care is every bit as “income elastic” in China as it is anywhere else.    That is to say that the Chinese, when given a bit more income, will spend proportionally more on new and better health care.  This demand is likely to draw in larger investment in health care and a higher number of students studying medicine, both good things for society as a whole.   But it has also spawned an enormous black market in human organs.

Why is this a problem of income distribution?  This story shocks us because the boy secretly sold his kidney to buy a computer,  not food for his starving family or medicine for a sick grandmother.  He is, after all, a boy, one dazzled by the new technology and not likely to think in terms of the long run consequences of his action.  But one would guess that most people who sell vital organs are driven by extreme need rather than a desire for luxury goods.  China, for all its millionaires, still counts the number of its poor people  in the hundreds of millions.  For the rich, buying organs is getting easier because they are growing richer.  Meanwhile, the relatively poorest face greater temptation than ever to sell their actual bodies just to get by.  If the story of the boy and his kidney shocks us, then should we not find the more mundane and prevalent cases just as appalling?

  1.  To what degree should each of the following be prosecuted for this criminal act?  (The buyer, the seller, the broker, the clinic, the doctor, the website where the boy made contact with the buyer)
  2. In what sense is this incident an example of the growth of more perfect information flows in the market?  On balance, do you think this is a good thing?
  3. When is an imbalance of income just another effect of market economics, and when is it considered exploitation?
  4.  Some countries are experimenting with a free (and legal) market for organs.  How might this affect the supply and demand in this market?
  5.   Ethics question:  In recent years, stories have emerged that prisoners in Chinese jails have had their organs forcibly removed and sold on the black market.  (These stories are, of course, blacked out by the authorities, as I observed while watching the first few seconds of such report in Shanghai).  If the state has the right to incarcerate and kill (in death penalty cases), does it have the right to save lives by compelling organ removal of the most serious prisoners?