Gabriel’s scarcity rent - it’s management stupid!

I’ve been having a conversation about food prices. It’s a fact that they have skyrocketed lately, and they don’t look like they’re going to go down soon. Why is that?

The first reason is, of course, that now we are more people eating. I personally haven’t changed my eating habits, but a lot of Chinese, fortunately, have. The huge Asian country witnessed the birth and nurturing of million of “little Buddhas” that serve as a sign that a lot of Chinese don’t suffer the fate of their not-only-culturally impoverished parents. And the more people eating, the more scarce food becomes, and that drives prices up, the simple law of demand.

Prices soaring? Not guilty!

Another way of explaining why the prices raise is because of utility. Utility describes what the consumers feel about the products: the more utility, the more people are willing to pay for it. Food is not only useful but really necessary. That necessity is expressed in the price. Utility, thus, is part of the price of the product. If this was the beginning of the XXth century, Eugen von Böhm-Bawerk would say it’s not utility but marginal utility, and he’d be right. The utility depends on the eyes of the beholder. And the utility of food becomes less important as you are fed, and then focus to things like not-so-useful diamonds.

Thus the price is ultimately related to scarcity and utility. Food becoming more scarce means that we’re going to pay more for it. And don’t expect that to change.

But is it so great the difference between food consumptions? A few years ago we had all these surpluses at both sides of the Atlantic Ocean, not knowing what to do with so much cereals and milk, heavy-subsidised goods, and now we are running out of them? That surely would mean great savings for the EU and US governments and tax-payers!

So, where have all the surpluses gone? Have the “little Buddhas” eaten so much? I don’t think so.

A system is, by definition, an ordered set of elements that includes relationships between them. In a price system then, there are not only products, but also a series of relationships that link them. Those relationships are key to understanding the whole system. Some of them establish products as complementary or substitutionary. The former will need each other thus demand of fuel will raise the more vehicles exist, the latter will substitute each other thus the use for private cars will shrink in congested cities that develop efficient mass-transportation systems. In that case the perceived utility for public transportation will be greater for some people, boosting demand.

Surprisingly substitutive: guilty!

When biofuel was invented everyone hailed the newborn as a chance for sustainable energy production. Now we had something useful and expensive to convert our cereal overstocks into.  Very high subsidies were required to start building alternative sources of energy like this one, but there was a case for it: less dependency from “dangerous countries” and a lot of big corporations interested in the processes (and subsidies). A great alternative to fossil fuels was being born, and also a less polluting one.

But what we didn’t anticipate was that move would tie prices of food and energy together. Thanks to the newly created market distortion (sorry, I mean subsidy) now there are new induced scarcities throughout the food chain: for example less and more expensive grain for livestock for example. Nobody anticipated either, until the Nobel laureate Paul Crutzen did, that more farming requires more nitrogen, and that nitrogen is highly polluting, especially when it gets released to the atmosphere as nitrous oxide (N2O) by means of biofuel.

There are many implications of the use of biofuels, some positive, some are not. But it’s not easy to take a look to the global picture.  In between of so many interested views and sponsored applied science it will take some time and a lot of effort to get perspective on the issue. But one thing is clear: don’t blame it on the “little Buddhas”.

The main goal of a company is to maximise shareholder value. If you write something like this just a few will disagree. But the fact is that this commonly accepted truth (”commonly accepted” should be disqualifying enough for something to be called truth) contains a great deal of ideology and political positioning. Should we question it then?

Chartered companies were created in Europe as regulated companies, with obligations and rights, that thrived in the 16th century. They were thought to facilitate new enterprises such as international trade and exploration in a time that the world was much bigger than it is today and, seen from the European world-view, unexplored. Usually they were awarded with monopolies resulting from the discovering of new lands. The challenge was to discover, open the new routes and make them profitable. Shareholders provided capital and benefited from profits. There were even “good government” dispositions (yes, that was prior to Enron).

They evolved. They originated the modern limited-liability companies. That was already the 19th century. They required (and still require) an official registration of a constitution document signed by its creators and first shareholders. Before they were only partnerships, some people operating together. But then they could be taxed and could own assets. They bear the consequences of their actions, not their owners. That way any loss would be limited.Those corporations would protect their shareholders, limiting their losses to the capital that had been invested. And they had rights to part of the benefits: dividends.

