Tuesday, December 31, 2013

Speaking Engagements

European Identity and The Euro Crisis: Fiscal Limitations For Federalist Aspirations – ‘Sovereignty Formulas between Autonomy and Independence: Towards a Reconfiguration of Europe?’ Workshop on the Dynamics of Nationalist Evolution in Contemporary Europe,Foresight Centre, University of Liverpool, 14-15 May 2015

The Demographic Challenges Facing Greece, A New Growth Model For the Greek Economy, 3 June 2015, Conference (here) organised by the Greek Chamber of Commerce and the Greek Parliamentary Budget Office

Ideas, Models, Values – College of Certified Auditors annual congress, Sitges, July 2014 (more here)

Spain & Japan: Two Developed Countries Facing a Lost Decade – CIDOB Centre for International Affairs, Barcelona, January 2014 (more here)

What do ageing populations have to do with the sovereign debt crisis? - Morningstar Investment Conference Europe, Vienna, March 2013 (more here)

The Demographic Revolution – A Threat to Our Pensions? - Globes Israel Business Conference, Tel Aviv, December 2012 (more here)

Saving the euro, but at what price? – Presentation, British Chamber of Commerce in Spain, Barcelona, November 2012 (more here)

Challenges Still Facing Spain - Euram, Olot, November 2012 (more here)

Portugal, Will The Last To Leave Kindly Switch Off The Lights! – Presentation at the Conference "Neglecting social Europe? The economic deadlock!" European Parliament Greens EFA, June 2012 (more here)

The Future of the Spanish Economy in the Eurozone - Euromoney Spanish Capital Markets Forum, Madrid, May 2012 (more here)

The Economic Consequences Of Latvia’s Demographic Decline – Presentation at the conference “Too Late To Defuse The Ticking Demographic Time Bomb For Latvia” organized by the American Chamber of Commerce in Latvia, Riga April 2012 (more here)

Decision making in the face of an uncertain future: ageing populations and Europe's debt crisis - paper presented at the EU seventh framework programme meeting “Exploring the future in complex social systems for decision making”, Department of Urban and Regional Planning, Florence February 2012 (more here)

The Future of the Euro - Barcelona Business Network, Barcelona, January 2012 (more here)

The Stability of the Euro- Borsadiner Financial Professionals Forum, Presentation, Barcelona, November 2011 (more here)

The Euro, Demography and Italy's Long Term Growth Challenge – Presentation, Italian Democratic Party Summer School, Cortona, September 2011 (more here)

The Coming Indian Summer? – Lecture, Danske Bank Central Bankers Forum, Copenhagen, June 2011 (more here)

Exporting Your Way Out Of Trouble Under A Currency Peg – Open University of Catalonia , Presentation during the Conference “Economic Crisis in Small Countries”, Barcelona, Catalonia, May 2011 (more here)

East Europe’s Looming Demographic Crisis - Stockholm School of Economics, Public Lecture Riga, April 2011 (more here)

Saying Goodbye to One Crisis, Only To Say Hello To The Next One - International Employee Benefits Association, 11th Annual Conference, Brussels, March 2011 (more here)

Why Economists Got It Wrong - London School of Economics, School of Management, Public Lecture, London, February 2011 (more here)

Is Spain’s Fiscal Correction Sufficient? – Barcelona, Borsadiner Financial Professionals Forum, November 2010 (more here)

Is Immigration A Solution To Our Long Term Pension Problems? - Bergen Business School, TED Talk, Bergen November 2010 (more here)

Can the Euro Be Saved? - Polish Economic Forum, Krynica, Poland, September 2010 (more here)

Spain - Towards Finland or Argentina? - Circulo de Economía, Presentation, Sitges, May 2010 (more here)

All About Edward

"Economists hitherto have tried hard enough and often enough to change the world, the real difficulty however is to understand it."

"In a world where expectations are (nearly) everything, to change our understanding is already to change our reality. Not only that, changing things this way is the most plausible, most cost effective and least destructive way of doing so" 

Barcelona Urban Legend

"Santiago Rosinyol had had a hard day. As he sat himself wearily down at the top of Las Ramblas he bent over to adjust a small sign which was propped-up awkwardly against his left foot. It read. "To trade: any three ideas of mine for one of yours". Unfortunately that day there were no takers. Nor indeed were there any the next day, or the next one, nor even the one after that. Evidently people thought there must be some kind of catch. Finally, and exhausted, Rosinyol folded his chair, ripped up the sign, and went sadly on his way."

Who am I?

That is a good question. One I think most of us should ask ourselves more often. Officially I am currently fifty sixty five, I live in a small village near the town of Figueres, about half an hour away from the frontier with France and more or less the same distance from the beaches of the sunny Costa Brava. Before that I lived for 20 years in Barcelona.  In fact the area I live in is called the "Alt Empordà", and these days more than either British or Catalan I would describe myself as Empordanense. It is a lovely area for those who don't know it, and aside from the beaches and the Salvador Dalí legacy there are mountainous areas as well as splendid planes populated by vineyards and olive trees.

If I were pinned down in a corner and had for once to say what, in a single word, I was - as opposed to who I am - I would undoubtedly say I was an 'economist', although this is a destiny that most of the people who know me well would say I had spent the better part of my life trying to avoid. Pinning it down even further I would probably clarify that I was in fact a macro-economist. I have to say that microeconomics, which is the kind almost anyone who isn't a macro-freak prefers, has always bored me - almost to tears, and indeed almost to the point of causing me to fail my first degree. The fact that microeconomics fails to "turn me on" is curious since I notice that the vast majority of popular weblogs deal precisely with micro-type topics. Evidently either most people have understood something which I have failed to grasp, or the opposite is the case.

Or could it be I am just fascinated by the big-picture stories.

Filling-in that little box which asks "how would you describe yourself (maximum 50 words)" has always being something of a problem for me. In fact I have the feeling that as soon as someone tries to put a label on me I am already struggling loose trying to escape from it. Perhaps the best commendation to my work was made by my old school headmaster who, in one of those endless termly reports, got right to the heart of things: 'is he trying to prove that any fool can miss a bus?' He was definitely right, I seem to have spent the best part of half a century becoming a specialist in missing buses.

Adding insult to injury in this thankless quest to follow the advice of Socrates and try to get to know better what it was I didn't know, I was once described by my Departmental Professor as a 'thief' for accepting my doctoral grant while continuing to spend my time reading the books and attending the courses that I chose to, the ones that I thought were interesting and relevant to my development both as a person and as someone who works with ideas. In a way I am still doing this, reading what interests me, and writing about what attracts my attention. In many ways it is what being independent means, even if it doesn't get you much in the way of work with what is known as the "official sector".

I think I suffer from what used to be called 'an excess of curiosity', the kind that kills cats, you know. This is a condition which has never been encouraged by the mainstream, and indeed the  scholastics even regarded it as the nearest thing to an intellectual sin. Philosophy is born of wonder, but an excess of it was thought to be fatal. Possibly it is, or at least not conducive to producing a corpus of work, since you never know where to draw the line.  I do take some consolation, however, in the thought that in an age where internet connectivity puts the generalist right back in business, and big-time, then the optimal level of healthy curiosity per cubic centimeter of neuronal mass may have just risen, and excessive curiosity might now not be the 'vice' it was once thought to be.

At least, this is how I square things with myself.

The humanist psychologist Erich Fromm wrote quite a lot about 'Having and Being'. I'm definitely on the 'being' side of thinks (indeed I just gave away the last consignment of what used to constitute a lifelong collection of books). Don't worry, they were all found good homes, it's just that I don't believe in leaving things around to accumulate dust, and books do accumulate lots of the stuff. Sartre on the other hand indulged himself with the exploration of the boundaries between being and doing. Again he was (existentially speaking) much more on the 'doing' side of things, (as was his writer friend Albert Camus). But there is doing and doing. The last time I was asked what it was I 'did', I replied rather cantankerously, that I don't do, I think. Perhaps if I said thinking is what they pay me for, that would sound less pretentious.

I mention this here since I suppose, tucked away in that response, somewhere there lies a feeling, possibly even a prejudice, which more or less sums me up. It runs something like this: if more economists spent more time really thinking about what economic systems are, and exploring more audacious hypotheses about how they might work, and how they might relate to other systems which interact with them (like the climatic or biological reproductive ones), and less time tinkering around with what appear to be me to be exceedingly ontologically-promiscuous, but at the same time all too often essentially useless, mathematical models, the as a profession they might have a better reputation.  The models they use all too often have a pretty questionable set of relationships with the day-to-day functioning of that all too real economic system we encounter all around us in our everyday lives. Well I think that if we made a move in that direction we might (just might), as a profession, make a better 'all round' job of anticipating some of the problems knocking around out there  before they come crashing into our lives making their presence only too obvious.

OK, so maybe Hegel was right, the owl Minerva does only get to fly after dusk, but do we really have to be so complacent about this that we simply lie down and accept it? Who could possibly have seen it coming? Einstein, I feel, had it about right, keep your explanation simple, but no simpler than the complexity of the problem you have in hand necessitates. (Six centuries earlier, Occam, of course, had  had a very similar thought).

My big (as in biiiiig) bet is that one or two simple parameters can explain more about the whole economic development process than we are conventionally prepared to admit. Pride of place here I would give, of course, to our biological reality, our fertility and our life expectancy, to how these change and to how the changes impact on population age distribution and structure, on performance and on productivity. Much of the rest of our secondary economic epi-phenomena - savings, investment, aggregate demand, interest rates, balance of payments, inflation, productivity - can, I conjecture, be better understood once this fairly basic 'ground-point' has been established. Alfred Marshall had it right, economics has more to do with biology than ever it has to do with physics.

