resilience, not stability

Archive for June, 2011

The Democratic Deficit in Europe and the Crisis in the Periphery

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Regardless of if and when Greece defaults, it is now clear that the Eurozone faces an existential crisis. The contradictions in the Euro are a symptom of a much deeper malaise and the inherent fragility of the European political project. As Martin Kettle points out, lifelong Europhiles now openly question whether the European Union itself is on its last legs.

At the heart of the European Union’s problems lies a structural ‘democratic deficit’. David Marquand gets to the heart of the matter in his excellent new book on Europe – at its core, Europe was always a technocratic undertaking aimed at transcending the “clamorous irrationality of political life”, in need of popular support but “wary of popular engagement”. This technocratic focus was not a bug but a feature, a natural byproduct of the emphasis on the “low politics” of agriculture, free trade, regulatory harmonisation etc. that is so amenable to technocratic decision-making. Underlying this approach was a “theory that integration would spread ineluctably, like an inkblot, from one policy domain to another…..The end was political, but the means were economic; and the means gradually eclipsed the end. Integration was supposed to spread, irresistibly and irrevocably, from one economic field to another; there would be no breaks in the process, when popular consent would have to be mobilized. Economic success, facts on the ground—market freedom, economies of scale, rapid growth, rising living standards—would be enough to embed the project in the public culture. There was no need to buttress legitimacy of the fact with the legitimacy of shared purposes. That would take care of itself.”

But as Marquand notes, this economistic and technocratic view is not rooted in the effective democratic consent of the citizens of Europe. In Marquand’s words:

You can’t hold institutions you don’t understand to account; and it is hard to see how they can represent you. And no one outside a tiny group of Euro-actors and Euro-academics understands how the European Union works. National politics often baffle ordinary citizens, not least because national governments are entangled in increasingly complex webs of European and global interdependence. But the citizens of the Union’s member states mostly have at least a vague notion of what national political parties stand for, and who national leaders and would-be leaders are. In the time-honored phrase, they can, if they wish, “throw the rascals out.” And there is, at least, a tenuous connection between their votes and the policies their governments pursue, None of this is true of Union politics. Voters in European elections can’t throw the rascals out. The connection between their votes and Union policies is not just tenuous but invisible. There is no shortage of rascals, but the most egregious of them belong to national governments and administrations, not to European institutions of any kind. Even the ones that do belong to European bodies—notably, Commission and Council permanent officials—are mostly out of reach of European voters and their representatives in the European Parliament. Worse still, there are no Europe-wide political parties to focus debate and offer choices to a European electorate. European citizens vote in European elections when they do (and, as earlier chapters have shown, increasing numbers don’t) to punish or reward national political parties, fighting on essentially national platforms. And though the European Parliament’s role in the Union’s legislative process has grown immeasurably in recent years, the process itself is both labyrinthine and impenetrable by outsiders….the EU has no buckor, at least, no buck that stops. There is only an endless maze of indeterminacy.

Apart from a growing apathy (as signalled by the low and falling turnout in European Parliament elections), a perceived inability to influence political outcomes through the democratic process opens the door for the electorate to pursue more radical options. It is not a coincidence that so many of the protests and movements across Europe in Greece, Spain, Ireland and France have focused on the common theme of demanding more direct and local democracy. Although most of these protests have been allied with a distinctly left-wing political stance, they share the emphasis on more direct democracy with many right-wing Euroskeptics. This radicalisation in response to a perceived loss of democratic voice is easily understood when viewed in the context of the history of democratic rights and universal suffrage. As Albert Hirschman has pointed out in his book ‘Shifting Involvements: Private Interest and Public Action’, the introduction of universal suffrage effectively delegitimised more direct revolutionary political action. In his words:

when the vote was granted to the people of France, and in particular to that obstreperous, unruly, and impulsive people of Paris which had just made the third revolution in two generations, it became enthroned in effect as the only legitimate form of expressing political opinions. In other words, the vote represented a new right of the people, but it also restricted its participation in politics to this particular and comparatively harmless form. It was similarly a means of offsetting the perpetual Parisian avant-garde and direct-action leanings by the much more traditional and law-abiding mood of the provinces. This interpretation of the universal vote decision as restraining and conservative in fact though not, of course, in intent is suggested by the conservative outcome of the April 1848 elections to the Constituent National Assembly-and, more important, by the moral force and claim to legitimacy which this freshly elected body was able to throw against the insurgents of June 1848. If insurrection is justified in the absence of free and general elections, as republican opinion maintained at the time, then, in counterpart, the implantation of universal suffrage could be held to be an antidote to revolutionary change. This was indeed the way the more conservative republicans saw it soon after the February Revolution, and the idea is well expressed in the contemporary slogan, “the universal suffrage closes the era of revolutions.”