Corporations thus existed per se, and were accountable to different kinds of stakeholders: not only their shareholders but also their customers, their employees (and that included their managers), their suppliers, the communities where they operate, and the whole of society. The company had to think of all of them.

But in some moment, probably in the same wave of thought that I described in the previous post The darker side of economics (how well intended theories can get the worst out of MBAs) things simply changed.

Shareholder value became anything. Superinflated-ego-CEOs came into view as the media cherished and the public agreed. We became used to greed, to super-heros that, by themselves, transformed companies into successes (yes, like if CEOs did everything all alone, and the shareholders owned everything). They began earning more and more, from stock options to huge sums of money, while employees were either laid-off or with raises along with inflation levels.Somewhere along the road we assumed that the CEOs were the companies and the shareholders owned the assets. Neither is true. The CEOs just have a small share of the work, but in every company there’s much more human capital than the CEO. And it’s the company that owns the assets, shareholders just contribute with another kind of capital in return for a share of the benefits, similarly to what banks do in return for interests. But shareholders can buy and sell at any time in the capital markets. Usually shareholders have no implication at all with the company, being funds that replicate an index or people that invest their savings and have no knowledge of the business at all (neither wish to have).

Shareholders provide funds, assume risks and, of course, expect value. But they are not the only ones to assume risks and expect value: so do employees, that cannot swap jobs as easy as selling stock on the market. And so do banks, and so do countries that, in the first place, enabled their charters and their limited responsibilities.

If they were all theirs, why should the rest of us grant them limited-liabilities? If owners could do whatever they wish with the assets, they should be registered to their names, and assume the whole range of consequences. A world were a few could do anything and still be protected wouldn’t be fair. Risk must be rewarded, for sure, but not just the shareholders’ that surely deserve their retributions: customers that buy must be taken care of because customers that feel that they are only cash cows or cheated won’t be loyal, as employees that feel that loyalty has stopped being reciprocal.

Companies are more than profit machines. There are dilemmas to be solved, stakeholders to be considered and prioritise, there’s more than cost/benefit analysis. They are more than isolated units. And they don’t have to be greedy, as we don’t have to be. There’s still room for principles, for integrity, for loyalty. And that’s for employees, for shareholders, for managers and for CEOs.

The subprime crisis has arrived. Yes, many anticipated so. That’s what happens when economy depends on expectations. They take some time to change and, when they change, they do it abruptly. Like those subprime mortgages that have transformed from “hot products” to “hot potatoes”.

Overall is not a matter of solvency but liquidity. I agree, tell that to those that will not be able to afford the mortgages, maybe up to 500.000 people in the US. But investors do not worry much about them. Investors just get scared and they stop pouring endless capital… until they start to do the same somewhere else.

Because companies still report record earnings and the price of gold has been rising non-stop. That means that the machine is still working.

But let’s not be too complacent. A wider crisis can still arise. If gold is “hot”, ABS are cooler than ever. ABS are asset-backed securities, financial products made up of mortgages and things alike that are covered by a real asset, such as your home. These are a way for banks to get cheap financing and externalise risks, because the default risk is transmitted by the ABS, while it wouldn’t be with debt, for instance.

If banks get increasingly difficult to finance, they will transmit this additional cost to companies and consumers. And that’s an entry point to generate a widespread crisis. Central banks should add additional liquidity to the system by lowering rates, but that seems unlikely given their current policies.

But, what about private equity? Now it will be more difficult for them to get cheap capital to finance, that’s for sure. But that doesn’t mean they have no future. On the contrary, they are now more needed than ever, because they are the ones to provide that leaning, that additional shakedown that companies needed in times of more expensive credit.

Remember, there’s much more to private equity than leveraged buy-outs, they have an important role in the markets, and that means they have an important role to play in this new situation.

PD: I read this morning in “The Economist” that the US were thinking of “relief measures” for the crisis. Then I changed to a Spanish newspaper and read about the Popular Party (centre-right and opposition and presumed liberal) to propose the right not to pay mortgages during a year for the unemployed. Alarmed by both news I couldn’t help the thought: regulation must ensure that the system is not abused but, let the market regulate itself. Although some regulations will be painful, it’s the most effective way we’ve come to know.