Going back to the practical end of things for a moment, and unwinding history a little by turning realism on its head for a change, I would say - as I indicate in the initial quote at the top of this page - that economists have hitherto been overly obsessed with trying to change the world, and insufficiently so with trying to understandi it!. If as we never cease to tell ourselves expectations matter, then what matters most isn't how things are, but how we perceive them to be.

Finally, to close this whistle stop tour of all my visceral weak spots, three of my favourite quotes on or by Keynes in whose spirit, but not whose letter, I walk:

"John Maynard Keynes was pretty generally regarded as an extremist"

(James Cox, Journey Through My Years, p 367),

"I have sown dragons, but harvested fleas"

(posthumously attributed),

and most important of all

"Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again"

(Tract on Monetary Reform p80).

I do not consider myself a Keynesian, yet I admire his life and his work enormously. I consider myself a Keynesian in the spirit of Keynes, not the letter. The times have changed and so have the problems, both theoretically and practically.

Keynes' problem was war, how to pay for it, and how to escape from the consequences of the indebtedness which comes with it. Our problems are different. They stem principally from our changing demography, and are issues like how to maintain our elderly populations free from penury in the longer run, how to handle the resource supply issues which accompany the rapid economic growth of some of the most populous countries of the world, and how to deal with the climatic impacts of the previous two processes, are the big items on our agenda.

However even if the problems may be very different, sometimes the economic dynamics are unnervingly similar: increasing population, like increasing military activity, tends to be inflationary, at least in an industrialised society. Population decline, and paying-off war debts tend, on the other hand, to be deflationary. But perhaps here the comparisons begin and end. We are a new generation and we have new problems. Perhaps the old labels no longer really help. For me the job of the economist, like that of any other scientist, is to try to understand. Paraphrasing a statement from Robert Lucas about economic growth, and appropriating it to my own circumstances: scarcely a day goes by when I don't think about the changing population structure of the planet, and what it means for us all.

Where Am I?

I live and work in Barcelona, the capital of Catalonia. Barcelona is a city with a long history and a diverse cultural heritage, which means that here we all speak at least two languages: Catalan and Spanish. Barcelona is, was and always has been a city of tremendous immigration, and with the migration it has always been a dynamic city, a city of cultural change.

Across the twentieth century these migration processes have marked Catalonia's history like little else (with the obvious exception of the civil war and the subsequent Franco dictatorship). The start of the century itself saw Barcelona as the vanguard city of a new Spain, with workers arriving from across the whole country to build the new metro system (Spain's first), and to erect the site for Spain's international Industrial Exhibition, which again, not coincidentally, was held in here. In the 1950's and 60's many more migrants came - in particular from Andalusia and Extremadura - to work in the new, rapidly developing, industries which characterised the end of the Franco era.

Today the migrants come from every farflung corner of this diverse planet, but they have one aim in common, to make their future in this wonderful city. This unprecedented recent migratory wave - Catalonia's population has grown from 6 to 7 million in just five years - is now, once more, making Barcelona the most culturally diverse and the most creatively dynamic city in modern Spain.

So it is fitting that I too who am, like my father before me, and his father before him, a migrant, should come here, to one of the migration capitals of modern Europe. Over the the years that I have been here - 16 to date - It is has become abundantly clear to me that immigration played an important part in Barcelona's history long before the arrival of the most recent and obvious waves. Whether you look to the early Phoenicians and Greeks, the later Romans to the arrival of the Converso Jews, fleeing persecution at the end of the middle ages, or to the migrants from France who came in the late 14th century, in this case fleeing to escape the plague, or if you turn your attention to the great internal Spanish migrations of the second half of the 20th century. One common thread remains clear: the singularity and evident prosperity of Barcelona and Catalonia has been in large part due to the singular combination of the hard-working and business-like mentality of the original Catalan inhibatants of this green and pleasant land and the the constant and steady flow of new and eager workers and citizens. This is the secret of the success, and yes, at a time when the seach for 'viable models' is rampant, it is something which I think it would be well worthwhile exporting.


Why am I doing these all this internet stuff that is. (More fundamental questions will have to be answered
elswhere). The conventional answer would probably be that I hadn't got anything better to do at the time.
But I'm sure my friends and family would remind me that that isn't true. Another very good explanation would be that running a blog and updating website pages helps you to order your thoughts, to classify and not lose your ideas. Again, you can share your discoveries - this is a little more difficult since first of all you have to locate the people who might be interested in them, or better said, they have to locate you, but perhaps this amounts to the same thing in the long run.

Deep down I suppose I'm doing this because I've rather stupidly convinced myself that I've got something to say. In particular you'll probably notice I tend to get rather excited about the way the population structure of our planet is in the process of changing. I also happen to hold the opinion that the history of our species is one of continuous migration (right from the very earliest days of our origins African origins). This reality feels rather strange since we tend to think of ourselves as sedentary, spending our time as we do establishing tribes, comunities, nations etc. What we actually do best and most is move, adapt and change. Perhaps this is another example of the lack of conformity between our self-image and our reality. In any event the recent patterns of global migration are not new, they are the continuation of processes that go way, way back. Our identities are changing, and one of my objectives here will be to try and chronicle how this is happening. The bottom line is that these two phenomena, demographic change and global migration are probably going to have important, and undoubtedly unexpected, consequences, and I'm going to try to follow and record them here, on my website and thorugh my weblog.

In my childhood days - I grew up in the UK of the nineteen-fiftees, in the grimy northern and decidedly unromantic city of Liverpool - there was an establishment TV commentator - Richard Dimbelby - who was always wheeled out to talk us through the things which were then thought to be important, and no matter what the occasion there he was (in fact two of his sons seem to have pretty successfully carried on the family tradition). I have always retained my youthful admiration for the masterful and dignified way he did what he did (even though my feelings about the events being commented-on has undoubtedly changed with the changing of the years).

So maybe that's my real ambition in doing all this, to be a sort of Dimbelby voice-over for the process, the self-conscious part of consciousness or whatever. (If I said just plain and simple that I was here to be a witness that would sound rather religious which it isn't meant to be, so let's just wind this up by saying that I like the thought of all this going to its eternal destiny in the hard drives of Brewster Kahle's Wayback Machine).


Finally I can't escape without saying something about my dear friends the bonobos. First of all what the hell are bonobos? Well in case you didn't know, bonobos and chimpanzees are our closest relatives in the animal kingdom, and bonobo's are, in fact, genetically closer to us than chimpanzees. If you don't know much about them you can find lots of information about bonobos at The Bonobo Conservation Initiative. You can also inform yourself there about the fact that BONOBOS ARE IN DANGER due to the fact that the last remaining populations are to be found in central Africa (in the Democratic Republic of the Congo) in an area of war and conflict. It is especially ironic that the last remaining members of a pacific and affectionate species should be endangered in this way by their human cousins.

I was first 'turned on' to Bonobos by the work of Richard Wrangham. An interesting interview with Wrangham can be found here, and a good introduction to the life and mores of bonobos can be found in this article from Scientific American by Frans de Waal (one of the first to seriously study bonobos).

The esential and obvious point is that bonobos are really a metaphor, a metaphor based above all in the fact that they resolve conflicts through affection, and not, as is all too often the case with their chimpanzee and human kin, through the use of tribal violence and aggression. Incidentally another thing humans have in common with chimps is territoriality, so the next time you hear someone slagging off a newcomer from some distant shore, just remember THIS BEHAVIOUR HAS BIOLOGICAL MORE THAN CULTURAL ORIGINS. Oh, we are so, so sophistocated. I'm still not decided whether this, following Nietzsche is 'human all too human', or following Eudald Carbonell, is rather 'human, not yet sufficiently human'. Be that as it may I canot help but share the hope of Norbert Elias that there is somewhere here a Civilizing Process is at work, or, as I prefer to call it, a domestication process.

Monday, December 30, 2013

Secular Stagnation Part 1 - Paul Krugman's Bicycling Problem

"What’s really happening fast is the demographic transition, with Europe very quickly turning Japanese."
Paul Krugman - For Bonds, This Time is Different

Ever since Larry Summers gave his game-changing speech at last autumn's IMF research conference the back-and-forth flow of arguments about secular stagnation has been almost non-stop (indeed Larry himself now has a webpage dedicated to the topic). First to dive into the swimming pool after the sounding of the starting pistol was Paul Krugman, with a series of blogposts and NYT articles (here, here, here, here, here, here, and here).  These were followed/accompanied by a series of commentaries (both for and against), and then finally we got to one of the potential end points of the argument, the "negative natural interest rates for ever and ever" model produced by Gauti Eggertsson and Neil Mehrotra (here) - summarised by Krugman in his memorable "Stagnation Without End, Amen" post.   A fuller bibliography of major milestones in the secular stagnation issue can be found at the foot of this post, but I'm going to eat up most of the column space here looking at just one Krugmans arguments - the one contained in Demography and the Bicycle Effect - since in many ways in goes right to the nub of the issue.

The background to the argument (as originally, even if prematurely, explored by Alvin Hansen, Günar Myrdal and even John Maynard Keynes himself in the 1930s) is that the population dynamics set in motion by the industrial revolution of the late 18th century have reached a historic turning point. In the two centuries or so that have elapsed since what many term the modern growth era got going three related but distinct processes co-existed in time:

1/ positive trend population growth
2/ positive trend economic growth 
3/ steadily accelerating technical change

You could call these the "stylized facts" which characterize the modern growth era, but the secular tendency in two of them  is about to undergo a seismic shift. At some stage during the 21st century global population will peak, and then gradually start to decline, probably forever more. In fact in some countries (principally in Eastern Europe, but also Japan, Germany, Spain, Portugal, and Greece) population is already falling. All of Europe will likely head in this direction sometime in the 2020s, although there is considerable uncertainty still about the actual path dynamics of this process since in addition to birth rates immigration rates also play a part. At the present time some countries in Europe (the UK, Germany, Switzerland) are in receipt of large numbers of migrants annually, while others are losing working age population precisely to the aforementioned trio.