Hirschman quotes Gambetta’s imploring speech to his fellow conservatives in defence of universal suffrage which captures this logic perfectly:

I speak to those among the conservatives who have some concern for stability, some concern for legality, some concern for moderation … in public life. To them I say: How could you not see that with universal suffrage, provided you let it function freely and respect, once it has spoken, its independence and the authority of its decisions-how could you fail to see, so I ask, that you have here a means of ending all conflicts peacefully, and of solving all crises? How could you fail to understand that, if the universal suffrage functions in the fullness of its sovereignty, revolution is no longer possible because revolution can no longer be attempted and that a coup d’Etat need no longer be feared when France has spoken?

It is in the troubled periphery of the Eurozone that this structural deficiency has reached a boiling point with the situation being made worse by the participation of the even less democratically accountable IMF. As the Guardian notes: “Eurozone policymakers too often treat democratic accountability as a luxury rather than a necessity, as shall be made amply clear this week when Brussels will force the Athens parliament to pass a raft of sharp spending cuts, tax hikes and privatisations – despite the hostility of Greek voters.” For much of the middle class in Greece, exit via emigration is a costly option given that they do not possess significant financial assets that can be easily transferred out of the country. As Hirschman would have predicted, absence of a viable exit option combined with the neutering of the democratic voice makes direct, even revolutionary action the only feasible option for many such Greek citizens.

The Greek middle class also feels squeezed due to what they perceive as the unfair burden of taxation foisted upon them relative to businessmen or the self-employed. Although it is entirely possible that this is simply a function of cronyism and corruption, taxing those who are least able to exit without incurring significant pain is the easy way out even in the absence of cronyism. In a globalised economy with free movement of capital, peripheral economies are unable to tax those sections of the populace who possess a credible threat of exit. The focus of increased taxes on those least able to exit, even if the policy is regressive, is therefore logical.

In a world where capital flight is an option for a select elite, social inequality instead of being alleviated by government policy is almost always exacerbated by it. Even the most progressive taxation and policy regime in theory translates into a regressive regime in practise. As Hirschman notes (emphasis mine):

There are numerous varieties of such mobility: transnational corporations can move subsidiaries from one country, considered unsafe, to another; more threateningly, mobility can take the form of international banks refusing to “roll over” their loans to a country that is considered to be “out of line.” Still, the principal weapon is wielded by the country’s own citizens – particularly of course by the more opulent ones among them – as they engage in capital flight on a massive scale whenever they feel threatened by domestic developments.
Occasionally these various exits do occur, according to the 18th-century script, in response to the arbitrary and capricious actions of the sovereign. But a much less favorable interpretation may be in order: exit of capital often takes place in countries intending to introduce some taxation that would curb excessive privileges of the rich or some social reforms designed to distribute the fruits of economic growth more equitably. Under these conditions, capital flight and its threat are meant to parry, fight off, and perhaps veto such reforms; whatever the outcome, they are sure to make reform more costly and difficult. It looks, therefore, as though the availability of the kind of exit that was hailed by Montesquieu and Adam Smith were today a serious menace: it damages the capability of capitalism to reform itself.

Hirschman also identified that the problem afflicts countries at the periphery of the global economy to a much larger extent than it does those at the core:

Capital flight is obviously much less of a weapon in the largest and most powerful countries where the owners of capital feel that there is no place else to go. Here it can be expected that voice will be activated by the impossibility of exit. Capitalists will make elaborate attempts to influence public opinion and public policy. An ideology in defense of capitalism will arise. At the same time, concessions are likely to be forthcoming where reforms of the system are obviously needed and are essential to the demonstration that the capitalist system can itself evolve and ameliorate the problems it creates. Purely on the basis of the differential availability of exit for capital and capitalists, one might therefore expect that the largest and most central countries of the capitalist system would be, at one and the same time, the ideological bulwarks of the system and its most active problem-solvers; the more peripheral states, on the other hand, might be in the grip of an anticapitalist ideology, and would at the same time exhibit unconscionable extremes of wealth and poverty……Here is perhaps a key to the old puzzle why anticapitalist revolutions have consistently broken out at the periphery rather than at the center of the capitalist system.