We make decisions all the time. And when we don’t, usually, problems become graver problems.As you know, it’s better to make the wrong decision than to make no decision at all.

But, on what basis do we construct our decisions? Some people are more practical than others, some people think more on the human side, some people abide to their principles no matter what, and some worry a lot about the consequences.

In fact the most considerable bulk of humans, and that includes me, just mix different ways of thinking and making decisions. We are not pure in our decision making. And the proportions change from one person to another. They depend on the mindsets, the circumstances, temperaments or even circumstantial moods.

We always think of our decisions as the most rational ones. We tend to perceive ourselves as non-biased. But we can’t help seeing the world through our filters. We reflect what we are on the decisions we make.

In this series of four posts, that altogether configure a meme, or a basic cultural unit, I want to identify four basical thinkers that defend very specific ways to make decisions.

These four basic ways of thinking are present in each one of us. They configure an important part of our decision making process, impersonating four different perspectives to every decision.

Think about them. They will help you understand the mental process that makes you consider different options and thus four different ways to weight outcomes. And they will help you in knowing yourself better and, why not, into making better decisions or at least understanding your decisions better.

The first way of thinking is consequentialism or utilitarianism.

One of the thinkers that most effectively impersonates utilitarianism is John Stuart Mill (1806-1873). Many things can be said about him. In fact he is worth much more than one post, being his thought configured by his father James Mill and his father’s friend Jeremy Bentham.

Stuart Mill was a deep boned liberal, fending for a slimmer and democratic government limited by individual freedom.

How would he reason? He’d think of the consequences of the actions. Thus, when we impersonate Mill we think how what we are about to do will affect on others. The concepts of utility and happiness come into front view. They become important under utilitarianism.

In fact he followed the ideas of Bentham, close friend to his father and mentor to the young John.

Jeremy Bentham was also British, and lived from 1748 to 1832. He can be considered the father of utilitarianism He was a liberal, defending the most basic rights, from the right to freedom in a world that still practised slavery, to the suppression of physical punishment, widely practised not only in prisons but also in schools, and specially the right of the individual not to be limited by the state in any way short of affecting negatively his fellow citizens.

In fact he’d be happy today to see that some of the subjects that he was worried about are being considered today. He supported the equality of women in every way, animal rights, the right to divorce and even homosexual rights. And that was 200 years ago! Education was essential for Bentham too.

In the economic sphere he abhorred of monopolies and usury, free trade, inheritance taxes, pensions and insurances. Both Stuart Mill and Bentham are usually regarded as proclaimers of a minimal state, but that’s not true. The individual freedom is paramount, but the states must guarantee basic rights and a basic equality to protect those who suffer. At the same time, the states must foster economic growth so as to facilitate a minimal subsistence level and encourage wealth.

Most of all, he incised decisively in a society, the British society, so fond of its traditional approach, initiating a wave of change, a progressive change towards a new idea: the well being of the majority. Well being that could even be translated to happiness. So the decisions in Britain had to be taken thinking of the population, and those who were affected by them.

The following quote from Bentham defines good and bad, moving closer to hedonism.

“Nature has placed mankind under the governance of two sovereign masters, pain and pleasure. It is for them alone to point out what we ought to do as well as to determine what we shall do. On the one hand, the standard of right and wrong, on the other the chain of causes and effects, are fastened to their throne.”

Consequentialism was thus being born, shaking the foundations of the British society and starting a movement to change the laws -another sphere of decisions- to have them aligned with the majority, not with the privileged ones. That was a huge leap towards progress and a fairer society. This wish for reform would help Britain to evolve further, no longer being constrained by mediaeval concepts. And with Britain, more nations followed in the will-be-developed world. No wonder Bentham supported both the American Independence and the French Revolution.There are differences between Bentham and Mill. The first thinks of the majority fostering the critique about the majority dictatorship. The second is able to modulate all that into a more sensible and respectful approach for the minorities. Stuart Mill had more time to elaborate and adapt his thoughts, and had an increased social component in his thought.