Hence the significance of the fact that Paul Krugman uses the expression "demographic transition" (for the first time to my knowledge) in the quote which opens this post. We are not talking here about some one-off problem (although often observers have spoken about Japan in just these terms), but a generalized phenomenon, a transition, something which eventually will affect all countries on the planet and our entire species. Previously people have tended to use the expression "demographic transition" to refer to the increase in the proportion of working age population and total population that accompanies the drop in fertility from high levels in less developed economies. The expression "demographic dividend" has often been used to describe the boost to economic activity this shift entails. Normally people assumed that this process would come to a halt around the 2.1tfr replacement level, but in one developed economy after another this hasn't happened, and those in which it has have been more the exception than the rule. So now reality pushes us towards a broadening in the definition of that transition towards acceptance of a later phase wherein populations age, and ultimately decline, a process which is greatly accelerated in those countries which have experienced long term very low fertility.

What Alvin Hansen and others started to think about in the 1930s was what the consequence would be for the second of the secular process which have characterized the modern growth era  (positive economic growth). What happens if populations (or better put working age populations) start to shrink? The kernel of their argument is summed up (here) by Paul Krugman as follows:
"To have more or less full employment, we need sufficient spending to make use of the economy’s potential. But one important component of spending, investment, is subject to the accelerator effect: the demand for new capital depends on the economy’s rate of growth, rather than the current level of output. So if growth slows due to a falloff in population growth, investment demand falls — potentially pushing the economy into a semi-permanent slump."
Pretty simple really, but isn't this just what Keynes says at the start of the General Theory, sometimes the simplest things are the hardest to see. Especially if our natural intellectual disposition leads us towards assuming the opposite. Apart from the theoretical simplicity, the idea is backed by plenty of empirical evidence. It has become clear in one country after another that there is a steady falling off of economic growth after the rate of working age population growth peaks and then starts to decline.

The Japan case (as shown above) is clear enough, but the start of this process is already observable in China, where working age population is currently peaking, and where growth rates have now fallen from the earlier double digit levels to ones in the 6%/7% range. People are even alarming themselves by saying we'd better get used to the idea of 5% growth, but in fact this easing in growth rates has little to do with a housing slowdown. Rather it is structural and long term, and Chinese growth rates will eventually fall to the level of Japanese ones (see my 2008 "Has China's Economic Growth Now Passed It's Peak"). Or does anyone seriously think China can keep going on the basis of attracting immigration?

What we are seeing then is that as working age population growth drops towards zero, so GDP growth weakens. The question is, as it turns negative will GDP growth (as opposed to GDP per capita growth) also turn negative. The answer is it depends. A simple approximation to a growth accounting model of the type used by IMF, OECD etc to calculate trend growth in an economy would be the following:

GDP growth = growth in working age population + TFP (total factor productivity) growth

Now, if working age population growth turns negative, then GDP growth can only be positive if productivity grows faster. One conclusion is very obvious here, handling the later stages of the demographic transition is all about managing the rate of working age population decline. This can be achieved to some extent via lengthening the working life, raising the participation rate, or having immigration. Even so, we may arrive at a point were GDP trend growth rates drop below zero. This situation is very near to being the case in Japan, Italy and Portugal, among others.

So we could be moving to a world were eventually both population and GDP decline. What about technology? Well this will need to be the subject of a separate post, but it is highly likely that the rate of technical  change will continue to accelerate, so we could have the peculiar situation that while GDP notional falls, and keeps falling, materially we feel a lot better off.

Well, after this excursus, let's go back to Paul Krugman's bicycling issue. Basically Paul has started to run into a problem that Claus Vistessen and I ran into on our Demography Matters blog. If the world is overpopulated, and there is a constant pressure on natural resources, then why are you economist types worried about falling populations? Wouldn't it be a positive for the planet?
"whenever I raise these points, I get questions from people who ask why I don’t regard slowing population growth as a good thing. After all, it means less pressure on resources, less environmental damage, and so on".
Now naturally at the moment in the US we are talking about slower population growth, but in Japan and parts of Europe - and eventually as we have seen probably everywhere else - population and working age population are already falling. But still, if slowing population growth is going to be a problem for an economy, then sure as hell falling population could be.
"What’s important to realize, then, is that slower population growth indeed could and should be a good thing — but that what passes for sound economic policy is all too likely to turn this potentially good development into a major problem. Why? Because under the current rules of the game, there’s a strong bicycle aspect to our economies: unless they’re moving forward sufficiently rapidly, they tend to fall over."
So what's the issue here? What he calls the current rules of the game (is it in our power to change them?)? Or the bicycle effect, which implies that we are perpetually "condemned to grow", since as Paul says, if our economies don't move forward fast enough they tend to fall over. This is what I intend to examine in the posts which will follow.

To close this introduction to my series on Secular Stagnation I would like to cite the end of the Keynes speech I mention above (here):

"A too rapidly declining population  would obviously involve many severe problems, and there are strong reasons......why in that event, or in the threat of that event, measures ought to be taken to prevent it. But a stationary, or slowly declining population may, if we exercise the necessary strength and wisdom, enable us to raise the standard of life to what it should be, whilst retaining those parts of our traditional life which we value the more now we see what happens to those who lose them"

"In the final summing up, therefore....... I only wish to warn you, that the chaining up of one devil may, if we are careless, only serve to loose another still fiercer and more intractable."


In this introduction we have seen that population decline may now well be inevitable, as may a turning negative of economic growth. This need not make us poorer, depending on how we:

a) develop technology
b) manage the process

As Paul Krugman warns, the current economic and financial "set up" implies the bicycle needs to constantly move forward, something which may prove more and more difficult to achieve. We therefore need as Keynes said, to exercise the necessary strength and wisdom. That is to say we need to adapt the current rules of the game to the new reality, and learn to manage the process. Is simply blowing bubbles the best way to handle this sort of epochal change? That is the topic we will turn to next.


 E. Cary Brown: Alvin H. Hansen's Contributions To Business Cycle Analyisis, 1989 (here)

Willem H Buiter: The Simple Analytics of Helicopter Money, Why It Always Works, Cepr 2014 (here)
Willem H Buiter, Ebrahim Rahbari & Joe Seydl: Secular Stagnation: Only If We Ask For It, Citi Global Economics View January 2014

Gauti Eggertsson & Neil Mehrotra: A Model of Secular Stagnation, 2014 (here)

Alvin Hansen (1939), “Economic progress and declining population growth,” American Economic Review.

John Maynard Keynes: Some Economic Consequences of a Declining Population, Galton Lecture, 1937 (here)

Paul Krugman: Inflation Targets Reconsidered, Sintra May 2014 (here)

Paul Krugman: For Bonds, This Time is Different, NYT 2 June 2014 (here)
Paul Krugman: Demography and the Bicycle Effect, NYT 19 May 2014 (here)
Paul Krugman: Secular Stagnation in the Euro Area, NYT 17 May 2014 (here)
Paul Krugman: Stagnation Without End, Amen (Wonkish), NYT 9 April 2014 (here)
Paul Krugman: Monetary and Fiscal Implications of Secular Stagnation, NYT 19 November 2013 (here)
Paul Krugman: A Permanent Slump?, NYT 17 November 2013 (here)
Paul Krugman: Secular Stagnation, Coalmines, Bubbles, and Larry Summers, NYT 16 November 2013 (here)

Paul Krugman: Monetary Policy In A Liquidity Trap NYT 11 April 2013 (here)
Paul Krugman: The Japan Story, NYT 5 Feb 2013 (here)
Paul Krugman: Japanese Relative Performance, NYT 9 February 2013 (here)

Paul Krugman: Japan: What Went Wrong? June 1998 (available in Japan section here)
Paul Krugman: Further Notes On Japan's Liquidity Trap, June 1998 (available in Japan section here)
Paul Krugman: It's Baaack: Japan's Slump and the Return of the Liquidity Trap, Brookings Papers on Economic Activity, 2:1998 (here)

Gunnar Myrdal: The Effects of Population Decline. Godkin Lectures, Lecture VI, 1938 (here)

Masaaki Shirakawa (2014):Is inflation (or deflation) “always and everywhere” a monetary phenomenon?, BIS (here)
Masaaki Shirakawa (2012): Demographic Changes and Macroeconomic Performance, Bank of Japan  (here)

Larry Summers (2014):On secular stagnation (here).

Timothy Taylor: Secular Stagnation: Back To Alvin Hansen, 2013 (here)

Brief Bio

"Economists hitherto have tried hard enough and often enough to change the world, the real difficulty however is to understand it."

"In a world where expectations are (nearly) everything, to change our understanding is already to change our reality. Not only that, changing things this way is the most plausible, most cost effective and least destructive way of doing so" Read more........

Born in Liverpool Edward Hugh is a macroeconomist of British origin who has lived in Catalonia for over 25 years. For 20 of those years he lived and worked in Barcelona, but since 2010 he has been living in a small village near the Costa Brava town of Figueres.

Hugh, who studied economics at the LSE in the late sixties before going on to do Masters and Doctoral studies in Manchester, is an expert on the impact of demographic change and migratory processes on economic growth.

His work came to the attention of a wider international public following the publication of a New York Times article highlighting his blogging activity and his anticipation of the Euro Area crisis.

Since the start of the crisis Hugh has been a reference point for the international press in relation to the difficult economic situation in Spain.

While in recent years he has diversified his writing activity he continues to be an active blogger, making regular and widely followed contributions to social network platforms like Twitter and Facebook. He has no party political affiliation or ideological attachment of any kind, and is proud of his reputation for outspoken politically-incorrect independent analysis. Apart from his writing and speaking activities Hugh is often sought out by investors for opinions on the issues of the day, in particular those relating to demographic patterns and Europe in general.

During the period between October 2010 (following the initial FROB intervention) and January 2013 (when the bank recapitalization was carried out) he was a board member of the bank Catalunya Caixa.