The simplistic viewpoint that democratic liberal Europe is immune to the kind of revolutionary uprisings we have seen in the Arab countries this spring is wrong – it is not just dictatorships that are prone to violent expressions of popular anger. The electorate needs to believe that their vote counts and that decisions impacting their lives are taken by a government that is accountable to them. Clearly this is no longer the case in many parts of the EU. And this disenchantment with vote as the mechanism of voice means that the people of Europe may choose much more radical means of voicing their frustration.

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Written by Ashwin Parameswaran

June 29th, 2011 at 11:48 am

Posted in Inequality

The Influence of Special Interests and Rentiers on Monetary and Fiscal Policy

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Triggered by Robert Kuttner’s column in the American Prospect, the explanation du jour of our current economic malaise blames the ‘rentier class’ i.e. owners of financial assets – the thesis being that wealthy Americans do not want any more inflationary policies to be enacted and may even prefer deflation instead. Paul Krugman argues that wealthy Americans do not want inflation because financial securities are overwhelmingly held by the richest 10% of the population. But what matters for the incentives of rich households is what proportion of their balance sheet is made up of nominal financial securities. And Edward Wolff’s paper shows us that a significant proportion of the balance sheet of wealthy Americans is made up of real assets – real estate, stock and business holdings.

Similarly, a return to deflation will result in a fall in demand for products and services sold by businesses and a deterioration in bank balance sheets with increased and disruptive bankruptcies. As Brad DeLong noted, no one benefits from a deflationary collapse in the economy. A much better explanation is offered by Matthew Yglesias when he observes that “the Fed has hardly been indifferent to the potential for monetary expansion. It’s just that the goal of monetary expansion has been to do just enough to stabilize financial asset prices without going far enough to produce catch-up growth in the labor market.” What wealthy Americans, businesses and banks share is a common interest in supporting asset prices (real and nominal), a lack of interest in seeking full employment unless it is a prerequisite for supporting asset prices, and an aversion to any policies that can trigger wage inflation.

This bias towards asset price inflation doesn’t just impact the amount of stimulus. It has an influence on the type of stimulus that is preferred in this class conflict. The goal of asset price inflation without wage inflation is best achieved by an exclusive reliance on monetary policy – as I discussed in a previous post, a combination of “liquidity” facilities to prevent a collapse in shadow money supply and open market operations/QE to reduce real rates across the risk-free curve. Given the anaemic state of household balance sheets and insensitivity of corporate investment to interest rates due to a cronyist corporate sector, lower rates will not trigger sufficient real economic activity to trigger wage inflation but they will support real asset prices. Even within the ambit of fiscal policy, supply-side incentives for businesses are preferred. Given a less than competitive corporate sector, these will feed through to business profits more than they will feed through to wage inflation and employment.

Some of you may have noticed the distinctly Marxist tone of this debate – an emphasis on class conflict that rarely permeates economic discussion in mainstream circles. This is not a coincidence – as I observed in an earlier post, the dynamics of a crony capitalist economy resemble a zero-sum Marxian class struggle. Rather than expanding the size of the economic pie, economic agents focus their energies on trying to capture a larger slice of a static, stagnant output.

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Written by Ashwin Parameswaran

June 13th, 2011 at 4:58 am

Forest Fire Suppression and Macroeconomic Stabilisation

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In an earlier post, I compared Minsky’s Financial Instability Hypothesis with Buzz Holling’s work on ecological resilience and briefly touched upon the consequences of wildfire suppression as an example of the resilience-stability tradeoff. This post expands upon the lessons we can learn from the history of fire suppression and its impact on the forest ecosystem in the United States and draws some parallels between the theory and history of forest fire management and macroeconomic management.

Origins of Stabilisation as the Primary Policy Objective and Initial Ease of Implementation

The impetus for both fire suppression and macroeconomic stabilisation came from a crisis. In economics, this crisis was the Great Depression which highlighted the need for stabilising fiscal and monetary policy during a crisis. Out of all the initiatives, the most crucial from a systems viewpoint was the expansion of lender-of-last-resort operations and bank bailouts which tried to eliminate all disturbances at their source. In Minsky’s words: “The need for lender-of-Iast-resort operations will often occur before income falls steeply and before the well nigh automatic income and financial stabilizing effects of Big Government come into play.” (Stabilizing an Unstable Economy pg 46)