But, back to decision making, what counts is that we make the decision thinking of the consequences, not out of principles or rules inherited over the centuries, not faith or revelation. There’s not statu quo to preserve, good intentions or psychological reasons, there’s only utility, general utility. The more useful the better.

It’s funny that the Wall Street Journal published this week an article about the consolidation of the European airline industry. I’ve written about Iberia and it’s many contenders in two previous posts: Airlines corporate hunt: British Airways and TPG finally join forces to buy Iberia and Iberia and its brides… where’s the value?

What has happened this time about Iberia? In fact very little.

I don’t know what the WSJ article said because I’m not a subscriber. But this wave of consolidation that they talk about has come to a stall in Spain. Why?

BA and Iberia: having second thoughts?

One of my assumptions was that, where there is a flagship airline, there are also political interests. No need to prove me wrong. Politics have a lot to do with that. And it’s Iberia who has been stalling the situation.

Because Iberia’s dominant position in Spain, specially in Madrid, has a lot to do with political connections. They have been granted the best slots and the lion’s share of Madrid brand new terminal: T4.

Madrid’s brand new Terminal 4, granted to Iberia and OneWorld

The Spanish government has already required that Iberia needs to be Spanish to keep enjoying the privileges it already enjoys (exclusive routes, slot assignement, top location at Spain’s first airport).

In time this privileges will cease to exist, specially when European regulations in open skies come to be in effect. But I don’t know any single country that doesn’t -or didn’t- protect its flagship airline.

The government’s point: we’ll still protect the status quo, but only for a Spanish company. And Texas Pacific Group or British Airways are not exactly Spanish. But, how do you know if Iberia is Spanish right now? How can you know who, in fact, owns free floating shares?

Anyway, these are advantadges that no company should have, regardless of its nationality. They are just imperfections of the market that the consumer ends up, as always, paying. But that’s how it is, and that’s how I like to tell

State Highway 121, Texas, U.S.

More noise from Texas

And right now another Spanish company, the infrastructure operator CINTRA is fighting for a highway concession in Texas: State Highway 121. The company already exploits two highways in the US: Chicago Skyway and Indiana Toll Road, and is already constructing a third one in Texas: SH 130. The concession was granted to CINTRA, but it has been recently revised. The Texas Transport Commision still has the final word but taking back a concession already granted to a Spanish company wouldn’t help politically Texas Pacific Group interests in Iberia.

Which strategy now?

Just let the time pass. Iberia has not given any of the contenders its data, and it is for a very good reason. The longer it takes, the better. Why? Spain will hold a general election in nine months. Maybe the government will change but, in any case, the government will be less pressured and open to negotiations.

One of the things that amazes me most is how almost anyone can define himself as a liberal. From people defending free market at all costs, to authoritarian leaders that start wars, to people defending compassionate conservatism, to people fighting for human rights and marriage for same-sex couples… all of them define themselves as liberals.

There’s only one other concept more self-identified than liberalism, that is centrism or, even better, the idea of being a moderate. Everybody is a moderate, regardless of what you may think, you’ll always find somebody more radical than you. But when one of the few people more radical than you happens to be Adolf Hitler, the odds are that you’re not as moderate as you might think.

Different kinds of liberals

Fortunately the richness of the English language provides us with alternative words to liberal, one of them being libertarian. Remember the post about Rawls and Nozick? Nozick would be a libertarian. Many people that are really libertarians label themselves as liberals. Why not? It’s rather clear the two concepts intersect somewhere.

But one of the best ways to classify the different kind of liberals is to use two dimensions for liberalism: social liberalism and economic (or fiscal) liberalism.

That is most helpful to classify people: some people defend a lot of freedom in front of the state for economic matters, that would mean few or no taxes at all, freedom of enterprise, expanded society shielding for investors or even managers, work force flexibility, no market regulations at all, and many more. They opt for a reduced state (Nozick’s style) that will center its tasks to protect property rights and contract rights and all kind of acquired rights. The only thing that the state would monopolise would be security, and for efficiency reasons. But then those same people would use that force-enabled-state to put social order. Where that begins is by putting trespassers to jail, but where that ends is not so clear: kicking immigrants back to their countries? forbidding abortion and jailing doctors? making compulsory to teach science conditioned to the Holy Bible? Outlawing and punishing sex before marriage? This kind of people were those who embraced Nozick’s ideas (they still do) and make him nervous and uneasy at the same time.