He has recently published a book on the Spanish economy (¿Adios a la crisis?, Deusto, 2014), one on Japan's economic crisis (The A-B-E of Economics, Create Space, 2014) and most recently "Is the Euro Crisis Really Over?" (Create Space, March 2015) He is a frequent contributor to the Catalan press and defends Catalonia's right to decide its own future. He has often been an informal adviser to the Catalan President Artur Mas on economic issues.

He is currently working on his next book - No Growth Societies - which will be written and published in English.

He is also a regular speaker and participant in Forums and Economic Seminars, within and without Spain, a vocation which has taken him across Europe and the Middle East, from Brussels and Vienna, to Riga and Bergen, to Doha and Tel Aviv.

Sunday, December 29, 2013

The "Hot Labour" Phenomenon

Strong growth. Rising real estate prices. Rapid job creation. Surging immigration. This list sums up the Switzerland of 2014 down to a tee. However, it also sounds like a description of what things were like in Spain in 2007 - shortly before the country's economy fell off a cliff. What follows is a conversation between financial journalist Detlef Gürtler and economist and crisis expert Edward Hugh about possible parallels and differences between the two booms, and the role of a new phenomenon which Hugh describes as "Hot Labour".

Hugh argues that this is a new phenomenon, and on the increase as a result of central bank bubble inducing activity. While immigration is a vital tool aiding economies to manage the population ageing process, it is important that economic activities be balanced. Immigration fueling boom/bust cycles is far from innocuous, and harm a country just as much as a sudden stop in capital flows if the immigration is followed by emigration.   

Detlef Gürtler: Well Edward, you personally lived through one of the most important real estate booms in European history - the recent Spanish one. Is the real estate boom we are witnessing in Switzerland in any way comparable?

Edward Hugh: Before I start, I think it's worth pointing out that it goes without saying the Swiss are quite different from the Spaniards; and the Swiss economy is completely different from the Spanish one. In this sense every boom or crisis is in its own way different from anything before. That said, such "trivia" doesn't normally stop economists like me from trying to draw comparisons, even if in this case I have to be extremely careful, since while I know quite a lot about Spain I know much less about Switzerland. So perhaps you will help me.

Detlef Gürtler: Yes, economists do make comparisons, and you were even so bold as to draw one between the German 1990s housing boom and the one which took place in Spain after the start of the century.

Edward Hugh: Well this comparison isn't so strange as it may seem. Many talk today about Spain becoming the new Germany - in the sense of an export powerhouse - and while this idea may have a rather dubious basis in reality the shift from domestic consumption to exports is quite striking.

In both cases the subsequent "regeneration" was preceded by a significant consumer boom, in both cases there was a strong increase in real estate prices including a construction boom, in both cases there was an increase in household indebtedness, in both cases the current account deficit deteriorated. And then in both cases there was a rude awakening. The only real difference was one of scale, and in this case scale is important. Spain had what was at the end of the day the mother of all housing bubbles.

Detlef Gürtler: But in each case there was  a completely different historical background and there were very different underlying motifs.

Edward Hugh: Yes, of course. But does that really make a difference when it comes to economic ambition? East Germany's citizens in 1992 - just like their Spanish equivalents in 2002 - saw how big the distance was between their consumption level and the western (or northern) one, and since they could in each case contract debt on what was for them fairly favorable terms they decided to put history straight and to carry out a rapid catch up in consumption. Really, Europe as a democratic political project has some of the responsibility here, since there was no equalizing mechanism put in place, but at the same time people felt they were entitled to similar living standards.

One of the new MEPs from the newly formed Podemos party put it like this in a recent interview: "they have sold us a system in which they told us we would all be rich and we were all going to live very well, and there was a period like that, but all that’s over now."  

Detlef Gürtler: The Germans, on the other hand didn't find themselves with mortgages well below the actual value of the relevant property, while Spaniards are already facing this problem.

Edward Hugh: No, you're right, but this isn't the whole picture. Weren't there massive tax breaks for builders and developers in East Germany, tax breaks which were rapidly converted into 100% financing whereby the government effectively assumed the cost of write-down?.

Detlef Gürtler: Only in the prospectuses of tax-saving-scheme promoters. In fact, many investors ultimately remained sitting on a mountain of debt, debt which was higher than the long-term obtainable sale price for the property.

Edward Hugh: I see. In Spain, instead, creative valuation techniques were used. The economic end  result is the same: you lose the property but get stuck with a large part of the debt.

Detlef Gürtler: And how does Switzerland fits into this picture?

Edward Hugh: Well lets start with something which at face value seems positive. For many years there was virtually no inflation in Switzerland, sometimes the situation was more like deflation. Now a bubble economy without inflation, surely that would seem to be a novelty.

Unfortunately, when you come to look into things a bit more it isn't quite the novelty it seems to be. In fact Larry Summers, in his secular stagnation speech to the IMF 2013 research conference drew attention to this phenomenon. 
"Many people believe that monetary policy was too easy. Everybody agrees that there was a vast amount of imprudent lending going on. Almost everybody believes that wealth, as it was experienced by households, was in excess of its reality. Too easy money, too much borrowing, too much wealth. Was there a great boom? Capacity utilization wasn't under any great pressure. Unemployment wasn't under any remarkably low level. Inflation was entirely quiescent. So somehow, even a great bubble wasn't enough to produce any excess in aggregate demand."
So it seems bubble economies without inflation are becoming more common. The big question is why.

Detlef Gürtler: But if we look at real estate itself we see a different picture. In many market segments show annual price increases of more than ten percent.

Edward Hugh: Well, that is presumably in no small part due to investors from around the world seeking a safe haven for their money in Switzerland.

Detlef Gürtler: Yes. But especially since the franc was coupled to the euro these investors switched from the Swiss currency into Swiss real estate.

Edward Hugh: And obviously this increase is not (or is only insufficiently) taken into account in the consumer price inflation rate. Here again we find a similarity with Spain where the large rise in house prices was not reflected at all in the official consumer inflation rate. So despite official price stability life feels like it is becoming significantly more expensive, especially for those looking for a new apartment.

Normally when addressing the question of whether a real estate bubble exists or not, it is important to think about leveraging, about  whether the home purchases are financed by credit. If real houses are paid for with real money paid, and this money comes from the outside, the economic effect could be seen as more economically similar to exports: A foreigner buys a piece Switzerland. If the price falls back, it is largely a problem for the external investor, not for the Swiss themselves or the Swiss banks.

On the other hand, if all this "speculative" activity drives up property prices in a deflationary environment where wages are stationary, the affordability problem creates a different issue for Swiss nationals.

Detlef Gürtler: And what about the British market? Would you say this is currently more driven by "irrational exuberance" than Switzerland ?

Edward Hugh: Great Britain has at the present time  the fastest growing economy among all industrialized countries. But why should Britain suddenly have become a stellar economy, an exceptional out-performer? Again all this euphoria in the UK really reminds me of Spain, since Spain in its day was also considered to be an "out-performer", experiencing a major economic miracle.

 London house prices are up 18% year on year, and the current account balance is worsening. At the moment national insurance data indicate that roughly 600,000 economic migrants are arriving in the UK annually. Not as many as in Spain during the boom times - either in absolute terms or proportionally - but still a significant number. Because the immigration is mainly focused on London, it is leading to large distortions which affect the whole economy. The new arrivals need homes, but naturally they start without work and are not looking to buy. They end up renting - in maybe groups of 3 or 4 - and are thus able to collectively pay rental prices which a normal family cannot afford. Hence the buy to rent business become interesting.

Sadly many of the young Spaniards arriving (maybe 60,000 a year) are fleeing the consequences of one bubble only to inadvertently fuel another.

Detlef Gürtler: But isn't this an example of exactly the kind of labour mobility the EU in general and (the euro zone in particular) wanted to see? People move from countries and regions were there is little work to those where there is plenty? This pattern of behavior was legendary in the USA. Isn't it good that it now comes to Europe?

Edward Hugh: Well, yes and no. The key point is that the employment growth needs to be sustainable. Look at Spain, nearly half a million former immigrants left the country last year. And yet one more time it is important to understand that Euro Area countries have a different set of institutional arrangements to the ones which apply to US states. When Detroit went bust, the Federal Government was there to act as backstop.

When such activity is not sustainable there is a self perpetuating component which is highly undesirable. As Londoners feel better off since the value of their home has risen the borrow and spend more. They become more leveraged.  This boost to economic activity in turn attracts new immigrants, which push up rents even further and with them property values, making Londoners feel even richer, and so on. As a result you get what you could call an unbalanced but self-reinforcing economic recovery. Hence the "superstar economy" aspect.

So the point is that while developed economy societies need positive migration flows as they age, they don't need just any old kind of flow, otherwise you could end up with problem bigger than the one you started with.

Detlef Gürtler: Thus, labor mobility has a procyclical effect. Where the economy runs well , the process works through increasing migration with everything getting better and better and better, until that is the day bubble bursts.

Edward Hugh: What we are talking about here is a new phenomenon. When people say our economies are becoming "bubblier"  they normally are thinking in term of financial flows. This is the area first are in which the self-reinforcing dimension of the process was evident. Think of what happened to small countries like Iceland or New Zealand in the run in to the global financial crisis.The Danish economist Carsten Valgreen coined the phrase global financial accelerator to describe what was happening.

Detlef Gürtler: You mean the way in which large speculative inflows produced a boom, which the respective central banks tried to contain by raising interest rates, but somehow these increases in interest rates only served to attract more speculative funds. 

Edward Hugh: Yep this was the the original pattern, but it's different now. This is in fact the most important thing which has changed since the German property boom of the 1990s. Migration flows have started to  play a role which is just as important as the financial flows one. The migrant flows we are seeing today are exceptionally large, and have the characteristic that - just like capital flows - they may reverse rapidly. You could call this the global labour flow accelerator. I am convinced that we are dealing here with something new, with a hitherto hardly recognized phenomenon - namely speculative labour flows, or if you prefer" Hot Labour ".

