Knowing and Making

Alan Sugar has belatedly discovered an important economic concept: the idea of incidence . The star of The Apprentice and former owner of Tottenham Hotspur has just realised that when new income pours into a competitive industry which relies on scarce resources, incumbent companies don't get to keep the money. The standard example of this in economics is farm subsidies. Although one might think farm subsidies are good for farmers, that is not really true. Because there's a fixed supply of farmland, whose price is determined by how much money a farmer can generate from it, all of the extra money is - eventually - captured by landlords in higher rents. Farmers might benefit in the short term, as this paper suggests , but when their leases are up for renewal the rent will go up. Football is no different - there's a limited number of talented players, and all the clubs want to buy them. So now that the Premier League makes £2 billion a year (twelve times the amount of 20...

Martin Wolf has described  the eurozone rescue package for Greece, correctly, as "a fudge". However, he thinks this is a bad  thing. Here's why it might not be. One of the key goals in designing a rescue package is to avoid creating moral hazard  - the risk that other countries look at the bailout, assume that they will be rescued too and therefore continue to borrow. If the rules for the bailout are clearly stated, that creates an anchor  which encourages people to trade up to it. The most obvious example is the Maastricht treaty rule which stated that countries in the EU must keep their fiscal deficit below 3% of GDP. Guess what size of deficit most countries ended up with? Around 2.9% was a pretty common figure. So if the rules for the rescue were made explicit, it would give governments very clear guidance on exactly what risks they could take. Inevitably, some would be tempted to push it to the limit - and fall over that limit, in the knowledge that the ...

Paul Krugman (via Niklas Blanchard ) is among many people asserting that: ...when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies. (Niklas says this violates the law of one price - but the law of one price applies only when there is one good. In fact, hardly any goods are the same between Germany and Greece - labour is not as productive in Greece, the local tastes are for different products, and many services are non-tradable and not subject to the law of one price. An important example of this is that retailing is a service. Both the cost of retailing and the demand for it (which in Greece is strongly derived from tourism) affect the price of goods sold in shops. So the existence of the euro doesn't by itself imply that wages and prices should equalise quickly.) But that is an aside. In fact, I am unconvinced that Krugman's statement is true at all. According to  this report , Greek unit labour costs last year...

In defence of Greece, I pointed out to a colleague the other day that the cost of a Greek CDS is only 4% for a five year period - meaning that you only need a 0.8% interest premium to make a Greek bond worthwhile, or that the market only gives Greece a 1/125 chance of defaulting each year. He responded with the valid observation that this is all very well, but who's offering this insurance policy and will they be around to pay it if Greece does default? After all, AIG wasn't. In fact, the 4% is not  the spread between the chances of Greece defaulting and a risk-free bond, as it's commonly presented. It is actually the spread between the chances of a Greek default and an  insurance company  default. It's a lot easier for an insurance company to go bust than it was two years ago. Not only have risk conditions deteriorated, but after AIG, Citi and the rest, it would be immensely tough politically to bail out another big insurance company or bank which had issued CDS...

There's a meme around which says that the euro is destined to break up because countries like Greece are fundamentally less productive than countries like Germany. A strategist at Societe Generale has put his name  to this idea, as has the director of the Open Europe (anti-EU) think tank. This argument supposes that the only way to become competitive is to devalue one's currency. But surely this applies within countries too? The southern half of Italy is much less productive than the north, while the reverse is true in Britain. But there are no calls for a London currency and when the lira existed, it was never under the threat of an Italian breakup. Different states in the US are just the same - with widely varying fiscal problems as well as the same diversity of competitiveness. At the individual company scale, Yahoo is less competitive than Google, but does Yahoo need its own currency to devalue? And 22-year-old new college graduate Travis is less productive than his e...

Interesting but depressing Paul Krugman interview Interesting but depressing Economist cover story I was going to write about bubbles, but an almost throwaway point from the Krugman interview led me into thinking about devaluations instead. He suggests that Spain might need to (as Estonia has already done) reduce wages and prices across its economy to regain competitiveness, because they can't take the shortcut of devaluing their currency. And this, as he points out, is going to be difficult. Devaluations were a concept that used to fascinate me as a teenager (OK, maybe I was an odd teenager - but in my defence this was before I had a girlfriend). The topic hasn't been as prominent recently, except in the debate on the Chinese-US exchange rate. But Krugman's comment started me wondering just why it should be so hard to achieve a cut in prices these days. After all, wages and prices are just nominal values; yes, there are costs to changing them but they're not tha...

Vaclav Klaus has become the final European leader to sign the Lisbon treaty into law, enabling it to take effect across all 27 countries. This is good news from a purely practical point of view - it streamlines decision making and enables the EU to work more effectively with a growing number of member states. From a symbolic point of view things are more controversial. It is a declaration that the European institutions intend to move forward rather than fading into irrelevance, and there are a number of important symbols which will reinforce this in the public view. In ten years it is possible to foresee a European president coordinating and powerfully representing European interests in the world. Possibly even the beginning of a European economic or fiscal presence. And most importantly, a more powerful, legitimate and meaningful democratic process in Brussels and Strasbourg. Most people would regard most of these things - in isolation - as positive moves. But they will inevitably ta...