So it seems clear you can be an economic liberal, but socially conservative. Or even authoritarian in that sense. That would lead to fascism. Or defend individual rights an at the same time wish for an economic system controlled by the state so no individual would be crushed in the economic sense. Also makes sense to me. In that case you could be a social liberal but a socialist at the same time. Ghandi or Zapatero (Spain’s Prime Minister) would be in that classification.

Let’s draw both dimensions:

• On the horizontal axis the economic dimension. More leftist would lay obviously on the left, like communism or socialism, planned or more regulated economies. On the right more freedom for entrepreneurs and companies, unregulated markets, more choices, and further right free market without any control that is savage and rough market. Milton Friedman would lean to the right, and general Pinochet, ex-dictator from Chili, would be on the extreme right.
• On the vertical axis the difference between libertarian and authoritarian. Fascism on the top, like Hitler, the more control the better, and liberalism on the bottom. That would suit Bentham and the hedonists for example. Ghandi and Friedman would be both social liberals, while one would lean to the left: Gandhi, and the other to the right: Friedman proclaiming both individual freedom and fiscal freedom.

This chart could summarise both parameters:

Now, test yourself and know where you are

The source for the previous graph is a very recommended link: http://www.politicalcompass.org/

In that page there is a questionnaire that you can complete. It’s made up of six pages, each one with a series of questions that will challenge both your political and economical views. And then locate you in the two dimensional space.

That’s what I’ve done. I’ve just completed the political questionnaire on http://www.politicalcompass.org/questionnaire. That was funny so I just thought I’d share my results with you

To my surprise, these were my coordinates:

• Economic Left/Right: 0.25
• Social Libertarian/Authoritarian: -2.87

What amazes me most is that I’ve always thought that centrism was a myth. Or at least a psychological effect: people would tend to think they were “in the middle” regardless of their views. How could anyone not agree with the affirmation “I am a reasonable human“? Even with the alternative one: “I am an unbiased observer of reality“?

Well, probably the test is wrong, but it put me on the center, right in between left and right. Am I the sole centrist that I know? Should I be analysed? Who knows…

And regarding the social scale, I’d be on the liberal zone, half way to anarchism, I guess that would be libertarian.

If you draw the coordinates, the blue point, I fall somewhere in between Gandhi and Milton Friedman, an funny mix. Still unsure of what that means to my future development as a human, I’ll have to think further about that.

As I wrote yesterday, ideologies and ideals do matter. And they define too the way we think and the way we use reasoning. So, if there are different ways to define justice, and each one of these ways means different ways of thinking and reasoning, each one of us might even end up with different economic conclusions. And that means trouble for Economy as a science.

How can we know if the things taught at business schools are true? Some used to be true, from a classical point of view, like Say’s Law: there can be no supply without demand.

Then keynesianism sent them back to the closet: supply creates its own demand. And the economy will keep growing until full use of resources: full employment.

Until 1929, something went wrong and that didn’t happen. Keynes himself realised. (I’ll write another day about liquidity traps and monetary policy)

But one of the essential instruments of keynesianism was the Phillips curve, remember it? More trouble.

The Phillips curve revealed: let’s reduce unemployment just changing prices!

It relates unenployment and inflation. It used to be said that raising inflation then the actual value of salaries go down and unemployment goes up because you have a cheaper workforce. (As a curiosity Samuelson and Solow were the ones to grasp the concept, not Phillips who had only collected data, and there was another previous economist: Fisher, who had understood the concept first)

Another of the advances of economy in post second world war, along with the IS-LM model of John Hicks, that of course is taken for granted in schools and its the foundation of what we call Macroeconomy.

Seen it before? The IS-LM model

But, although they didn’t know it, the Phillips curve was born already dead.

Milton Friedman and Edmund Phelps realised that the fact that people knew about the Phillips curve rendered it unusable.