Detlef Gürtler: "Hot Labour "? Never heard of it .

Edward Hugh: Neither had I, till I saw what was happening in Spain. As we mention above, I started speaking about this in 2006.

Detlef Gürtler: Did you invent the expression yourself?

Edward Hugh: No, I got the idea from someone called Pepe .

Detlef Gürtler: Pepe ? Which Pepe ?

Edward Hugh: Well I don't know him personally, or even his full name . Pepe was a commentator who showed up on my Blog. He used this term to distinguish those immigrants looking for a new home, a new life, and a new society to integrate in, from another group, those just moving for work or adventure without for any clear plan.  Locate work quickly, and if a crisis hits then change country.  Possibly this is not a conscious initial decision, but this is how it works out in practice.

Many young Spaniards working now in London or Berlin seem to fit this category. They don't really plan to emigrate, they just want to survive what they perceive as a "difficult period".  If asked in a survey about how they see their future they will normally say they are working abroad "temporarily" and will eventually return home. In fact they may never return home, emigration is a process which is not the product of a firm initial decision, but they also may be forced to move on quickly if the economic recovery where they have foudn work becomes volatile.

So the distinction between immigrants and Hot Labour could be thought of as following the same pattern as a similar one which describes in capital flows, where people have long distinguished between foreign direct investment and speculative investments , as in the expression " Hot Money ".

Detlef Gürtler: In the case of capital flows it is not so hard to differentiate one from the other : direct investment normally relates to plants and machinery, Hot Money is normally associated with securities such as stocks and bonds. How would you differentiate the various migrant populations?

Edward Hugh: First of all : not at all. The vast majority of immigrants change countries for economic reasons, but this does not tell us  anything about whether and how quickly they will leave the destination country if an economic crisis breaks out.

Detlef Gürtler: What would be " fast " in migration dimensions?

Edward Hugh: Well you could say a "fast " wave of migration today is one which turns around in a  period of say five years. Previously such waves were conceptualized in terms of generations. So now we should really not take for granted that all the immigrants who come in a boom phase will remain in the country in the longer term.

Detlef Gürtler: As were the experiences with the boom and crisis cycles in Germany and Spain?

Edward Hugh: The 1990s German phenomenon largely predates the modern phenomenon. At the end of the nineties immigration stalled but hardly reversed. This was probably largely due to the noticeable influx of people of German descent coming from Eastern Europe - they came because there was an opportunity to do so, but they were more like classical immigrants, they came to stay.

But now we are seeing a different phenomenon in Germany, suddenly we have seen a shift in the direction of migrant flows. During the early years of this century the number of people leaving Germany and the number arriving more or less balanced. In 2008 and 2009 in fact more people left than arrived. But since 2010 the number arriving (and the difference between those arriving and those leaving) has steadily increased. The result has been that the German population, which was expected to start falling, is now rising. And since most of those arriving are in younger age groups the same is true of the working age population.

Provisional estimates from the German Statistics Office,  suggest 1.226 million people emigrated to Germany in 2013, an increase of 146,000, or 13%, from 2012. The last time immigration on this scale was recorded in Germany  was in 1993. On the other hand some 789,000 people left Germany in 2013, 77,000 (+11%) more than in the previous year. The result was net immigration of 437,000 – also the highest figure since 1993.Naturally such a large number of people entering is producing a pressure on property prices in just the same way as in London, especially in Berlin and Bavaria.

Detlef Gürtler:  How does this recent German experience compare with Spain?

Edward Hugh: In Spain, both the growth and the subsequent decline have been very rapid. Between 2000 and 2010 the Spanish population grew by more than fifteen percent, from 40 million to 46 million. The number of non Spanish nationals in the country rose sixfold - from one million to 5.8 million .

Now all of this has completely inverted: in 2013 alone approximately half a million people left, most of them former immigrants. The National Statistics Office estimates that the country's population could fall by 2.5 million between now and 2023. The long term consequences for Spain, and the Spanish economy are hard to foresee at this point, but they are hardly going to be positive.

On the other hand people continue to arrive in Spain, principally from sub-Saharan Africa. This is a more classic immigration trend. People are not simply coming for work, they are also coming in search of a new life. Even though economic conditions are difficult most of these will stay and eventually take their lives forward.

Detlef Gürtler: Was the initial intention of most of the migrants who came to Spain during the first decade to stay?

Edward Hugh: I would say for the majority this was not initially the case. Back in 2002 I interviewed a group of Bulgarian immigrants about their intentions. The results were predictable enough. Certain groups who might have felt themselves disadvantaged in their own country - women, gays, religious minorities - wanted to make a long term change, but the majority felt they were in Spain temporarily, to earn some money and go home. This is what most of the literature on the topic explains. But most of the people I interviewed are still in Spain. This is normal. Time passes, you put down roots. Finally you have no real "home" to go back to.

Actually I would say that personally this is my own case here in Catalonia.

A somewhat similar phenomenon can be observed among the large number of female care and domestic workers who arrived from Latin America. This immigration was also a new phenomenon, since the women who arrived had largely been married and had children who were being looked after by grandparents. They sent virtually all their earnings home every month, possibly to buy a home. Some of these women have now left, but since caring for elderly at home is a growing occupation in Spain, and many Spaniards are reluctant to do it, the majority are still here, and increasingly they bring their children to Spain to live with them.

But many of the immigrants from Latin America , Romania and Morocco were employed in the construction industry and services sectors like bars and restaurants are leaving in large numbers. How long can they support themselves in a foreign country without work? So despite the fact they might prefer to stay, many are now leaving.

Detlef Gürtler: And how does all this compare with Switzerland ?

Edward Hugh: Well in  immigration terms Switzerland has a net population growth of about one percent per year (most European countries have very little natural population growth), putting it somewhere between the nineties German value (of about 0.7 percent per year ) and the most recent Spanish one (about 1.5 percent growth per year).

Detlef Gürtler:  Yes, and the immigration trend has recently accelerated. Already it is noticeable that something more than a normal recovery phase upswing is in motion. The older Swiss learned in school that their country had around six million inhabitants. The  younger ones found the number had already risen to seven million . In 2013 we found that for the first time the country had more than eight million inhabitants, and many forecasts now predict that the number can easily reach nine million. This in a country with a total fertility rate of around 1.5.

Edward Hugh: It is interesting to note that the Global Property Guide single out immigration for mention in the context of recent house price movements in Switzerland. "One factor has been an increase in the number of immigrants which has led to higher demand for houses. From 2007 to 2011, net migration into the country reached 365,500 people"

What Spain has shown us is that such trends do not necessarily last forever. Anyone with high rates of immigration and a nicely booming economy should also consider that substantial outward migration can occur when the economy weakens. If we are talking about a boom-bust then naturally things are much worse. Sustainability has to be a key idea we get our heads around in this context.

Detlef Gürtler: Unless, of course, the immigrants had come to stay, as was once the case in Germany , with the German-born migrants from Eastern Europe.

Edward Hugh: Yes, but this doesn't seem to be to be the Swiss case. Switzerland is very open when it comes to labor flows when there is work, but much less open when it comes to the subsequent integration of migrants.

Detlef Gürtler: And with an extremely liberal labour market jobs in Switzerland can not only be created  very fast, they can also be deleted very quickly.

Edward Hugh: Which makes Switzerland quite vulnerable to a Hot - Labour type phenomenon, with the capacity  for a very rapid job creation phase followed by a rapid job destruction one. If that were to happen, then people shouldn't be surprised if an economic downturn transforms itself into a veritable downward spiral. When there is work, the new migrants are made to feel somewhat welcome, but when they are without a job, just how much support is available for them? Very little it seems.

Detlef Gürtler: So it's like a game of Monopoly, where at some point you simply get sent back to "Go", the original starting point.  It looks like in Spain at the end of the recession many economic data  looked more like those of the year 2000.

Edward Hugh: Would that you only got sent back to the starting point! On some indicators - unemployment for example - Spain by 2020 may still be worse off than it was in 2000. The age structure would be another example. Those currently leaving the country in droves  in order to seek employment elsewhere  are predominantly young and well educated. Those who remain are either older,or without either skill or qualification. There is a massive human capital loss, and population ageing is accelerated.

Detlef Gürtler: How do such movements affect things like pension systems?

Edward Hugh: Well the initial inward surge is, of course, very positive. Pensions look much more sustainable, but if things go wrong then suddenly they aren't and pension reforms become urgently necessary. Spain has now had two of these since the crisis started.

Detlef Gürtler: But that is looking at things from the point of view of the receiving country. What about the sending one?

Edward Hugh: Well obviously, migrants moving from countries with very low fertility - like Eastern and Southern Europe - leave a serious hole behind them. One which threatens the future of the pension systems there.

Switzerland, with its island type location and the very Hot - Labour  type context can simply wring its hands over the situation as people who have contributed to the welfare system for years suddenly leave. But in the European Union, with its formal commitment to some sort of a politically shared project, there will inevitably be pressure for another kind of solution, one which involves some sort of common pension system.

People in the UK are want to complain about EU labour mobility, and arrivals from Eastern Europe, but countries like Latvia, for example, are hardly going to be sustainable if something isn't done.  It seems to me to be quite irrational for a country to enjoy a boom as a result of immigration, one which in addition means many urgently necessary structural reforms are pushed aside, while another country suffers only the negative consequences of emigration, getting stuck in a long depression while the entire pension system is pushed towards collapse. And then just a few years later the economic situation and the migratory pattern rotates one more reproducing the twin picture of complacency and collapse .

Detlef Gürtler: The technical term for the EU institutional change you mentioned is "intra-European Compensation", which probably means what the Germans call "Social union ".