SImilarly, the battle for complete fire suppression was won after the Great Idaho Fires of 1910. “The Great Idaho Fires of August 1910 were a defining event for fire policy and management, indeed for the policy and management of all natural resources in the United States. Often called the Big Blowup, the complex of fires consumed 3 million acres of valuable timber in northern Idaho and western Montana…..The battle cry of foresters and philosophers that year was simple and compelling: fires are evil, and they must be banished from the earth. The federal Weeks Act, which had been stalled in Congress for years, passed in February 1911. This law drastically expanded the Forest Service and established cooperative federal-state programs in fire control. It marked the beginning of federal fire-suppression efforts and effectively brought an end to light burning practices across most of the country. The prompt suppression of wildland fires by government agencies became a national paradigm and a national policy” (Sara Jensen and Guy McPherson). In 1935, the Forest Service implemented the ‘10 AM policy’, a goal to extinguish every new fire by 10 AM the day after it was reported.

In both cases, the trauma of a catastrophic disaster triggered a new policy that would try to stamp out all disturbances at the source, no matter how small. This policy also had the benefit of initially being easy to implement and cheap. In the case of wildfires, “the 10 am policy, which guided Forest Service wildfire suppression until the mid 1970s, made sense in the short term, as wildfires are much easier and cheaper to suppress when they are small. Consider that, on average, 98.9% of wildfires on public land in the US are suppressed before they exceed 120 ha, but fires larger than that account for 97.5% of all suppression costs” (Donovan and Brown). As Minsky notes, macroeconomic stability was helped significantly by the deleveraged nature of the American economy from the end of WW2 till the 1960s. Even in interventions by the Federal Reserve in the late 60s and 70s, the amount of resources needed to shore up the system was limited.

Consequences of Stabilisation

Wildfire suppression in forests that are otherwise adapted to regular, low-intensity fires (e.g. understory fire regimes) causes the forest to become more fragile and susceptible to a catastrophic fire. As Holling and Meffe note, “fire suppression in systems that would frequently experience low-intensity fires results in the systems becoming severely affected by the huge fires that finally erupt; that is, the systems are not resilient to the major fires that occur with large fuel loads and may fundamentally change state after the fire”. This increased fragility arises from a few distinct patterns and mechanisms:

Increased Fuel Load: Just like channelisation of a river results in increased silt load within the river banks, the absence of fires leads to a fuel buildup thus making the eventual fire that much more severe. In Minskyian terms, this is analogous to the buildup of leverage and ‘Ponzi finance’ within the economic system.

Change in Species Composition: Species compositions inevitably shift towards less fire resistant trees when fires are suppressed (Allen et al 2002). In an economic system, it is not simply that ‘Ponzi finance’ players thrive but that more prudently financed actors get outcompeted in the cycle. This has critical implications for the ability of the system to recover after the fire. This is an important problem in the financial sector where as Richard Fisher observed, “more prudent and better-managed banks have been denied the market share that would have been theirs if mismanaged big banks had been allowed to go out of business”.

Reduction in Diversity: As I mentioned here, “In an environment free of disturbances, diversity of competing strategies must reduce dramatically as the optimal strategy will outcompete all others. In fact, disturbances are a key reason why competitive exclusion is rarely observed in ecosystems”. Contrary to popular opinion, the post-disturbance environment is incredibly productive and diverse. Even after a fire as severe as the Yellowstone fires of 1988, the regeneration of the system was swift and effective as the ecosystem was historically adapted to such severe fires.

Increased Connectivity: This is the least appreciated impact of eliminating all disturbances in a complex adaptive system. Disturbances perform a critical role by breaking connections within a network. Frequent forest fires result in a “patchy” modularised forest where no one fire can cause catastrophic damage. As Thomas Bonnicksen notes: “Fire seldom spread over vast areas in historic forests because meadows, and patches of young trees and open patches of old trees were difficult to burn and forced fires to drop to the ground…..Unlike the popular idealized image of historic forests, which depicts old trees spread like a blanket over the landscape, a real historic forest was patchy. It looked more like a quilt than a blanket. It was a mosaic of patches. Each patch consisted of a group of trees of about the same age, some young patches, some old patches, or meadows depending on how many years passed since fire created a new opening where they could grow. The variety of patches in historic forests helped to contain hot fires. Most patches of young trees, and old trees with little underneath did not burn well and served as firebreaks. Still, chance led to fires skipping some patches. So, fuel built up and the next fire burned a few of them while doing little harm to the rest of the forest”. Suppressing forest fires converts the forest into one connected whole, at risk of complete destruction from the eventual fire that cannot be suppressed.