Why? If prices were expected to change, salaries would change accordingly. We change our wages taking into account the yearly change of prices. (At least that’s what my contract says)

The death of the Phillips curve gave birth to the theory of expectations: there is a natural rate of unenployment and you can have some effect on the short run, but not on the long term because *people do know what you’re trying to do*.

Monetary policy (remember my blog about Euro exchange rates?) or fiscal policy? The war had begun and it’s still not over.

It is Robert Lucas who said that people’s behaviours change in response to government policies. (In other words, we citizens are sort of numb, but not too dumb.) And the Lucas critique says that you cannot make political decisions solely based on series of historical data, because when you change the rules things won’t happen the same way.

And back to the beginning, how many sciences do you know whose rules can be changed by politicians?

It’s easy to say that ideals don’t matter anymore and all political parties are very much alike. Maybe they are, maybe they are not, but ideals still do matter, and there are many ways to economic justice.

It’s always a good moment to review the works of John Rawls. American philosopher, 1921 - 2002, his definition of justice is specially interesting. John Rawls () was an egalitarian liberalist. He defined “justice” as equity and fairness opposed to favoritism, utilitarianism (greater good for the majority at the expense of a minority) and prejudice.

This necessity to avoid prejudice reminds us of the “social contract” of Locke, Hobbes and Rousseau. Justice would require a collective agreement by the different parts regardless of their private interests. This means that a valid contract requires freedom to accept it or not and thus can never be imposed.

The “veil of ignorance” would help the different parts to reach a just agreement because they’d forget who they are, where they come from and what they own, in a similar way that the ideal politician would try to represent all electors regardless of the political party they have voted (!!!) to ensure fair laws. That would mean no lobbying, no big business in election campaigns, and candidates wouldn’t need to be very rich (as they are now in the US, although the US Constitution agrees with Rawls).

For example, imagine a group of shipwreck survivors. They begin anew so they part the land. And they decide to share it on equal parts. But not all parts of the island are equally productive so they reach an agreement: they will all give their land to the lucky owner of the “food well” in exchange for the right to be fed for the rest of their lives.

But time goes by, and another generation comes. And the lucky child who has inherited all the land decides to share the “food well” only in exchange for twelve hours of labour from the other residents. Would that be fair?

From a liberalist point of view, it wouldn’t. The choice is forced upon the residents: either agree or perish. There’s not an equality situation in the contract, nor a way to opt-out. And if they were to make the new contract under the “veil of ignorance”, without knowing who’d be the fortunate ones, they wouldn’t make the bet.

Egalitarian liberalism tries to lever the playing field. It tries to identify which are the legitimate trades and which are not. (Remember the blog entry on Aristotle?) The market won’t produce justice by itself, so it must be controlled by some kind of superior institution: the state, that protects individuals from abuse. (More about Rawls political liberalism here)

And then there is Robert Nozick, also an American philosopher, 1938 - 2003. Nozick is a libertarian, opposed to the social-democratic liberalist values of Rawls.

Nozick wants to refute liberalism, which he sees opposed to personal freedom. He defines the state as a “watchman”, or a “security company”, but nothing more than that. It’s own existence would only come from the right of the individuals to defend themselves, which they’d externalise. From externalisation would come economies of scale that, in a competitive market, would end up in a monopoly of a great security company. Now change the name of the company and call it “state”.

The state wouldn’t regulate economic activities, wouldn’t provide education or wouldn’t think of what is fair or not. The state only would have the power to defend its citizens and its rights (emanating from the individual right to defend yourself). No taxes, no health care, no minimum wages. Nothing.

In the island case, the owner of the land could do with his property as he sees fit. And the contract would be a perfect valid contract. A capitalist act between consenting adults, nothing more to it. (More about Nozick here)

Rawls and Nozick provide their own conception of social justice. From this basic set of rules, they derive the way society should work. But they are two incompatible views. In this great duality between Rawls and Nozick many might see the dual principles that Europe and America developed from. Big government can be something inherently good for some Europeans at the same time its the “big Satan” for some Americans.

Needles to say between black and white there’s an infinite range of greys. (Fortunately)

Following the previous thread about lag, devaluations and j-curves now there is a real case of politicians versus economists. In this case France’s brand new president: Sarkozy and the European Central Bank (ECB).