Edward Hugh: Right. If the Euro and the EU are to continue then this would seem to be inevitable. Or do you expect the Germans to declare that they, in the future, will maintain their pension level thanks to the contribution of Spanish immigrants? And that this outcome is socially just, just because so many Spaniards have benefited from coming to Germany and are willingly depositing their contributions in the German pension box to show their gratitude?

But wouldn't it be totally economically irrational that a  common currency which is set up with totally inadequate institutional support, which overseas the generation of economic imbalances that cannot be corrected via either currency appreciation or depreciation, simply washes its hands of the search for a just solution. Other mechanisms must be established to allow these countries to recover and restore some sort of balance.

Detlef Gürtler: Balance? But don't many agree with George Soros when he argues that financial markets don't tend towards equilibrium, but fall into boom-bust cycles over and over again. Can it be that the the markets for human capital behaves similarly?
Edward Hugh: That could be, and that is the phenomenon I would like to draw attention to. However, the possibility has not been sufficiently explored so far,  so let's just leave this outcome today as an "educated guess". But whether we are talking about booming labor markets, like Germany, Switzerland, Great Britain, or busted ones, like those in Spain and Greece we are producing a lot of data with which it should be possible to either confirm or refute the conjecture.

And one last closing point. I have long favored (and continue to favor) sustainable immigration as one way to manage population aging (see my Message To Central Bankers Target Median Ages!: 2006, or my reply to Marty Feldstein "The Effects of the Ageing European Population on Economic Growth" of the same year). But for such a policy to work as intended we need to stop trying to reflate economies which for demographic reasons are trying to disinflate, and develop policies which are appropriate to the times we live in. The first step along this road is recognising that we have a problem.

The above is an adapted translation from German of an interview which originally appeared in the magazine GDI Impuls.

Saturday, December 28, 2013

As Good As It Gets In Latvia?

For Maurice Pialat, champion of the marginal centre.
"This raises a final question, which, while not central to the issues of this paper, is nevertheless intriguing: How can a country with a low minimum wage, weak unions, limited unemployment insurance and employment protection, have such a high natural rate [of unemployment]?"

"To summarize, the actual unemployment rate is still probably higher than, but close to the natural rate of unemployment. Latvia may well want to take measures to reduce its natural rate, but the recovery from the slump is largely complete."
Boom, Bust, Recovery Forensics of the Latvia Crisis, Olivier Blanchard, Mark Griffiths and Bertrand Gruss

With these words three IMF economists (hereafter BGG) effectively signed off on their study of "what just happened on Latvia" and, they hoped, drew to a close a debate which has been going on now for some 6 years. In fact, far from closing the debate, what they may have done is effectively extend it into new terrain, since these apparently harmlesss words - "the recovery from the slump is largely complete" - have far reaching implications, as does the methodology they use for reaching it. These implications reach well beyond Latvia, and even far beyond the Baltics and the CEE in general, despite the conclusion that everyone seems to be reaching that Latvia was just a "one off". Possibly without intending to do so, they have drawn onto the clinical investigation table issues which have been mounting  up in the theoretical lumber rooms of neoclassical growth theory for some time now, issues which begin to assume a paramount practical importance in the context of our rapidly ageing societies. What, for example, do we understand by the term "convergence" these days? And if "steady state" growth can no longer be understood as implying a constant growth rate (trend growth in developed economies is now systematically falling) should we be considering the possibility that headline GDP growth will at some point turn negative, even if GDP per capita may continue to rise, due to the fact that populations are steadily starting to shrink. And if the answer to the former question is "yes", then what are the implications of this for the financial system, for the system of saving and borrowing, and for the sustainability of legacy debt? Not little questions these, but ones which will need to find answers and responses in countries like Latvia over the next couple of decades.

And again, returning to a question I raise about Ukraine (here), while Latvia's recovery may be complete and thoroughgoing, what satisfaction can we really take  from our knowledge of this when - according to the country's President Andris Berzins - the end state leaves the very survival of the country as an independent entity ten years from now as an open question? The problem - the country's population is falling, along with its workforce, and young educated Latvian's continue to leave looking for a brighter future elsewhere, even if they now do so at a slower rate than they did during the height of the crisis.

This is the first time I have written anything on Latvia in some time. In 2007 and 2008 I argued for Latvian devaluation, but refrained from continuing to do so in 2009 since the will of the Latvian people was so obviously against taking this path. I think policy has to work in the real world and not in the one we - like visitors to Andrei Tarkovsky's "room" - might wish we were in. But more than the going back over the debate  about whether or not it would have been better to devalue - we will never know the answer to this one, although although the viewpoint still seems to me a more defensible view than many imagine - what I would like to stress here are the reasons which lead me to arrive at the conclusion is was a good option, along with the factors which influenced me in getting there. These are set out in my June 2007 monster post: Is The Latvian Economy Running Out Of People?. The post is a long one, extraordinarily so as I say there, even by my standards. But going back over it, and with more than six years of hindsight to benefit from, I can't help feeling there is not a great deal I would change or even add. As I say in the introduction to that post:
"It is generally recognised by most external observers that this malaise has its origins in structural problems in the Latvian labour market, and it will be argued here that these structural problems have their roots in recent characteristics of Latvian demography (namely high out-migration and a sustained low birth rate). As such there is no easy solution. Even in the longer run the position will inevitably be difficult, since demography almost inevitably casts a long shadow. This does not mean, however, that we should be complacent. There are steps which can be taken to address the issues which Latvia faces in the short term, and it is important that such appropriate measures are enacted. These measures clearly include policies to reduce the dramatic overheating which is taking place, but they also should include policies to loosen the labour supply, not only by encouraging increased labour market participation and mobility, but also by actively encourage inward migration. Such policies may be seen as short term measures which are vital to move Latvia away from an unsustainable and towards a sustainable economic path."

Measuring Trend Growth

The facts of the crisis in Latvia are by now more or less well know. As BGG outline it the story runs as follows:
"The basic and striking facts to be explained are given in Figure 1 (see chart reproduced above - EH): An increase in GDP of almost 90 percent from 2000:1 to 2007:4, followed by a decrease of 25% from 2007:4 to 2009:3, and a recovery, as of 2013:1, of 18 percent. A mirror image in terms of unemployment, with a decrease in the unemployment rate from 14% in 2000:1 to 6% in 2007:4, followed by an increase to more than 21% in 2010:1, and a decrease since then, down to 11.4% in 2013:2."
For anyone seeking more background BGG gives an excellent and informative summary. What went on in Latvia was not a fiscal overspending issue (which is not to say the administration should not have been running a higher surplus during the latter part of the boom), but an accelerated credit-driven consumer demand and (housing) investment boom financed by external borrowing. This boom massively structurally distorted the economy, in the process taking output to levels well above those which were sustainable in the longer run. As BGG point out, "the ratio of private consumption to GDP (in constant prices) increased from 62% to 72%, [and] the ratio of investment to GDP (also in constant prices) from 22% to 36%." Now you don't have to be a mathematical genius to spot that 72 and 36 add up to 108, ie consumption and investment total more than 100% of GDP. How can that be, you may ask. The answer to the apparent inconsistency is that the difference is made up by imports (or the trade deficit), ie the Latvians were consuming all their own GDP and part of someone else's, with the difference being made up by external borrowing. BGG put it more elegantly:
"As a matter of arithmetic, the result of increasing consumption and investment ratios was a steady deterioration of the current account balance, with the ratio of the current account deficit to GDP increasing from 5% of GDP in 2000 to peak at a very large 25% in mid-2007."

So it is clear the Latvian economy was running above capacity, but how much above capacity? This is really what the present debate is about, since depending on the answer you give to that question the estimated current trend growth level of the country will be either higher or lower, as will the non-inflationary unemployment rate. Using various vintages of output gap estimates taken from real time EU Commission economic forecasts (12% positive  in 2007 as estimated in  2013) the authors derive a series of cyclically adjusted fiscal balances which show how, at least from the current vantage point, the size of the output gap, and hence the degree of laxity in the fiscal stance, was systematically underestimated. In 2007, for example, the EU Commission only thought the positive  gap (ie degree of overheating) was some 3%. Well its always easier to see things more clearly with hindsight might be the common sense response. Would that things were so simple!

An Interlude Concerning Production Function Metaphysics

What is involved here is a really important and hard to resolve methodological (and even, god help us, epistemological) issue (especially in countries which pass thorough a deep and protracted economic slump) - what is the special privilege of the present as a valid vantage point, when compared with the virtual infinity which time will eventually offer us?

After all, in the "present" which was 2007 things did look very, very different. Perhaps our current evaluation of our own "present" is just as conditioned as earlier perceptions of earlier "presents" were. The problem is we are using our present appreciation of the way things are to reach conclusions about the past which may look very different in some other, future, present. Yes, you're right, there is an element of circularity in the kind of argument that is used by BGG. As the people in the trade put it, potential output is an unobservable latent variable, you know, a bit like the Higgs particle, something you can't see or measure, but which you have to assume to exist for everything else in your theory to make sense.

As one of the IMF authors, Bertrand Gruss, puts it in his paper on the topic, there are "many different methodologies" which can be used "each of them encompassing a different precise definition of potential output and entailing advantages and disadvantages". All of them have, however, one thing in common:  "potential output estimates are subject to substantial uncertainty." As he also notes, in the case of a country like Latvia, emerging from a substantial slump, the degree of uncertainty is especially large. So those who would use the arguments in BGG to argue something simplistic, be chastened, the room for error is large. But then "substantial uncertainty exists over the past and future" doesn't make for good headlines, and, perhaps more importantly, doesn't inspire confidence in the policymakers who admit this.