In the absence of disturbances, connectivity builds up within the network, both within and between scales. Increased within-scale connectivity increases the severity but between-scale connectivity increases the probability of a disturbance at a lower level propagating up to higher levels and causing systemic collapse. Fire suppression in forests adapted to frequent undergrowth fires can cause an accumulation of ladder fuels which connect the undergrowth to the crown of the forest. The eventual undergrowth ignition then risks a crown fire by a process known as “torching”. Unlike understory fires, crown fires can spread across firebreaks such as rivers by a process known as “spotting” where the wind carries burning embers through the air – the fire can spread in this manner even without direct connectivity. Such fires can easily cause systemic collapse and a state from which natural forces cannot regenerate the forest. In this manner, stabilisation can cause changes which cause a fundamental change in the nature of the system rather than simply an increased severity of disturbances. For example, “extensive stand-replacing fires are in many cases resulting in “type conversions” from ponderosa pine forest to other physiognomic types (for example, grassland or shrubland) that may be persistent for centuries or perhaps even millennia” (Allen 2007).

Long-Run Increase in Cost of Stabilisation and Area Burned: The initial low cost of suppression is short-lived and the cumulative effect of the fragilisation of the system has led to rapidly increasing costs of wildfire suppression and levels of area burned in the last three decades (Donovan and Brown 2007).

Dilemmas in the Management of a Stabilised System

In my post on river flood management, I claimed that managing a stabilised and fragile system is “akin to choosing between the frying pan and the fire”. This has been the case in many forests around the United States for the last few decades and is the condition into which the economies of the developed world are heading into. Once the forest ecosystem has become fragile, the resultant large fire exacerbates the problem thus triggering a vicious cycle. As Thomas Bonnicksen observed, “monster fires create even bigger monsters. Huge blocks of seedlings that grow on burned areas become older and thicker at the same time. When it burns again, fire spreads farther and creates an even bigger block of fuel for the next fire. This cycle of monster fires has begun”. The system enters an “unending cycle of monster fires and blackened landscapes”.

Minsky of course understood this end-state very well: “The success of a high-private-investment strategy depends upon the continued growth of relative needs to validate private investment. It also requires that policy be directed to maintain and increase the quasi-rents earned by capital – i.e.,rentier and entrepreneurial income. But such high and increasing quasi-rents are particularly conducive to speculation, especially as these profits are presumably guaranteed by policy. The result is experimentation with liability structures that not only hypothecate increasing proportions of cash receipts but that also depend upon continuous refinancing of asset positions. A high-investment, high-profit strategy for full employment – even with the underpinning of an active fiscal policy and an aware Federal Reserve system – leads to an increasingly unstable financial system, and an increasingly unstable economic performance. Within a short span of time, the policy problem cycles among preventing a deep depression, getting a stagnant economy moving again, reining in an inflation, and offsetting a credit squeeze or crunch….As high investment and high profits depend upon and induce speculation with respect to liability structures, the expansions become increasingly difficult to control; the choice seems to become whether to accomodate to an increasing inflation or to induce a debt-deflation process that can lead to a serious depression”. (John Maynard Keynes pg163–164)

The evolution of the system means that turning back the clock to a previous era of stability is not an option. As Minsky observed in the context of our financial system, “the apparent stability and robustness of the financial system of the 1950s and early 1960s can now be viewed as an accident of history, which was due to the financial residue of World War 2 following fast upon a great depression”. Re-regulation is not enough because it cannot undo the damage done by decades of financial “innovation” in a manner that does not risk systemic collapse.

At the same time, simply allowing an excessively stabilised system to burn itself out is a recipe for disaster. For example, on the role that controlled burns could play in restoring America’s forests to a resilient state, Thomas Bonnicksen observed: “Prescribed fire would come closer than any tool toward mimicking the effects of the historic Indian and lightning fires that shaped most of America’s native forests. However, there are good reasons why it is declining in use rather than expanding. Most importantly, the fuel problem is so severe that we can no longer depend on prescribed fire to repair the damage caused by over a century of fire exclusion. Prescribed fire is ineffective and unsafe in such forests. It is ineffective because any fire that is hot enough to kill trees over three inches in diameter, which is too small to eliminate most fire hazards, has a high probability of becoming uncontrollable”. The same logic applies to a fragile economic system.

Update: corrected date of Idaho fires from 2010 to 1910 in para 3 thanks to Dean.

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Written by Ashwin Parameswaran

June 8th, 2011 at 11:35 am