I don’t want to appear one-sided with this guy. There are many likeable things in him, but there’s something bonapartist about him (yes, Napoleon Bonaparte was one of the predecessors of populism, IMHO). Even Angela Merkel, the gal that has raised the German’s economy and self-esteem, is a bit anxious about him.

different leaders, different perceptions

Sarkozy has decided to erode the ECB’s independence. In fact that’s a long tradition in French politics and Sego wouldn’t have done otherwise. I’m not the one to say that ECB’s decisions, taken by some economists inside that fortress, cannot be improved. (Wish I knew better than them) But i can see something inherently good from having economists insulated from politics.

Sarkozy is a clear opposer of a strong Euro. In his campaign he claimed he’d pressure ECB to force a devaluation and blamed the current exchange rate of all evils. It’s getting boring to hear that Brussels is blamed for everything local politicians don’t want to assume.

It’s true that the Euro is expensive and that hurts exports, but it is also true that means cheap energy, which Europe is highly dependent on. If the high exchange rate was a problem, it’d be only part of it.

Exports have been bad for France, but not that bad for Germany which is back in the road to growth (one million jobs created in the last year and a new exportation record), and they share the same exchange rate. Maybe there’s something related to a strong participation of the state in the economy, an inflated welfare state that makes for a nice way of living but leaves a huge bill to pay, or simply resistance to change, a very well known fright to loose a higly secured way of life that is not compatible with much needed reforms. (3 hour week, low spending in research and development, low inflation control…)

Don’t forget that most of exports and imports of the Euro zone are between member countries. And those interchanges are not affected by exchange rates. And many of the other countries, such as Spain (wish we had the strength of the French economy), have made steep reforms and changes, opening the economy, growing strongly (of course with a lot of structural problems but nonetheless strong growth), and reducing unemployment. Euro devaluations won’t help the French compete with the Germans or stop the relocation of industries that move to Eastern Europe seeking lower wages.

But it’s not only a exchange rate problem: there’s a new European scepticism there, similar to that experienced by Britons, but this time french-flavoured: “faire plier le BCE” (make it bend). Something about French self-economic determination and distrust of an Euro that is not maleable to political interests. (and remember: the loss of independence and thus credibility of the ECB would come with a cost too)

Trichet says: do not mess with the ECB

It’s funny that happens while the ECB’s president is a frenchman: Jean Claude Trichet.

I promise not to bother you much with my “lag” thoughts, although I can’t help writing some more about it.

Another common situation is a devaluation. Usually when a country devaluates its currency it does so thinking about competitivity. That means it will be able to sell more and improve its trade balance.

But, it is really going to improve? Well, in the short run it’s going to have to pay more for its imports, and its exports are going to be just the same. So, while improvements still lie ahead, the short run means more trouble.

That’s what the students of international economics know as the J-curve. I’ve modelised the curve from a Poisson distribution (the inmediate effect) plus a step function (the long run) and it looks like this:

So, if politicians decide a devaluation in their second term, situation will worsen enough not to show any benefit before their reelection campaign. That means trouble: lag matters. And that means that some countries are more able to use this kind of resources than others: the ones whose rulers don’t have to face reelection.

But I bet reality won’t be so simple. Other countries are able to react and will, in time, adjust their currencies to match. That means that, on the long run, the changes will be minimal, if any. I’ve tried to modelise that too with two Poisson distributions of different parameters:

That means that there will be a net gain based on the first-mover strategy: in the example chosen the area that is below the axis is smaller than the area above (exactly one half), but there will be no yearly gain on the long run.

Going back to the point, this is a dynamic model. Things don’t happen the same day, time matters and there are several effects counteracting each other. The order matters cos there is not advantage on the long run but just gains.

And every decision will have its consequences that, in time, will mix with more decisions. If we observe economic reality we may not be able to see the consequences of just one action but a continuous mix of different decisions of several participants.

Let’s go back to our politician. He lost his reelection to his rival that decided to do the opposite and restore the previous exchange rate. Now we imagine that the same ripple effect happens the other way round and the economic system just responds the same (opposite) way:

Look from terms 4 to 8. A new boom? Did the new politician save the country? Who will be elected in next election due for year 8? What will happen in the long run? Funny how lag matters.