So does each historical moment have its own special "truth" as far as potential output goes? This point - present moment bias - is described by Paul Krugman like this: "These methods automatically interpret any sustained decline in actual output as a decline in potential, and they cause that re-estimate to propagate backward through time." This approach could be described as "present moment reductionism" in the sense that events in the past are viewed and evaluated from the standpoint of the present, in a way which makes them explicable and comprehensible only in terms of the present they give rise to. The German philosopher Liebniz once put it this way,  we live in "the best of all possible worlds", if not in the best of all imaginable ones (back to Tarkovsky's room).

Basically, it is difficult to avoid the bad performance generated during the slump  "contaminating" the data. What we really need is information on Latvia's future performance, then we could situate the present. We need a time series from the future, then we could see much more clearly what is happening now. Unfortunately for us we can't have access to one. The "set up" (or world) we live in has this characteristic.On some views this is precisely what makes it interesting.

At the same time recognising this reality doesn't make the problem simply go away. As macroeconomists we are constantly forced to make what come near to being ad hoc judgements, and we need to do so time and time again, as we go forward and on the fly. As the Spanish poet Antonio Machado put it, "el camino se hace andando" - we make the path we walk along as we walk. The difficulty is that we are in a bit of a "garden of forking paths" here, since the decisions taken in 2008 and 2009 are the reason we have reached reach the endpoint we are at now, and it is this (momentary) endpoint which conditions our judgement about the initial conditions we set out from. And this is the case even though, had we taken another path  at the outset we would surely have arrived at another "now" from whence the starting point would have been seen differently.

That master of neo-classical growth theory Robert Solow put it thus in his Nobel acceptance speech:  
Growth theory was invented to provide a systematic way to talk about and to compare equilibrium paths for the economy. In that task it succeeded reasonably well. In doing so, however, it failed to come to grips adequately with an equally important and interesting problem: the right way to deal with deviations from equilibrium growth........if one looks at substantial more-than-quarterly departures from equilibrium growth........... it is impossible to believe that the equilibrium growth path itself is unaffected by the short- to medium-run experience.......So a simultaneous analysis of trend and fluctuations really does involve an integration of long-run and short-run, or equilibrium and disequilibrium. 
As he says, it is impossible to believe that the longer term path of the economy is unaffected by the trajectory taken during the deviations from trend - whether upwards or downwards.

(Incidentally, I used the comparison with Liebniz above because it seemed appropriate, because it seemed to me that Liebniz's "rationalisation of the real" was exactly what is going on here. This attitude was famously satirised by Voltaire in his Candide. Curiously when I went back to the Solow speech to dig the above extract out what else did I find - a reference to Candide. Happy to be in good company).

Now in fairness our IMF authors are well aware of this issue, although I'm sure they'd like to put it all very differently. Indeed, while they cite the EU Commission output gap estimates, they also carry out their own calculations (at least one of them Bertrand Gruss (as mentioned above) does, with the results being published in the 2013 edition of IMF Latvia selected issues). As his says in his commentary on the study findings:
"Many different methodologies have been used to estimate potential output, each of them encompassing a different precise definition of potential output and entailing advantages and disadvantages. No specific approach can be taken to be “the” correct one and potential output estimates are subject to substantial uncertainty. This uncertainty is probably even larger for countries like Latvia, a transition economy still going through substantial structural changes and coming out of a severe crisis that has likely rendered obsolete a significant part of the economy’s productive capacity."

For technical reasons which we don't need to go into here, BGG decide to use a production function methodology broadly similar to the one in the diagram above (click on image for better viewing), which is in fact the one they use over at the European Commission (Roeger, 2006) where they got the 12% 2007 output gap result.  In fact the IMF variant isn't identical. Their result (at least as of last January when the study was reported):  "Output was probably about 5–10 percent above potential before the crisis, although the extent of overheating at the pre-crisis boom is particularly uncertain."

[For the wonks, the benchmark PF model they used suggested the output gap peaked at around 5 percent of potential output before the crisis - well below the 12% level suggested by the EU Commission. Then, since they were worried about possible cyclical contamination of the TFP input, they used an alternative potential TFP series (cleaned up by applying an HP filter) and this gave them a gap estimate of about 9.5% much nearer to the EU Commission figure, which ain't that surprising since it is Roeger's preferred technique (see right hand path in diagram).]

Just to give us a feel for the kind of range of certainty involved here, Bertrand Gruss concludes his results by stating the following, "While acknowledging the uncertainty of estimates, staff believes output was significantly above potential before the crisis, but probably in the 5–10 percent range rather than in the 15–20 percent range".

More important than the actual result in my opinion is how they achieved it. A quick inspection of the left hand path in the diagram will reveal that a very significant part of the calculation revolves around labour inputs which ultimately depend on demographic dynamics. Indeed Gruss justified his preference for the production function approach precisely for this reason: "The emphasis on a production function approach reflects both staff view that it represents an adequate framework for Latvia (where, for instance, population dynamics and structural unemployment play an important role in potential labor and potential output estimates)....".

Put simply the only real positive impetus to trend growth we can expect in the future from Latvia will be on the TFP side, since the labour input component will turn negative at some point (if it hasn't already done so). Bertrand Gruss in fact puts it quite bluntly: "Labor is not expected to contribute to potential growth in the coming years."

Demographic Destiny?

Now, quite coincidentally, the IMF is finally getting round to thinking about the demographic side of the European periphery problem (not sure why it took them so long since they've been using the kind of production function methodology described above  for years). Well, at least in the Latvian context it is. I say "finally" because for whatever reason there seems to be some sort of resistance among fund economists to thinking about demographic issues (including migration flows) as part of the core macro picture, yet as can easily be seen above it really is, and Robert Solow wouldn't doubt it for a moment.

Anyway, their current thoughts on the Latvian demographic outlook can be found in the form of an appendix to their 2012 Latvia Article IV consultation report. Coincidentally this report was published at the same time as the second part of their program monitoring reflections, ie the signal being given would seen to be that while demography is important, it is an "issue pending" which can be safely passed over to the post program environment. This is in complete contrast with the methodology being advocated here which is that the program should in part have been designed with this central issue in mind. I have been advocating this since 2007 and I will continue to do so.

Be that as it may, as they inform us in their appendix, Latvia’s population is shrinking rapidly.  

During 2000–11, the population declined by about 14 percent (340 thousand people). Emigration was responsible for about two thirds of this decline while natural change due to low fertility accounted for the remainder: 

Emigration: an estimated 200–215 thousand people, mainly young people—roughly 9 percent of the population—have left Latvia during 2000-11 (Hazans, 20111; and Central Statistics Bureau); and 

Low fertility: the decline of the population for natural reasons was about 125–140 thousand people (5 percent of the population). The number of births has halved since the early 1990s—from around 40,000 annual births to around 20,000—falling below replacement levels.

In fact saying that fertility has fallen below replacement levels is putting it mildly, since the Latvian fertility rate is currently around 1.3 (one of the lowest in the EU) and has been effectively below replacement since the country came into existence. The number of births has been falling more rapidly since the onset of the crisis due in part to the harsh economic conditions but also aided and abetted by the fact that the majority of the women emigrating are of childbearing age.

So Latvia is facing a massive challenge. A combination of low fertility and emigration mean that the population is shrinking rapidly and at the same time ageing. The proportion of over 65s is set to surge between now and 2030 as it is all over Europe. Naturally with the hole in the pyramid left by the "missing births" and the working-age-population migration-loss the country is bound to be an example of one of the worst case scenarios, far worse than Japan, since Japan has only been resisting immigration, it has not lost population through emigration. Fortunately, the country has a possible solution - it belongs to the EU, is about to join the Euro, and the possibility exists that the Euro Area will become a transfer union over the next decade. At least that's the theory, I don't doubt the reality could well be different. But really the creation of this transfer union is Latvia's only hope now, and obviously it would be a substantial net beneficiary, since otherwise it is hard to see how the country will be able to offer its elderly population modern minimum standard welfare services like health and non-poverty-inducing pensions.  

Emigration and the IMF Program

Actually BGG do try and address some of these issues. They do so since, as they say, "an important part of the adjustment has taken the form of emigration". As they also point out Latvian emigration long predates the crisis. The average net emigration rate was 0.5% from 2000-2007. It increased to an average 1.3% from 2008 to 2011, but by 2012, was roughly back to its pre-crisis average. So emigration isn't a product of the crisis, it was simply made worse by it, but still, and going back to Solow  ( it is impossible to believe that the equilibrium growth path itself is unaffected by the short- to medium-run experience.) how far was Latvia's longer term future being put at risk by the form in which the adjustment occurred.

[Just as a side issue it is worth noting that exactly the same question arises in the context of the Greek adjustment. Had the IMF forced the EU to accept debt restructuring and an EFF rather than the initial SBA, the pace of the fiscal adjustment could have been slower, and the loss in output lower. Mein Gott, we might not now be talking about a current estimate of a Greek output gap of plus 10% in 2007 (if you follow the logic of the argument advanced earlier). See my "Second Battle of Thermopylae" post].

In fact BGG do attempt to address this issue:
"The question however is whether this emigration is, in some sense, a failure of the adjustment program. In the United States, migration rather than unemployment is the major margin of adjustment to state specific shocks ..... These adjustments are typically seen as good, indeed as the main reason why the United States functions well as a common currency area: If there are jobs in other states, and if moving costs are low, it is better for workers to move to those jobs than to remain unemployed."
This is an argument that it commonly advanced in the context of Euro Area issues (let's leave aside for the moment the fact that Latvia wasn't in the Euro) - in an optimal common currency area this sort of labour mobility is a good thing. In addition let's leave aside the question that Europe isn't the United States, that it is a continent made up of nations, and that these nations form part of our identity as Europeans in a way which is hard to quantify economically and in a way which can't simply be wished away by waving a magic wand (or paying another visit to Tarkovsky's room), the fact of the matter is that the Euro Area isn't an optimal common currency one. At least institutionally it isn't. To become one of those it would need to have a common treasury and a common unemployment benefit and pension system, etc.

Unfortunately, this is an issue which BGG, like so many before them, simply slide silently past - "the largely permanent departure of the younger and more educated workers may indeed be costly for those who stay" -  like a ship in the night looking for open water while at the same time carefully evading the enemy  minefield.
"Is the answer [to the above question:EH] different for a small country than for a US state? Some economic aspects are different: Some of the costs of running a country are fixed costs, and thus may not be easy to support with a smaller population. In the United States, many of those costs are picked up by the Federal government (although, as we have seen for Detroit, the remaining fixed costs per capita may become too large for a state or a city to function). This is not the case for a country, which must for example finance its defense budget alone."
The reference to Detroit is of course salutory (this is exactly the problem), although it is curious that the example they take for the fixed costs of having a separate state is defence, an area where Latvia obviously benefits from the existence of external institutions like NATO and the EU. Again, the extent would be hard to calculate, but one of the factors which must have influenced Latvian's in their decision not to offend their EU partners by devaluing the Lat must have been a consideration of just this issue.

Still, the question remains, from a demographic point of view could things have been done differently? It's very hard to give a conclusive answer. My argument in favor of devaluation was always based on the potential demographic dynamics  which it might induce. Obviously there would have been a large drop in output, but Latvia had one of those in any event. Would less people have migrated out? That is very doubtful, and indeed, as BGG point out, people were emigrating even at the height of the boom. But then again, would the post crisis potential growth rate have been higher? Would the country still have had to face a non inflationary unemployment rate of 10%, or would the additional international competitiveness achieved have meant it was much lower? Would immigrants be arriving to do some of the lower skilled work?

The thing about this last point is, more than just ending the emigration what Latvia really needs (like Japan, like South Korea) is immigration to shore up the population pyramid, to make the welfare system sustainable in the longer run, especially since although the country's future currently depends on the creation of an EU transfer union there is no guarantee there is actually going to be one.

It is unlikely that the emigration hemorrhage would have been avoided even with devaluation - large numbers of Argentinians, for example, arrived irregularly in Spain in 2002 and 2003 and the two countries weren't in any kind of bilateral Schengen arrangement. But would the natural rate of unemployment have been different following the adjustment? We will now never know.

However,  an argument from two of my Economonitor colleagues - Andris Strazds and Thomas Grennes - should give us some food for thought. According to these authors, when it comes to emigration dynamics "Unemployment Matters Much Less Than Relative Income Levels". Now despite the fact that one might have some reservations about the actual methodology they use (they seem, for example, to confound the migration component in population dynamics and the birthrate one where in fact these are quite distinct channels) they are certainly digging in the right area, as the following chart which comes from a pre crisis IMF report makes clear.

The problem, of course, isn't only relevant to Latvia. Despite the fact that Spain's unemployment rate is currently around 27% immigrants continue to arrive in the country (often risking their lives to do so), a fact which puzzled the Financial Times demography correspondent Norma Cohen when we spoke about this article. "Why on earth," she asked me "would people want to come to Spain with such a high rate of unemployment?" Because salaries are better than in their home countries would be the simple answer, and because they are willing to do work which many Spaniards are reluctant to do, at least at the salaries which are on offer. So economic migrants continue to arrive, an estimated 300,000 of them last year, even though the net migrant flow reversed since more left (both native Spaniards and immigrants) with Spain's population falling for the first time in modern history as a result.

The idea of "centre and periphery" seems like a useful analogy here, since more than simple emigration or immigration what we seem to have is a steady displacement of population with migrants of lower skill entering one side of a country while higher skilled natives exit across the other. In this sense one can truly speak about "population flows". Naturally the net human capital loss involved  is substantial. Italy had some three million immigrants during the first decade of this century, but the overall annual rate of growth was not much above zero.

Beyond implementing the maximalist programme of a completely federal Europe with population moving in one direction and transfers moving in the other  it is hard to see what the solution is here.


"Do these lessons extend beyond Latvia? The evidence from adjustment in Euro periphery countries suggests great caution." - BGG

"I’m not sure I believe this [BGG] story but if you do, what lessons does Latvia hold for other countries, and the euro in general? And the answer, in brief, is none. Latvia’s story as I’ve just told it looks nothing like anything we’ve seen in the past, and probably not like anything we’re likely to see in the future – including, by the way, Latvia’s future." Paul Krugman, Latvian Adventures

The general consensus seems to be that Latvia is an interesting case study, but one where the lessons learned have little application beyond the country's frontiers. I'm not sure I buy this. Let's start at the beginning.

We all know what happened in Latvia - the country's economy massively overheated - but are we so sure why it happened? The answer isn't as obvious as it seems. The quick synthesis explanation offered by BGG runs as follows:
In short, the anticipation of a large scope for catch up growth, together with cheap external financing, led to an initially healthy boom. As time passed, the boom turned unhealthy, with overheating leading to appreciation and large current account deficits, with lower credit quality, and with balance sheet risks associated with FX borrowing.
Yep, but why was there so much external financing available, and why did it continue even after it was obvious to all bar the Latvian government that the accumulating imbalances were putting the country at risk of disaster? Paul Krugman puts my question in a little more elegant fashion:
 First of all, on a conceptual level, how does an economy get to operate far above capacity? We understand operating below capacity: producers may fail to produce as much as they want to if there isn’t enough demand for their products. But how does excess demand induce producers to produce more than they want to?
I think part of the answer here is that we all generally thought that in an epoch of large scale globalisation with extensive migrant and fund flows "open" really did mean open, in the sense that to erect a well functioning economy all you needed was a large strip of land (of which Latvia has plenty), cheap tax rates and flexible labour laws, then the entrepreneurs, the capital and the labour would all flow in. The problem in Latvia's case was they didn't. The capital was there, so were the entrepreneurs, but one of the other factors was in short supply, and indeed instead of flowing in it was flowing out. Then bang!

That's over-simplifying a bit, but it is the bare bones of the situation, a situation which surely has lessons to be learnt for other CEE countries (or far flung places with similar underlying demographics like Vietnam). In particular the word "Ukraine" comes into my head.

But beyond this, why was all that capital flooding in to finance something which to the careful eye was evidently not working? My reply would be, and taking us back to the literature of the time, the operation of the Global Financial Accelerator, a term coined by the Danish economist Carsten Valgreen to describe what was happening in Ireland and Latvia before the crisis actually hit. Essentially, in an environment of ample global liquidity being generated by central banks in countries which don't have the capacity to absorb all the liquidity phenomena like Latvia and Iceland simply happen, as we have been seeing in recent months as the Fed tapering debate lead to a sudden stop in one Emerging Market after another. Fortunately on this occasion the liquidity was being withdrawn before the kind of massive imbalances we saw in both Latvia and Iceland had time to occur. I for one, at least, think it's worth considering what happened in Latvia, and what can be learned, in the context of the current EM debate.

Another issue worthy of note, as I say in the introduction to this post, concerns the issue of convergence. Historically it has been assumed that per capita incomes in countries forming part of the EU would tend to grow at faster rates than those in richer economies with the result that all member state economies should eventually converge to some common living standards band in terms of per capita income. This now seems unlikely to happen, especially given the demographic and growth outlook on the periphery, Latvia included. The economy is growing well right now, but as we can see it is labouring under severe structural problems (the unemployment rate) and the demographic outlook suggests that growth will now steadily weaken. What we have is as good as it gets.

Ironically GDP per capita has been performing well in relative terms since the bust, and in ways the textbooks never envisaged - through a drop in the population numbers. Despite the fact that output is still well below the pre crisis level, as BGG note, Eurostat estimates PPP GDP per capita to now be at 9% above its 2008 peak.

Finally there is the point about how the adjustment took place. As BGG explain, the majority of the internal devaluation took place not through wage and price reductions, but through productivity - the mysterious factor X. But is it that mysterious? What happened was that there was massive labour shedding, as unemployment shot up to 22%. Then, as growth resumed, employment didn't follow (mirroring a pattern which arguably we are seeing in a milder form elsewhere, in other countries which are recovering from sharp housing busts). So while output recovered employment didn't which simple arithmetic tells you results in a strong productivity boost. As BGG explain, there was a strong underlying improvement in TFP taking place due to the "catch up" effect, and this undoubtedly helped Latvia in ways we don't yet fully understand. More study would be useful, since again I do think there are things to be learnt.

As a last word I would say that if you are reading these lines you have probably struggled your way all through this inexcusable indulgence in  verbiage. In which case thank you. You may also have noticed I haven't referred to the issue of fiscal austerity once. Not even a teensy weensy bit. There is a simple explanation for this, the Latvia debate was all about whether or not to devalue, it never was a for or against austerity one. As Paul Krugman puts it: "if we were really looking at an economy with a double-digit inflationary output gap, even the most ultra-Keynesian Keynesian would call for fiscal austerity". For reasons I have outlined above, I don't fully grant the whole inflationary output gap estimate, but still I think the point holds, this was never about for or against fiscal austerity, since among other reasons it was never about public sector debt.


The paper published by Blanchard, Griffiths and Gruss relies heavily on the work of the Latvian demographer Mihail Hazans whose groundbreaking studies effectively forced the Latvian authorities to amend their population and migration estimates. I had the pleasure of meeting Mihail when I shared a platform with him in a colloquium organised in 2012 by the American Chamber of Commerce in Riga. The title of the gathering was, not surprisingly, Latvia's Demographic Future (you can find my presentation here).

Basically every country on the EU periphery needs its Mihail Hazans, since we have no accurate or systematic system for measuring these important migrant flows.

In response to what I perceive to be a major lack of knowledge and information I have established a dedicated Facebook page in a vain attempt to campaign for the EU to take the issue of  emigration from countries on Europe's periphery more seriously, in particular by trying to insist member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are.

If we don't have the necessary information then how can we hope to formulate the adequate policy responses. If you are willing to agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometimes great things from little seeds to grow.