Greece: When history repeats itself

By Jacques Le Cacheux

The duration of the Greek crisis and the harshness of the series of austerity plans that have been imposed on it to straighten out its public finances and put it in a position to meet its obligations to its creditors have upset European public opinion and attracted great comment. The hard-fought agreement reached on Monday 13 July at the summit of the euro zone heads of state and government, along with the demands made prior to the Greek referendum on 5 July, which were rejected by a majority of voters, contain conditions that are so unusual and so contrary to State sovereignty as we are used to conceiving of it that they shocked many of Europe’s citizens and strengthened the arguments of eurosceptics, who see all this as proof that European governance is being exercised contrary to democracy.

By requiring that the creditors be consulted on any bill affecting the management of the public finances and by requiring that the privatizations, with their lengthy list dictated by the creditors, be managed by a fund that is independent of the Greek government, the euro zone’s leaders have in reality put Greece’s public finances under supervision. Furthermore, the measures contained in the new austerity plan are likely to further depress the already depressed domestic demand, exacerbating the recession that has racked the Greek economy in 2015, following a brief slight upturn in 2014.

Impoverishment without adjustment

The Greek crisis, which in 2010 triggered the sovereign debt crisis in the euro zone, has seen prolonged agony punctuated by European psycho dramas that always conclude in extremis by an agreement that is supposed to save Greece and the euro zone. From the beginning, it was clear that a method based on the administration of massive doses of austerity without any real support for the modernization of the Greek economy was doomed to failure [1], for reasons that are now well understood [2] but at the time were almost universally ignored by officialdom, whether from European governments, the European Commission or the IMF, the main guarantor and source of inspiration for the successive adjustment plans.

The results, which up to now have been catastrophic, are well known: despite the lengthy austerity cure, consisting of tax hikes, public spending cuts, lower wages and pensions, etc., the Greek economy, far from recovering, is now in a worse state, as is the sustainability of the country’s public finances. Despite the agreement in 2012 of Europe’s governments on a partial default, which reduced the debt to private creditors – relief denied by those same governments two years earlier – Greece’s public debt now represents a larger percentage of GDP (almost 180%) than at the beginning of the crisis, and new relief – this time probably by rescheduling – seems unavoidable. The third bailout package – roughly 85 billion euros, on the heels of approximately 250 billion over the past five years – will be negotiated over the coming weeks and will be in large part devoted just to meeting debt repayments.

Meanwhile, the average living standard of Greeks has literally collapsed; the difference with the euro zone average, which had tended to decline during the decade before the crisis, has now widened dramatically (Figure 1): the country’s GDP per capita is now a little less than half that in Germany. And GDP per capita still only poorly reflects the reality in an economy where inequality has increased and spending on social protection has been drastically reduced.

G1_Post2207ang

The new austerity plan is similar to the previous ones: it combines tax hikes – in particular on VAT, with the normal rate of 23% being extended to the Islands and many sectors, including tourism, that were previously subject to the intermediate rate of 13% – with reduced public spending, and will result in budget savings of about 6.5 billion euros over a full year, which will depress domestic demand and exacerbate the current recession.

The previous adjustment plans also featured “structural” reforms, such as lowering the minimum wage and pensions, deregulation of the labour market, etc. But it is clear that the fiscal component of these plans did not have a very visible impact on government revenue: after having declined significantly until 2009, the Greek tax burden – measured by the ratio of total tax revenue to GDP – has definitely increased, but not much more than in France (Figure 2). This does not mean, of course, that an even stronger dose of the same medicine will lead to better healing.

G2_Post2207ang

Does history shed light on the future?

The ills afflicting the Greek economy are well known: weak industrial and export sectors – apart from tourism, which could undoubtedly do better, but performs honourably – numerous regulated sectors and rentier situations, overstaffed and inefficient administration and tax services, burdensome military expenditure, etc.

None of this is new, and no doubt it was the responsibility of the European authorities to sound the alarm sooner and help Greece to renovate, as was done for the Central and Eastern Europe countries in the early 2000s in the years before they joined the European Union. Will the way it has been decided to do this now, through a forced march with the Greek government under virtual guardianship, be more effective?

If we rely simply on history, the temptation is to say yes. There are many similarities between the situation today and a Greek default back in 1893. At that time Greece was a relatively new state, having won its independence from the Ottoman Empire in 1830 following a long struggle supported by the European powers (England and France), which put the country under a Bavarian king. Greece was significantly poorer than the countries of Western Europe: despite an effort at modernization undertaken after independence that was led by the Bavarian officials assembled around the Greek King Otto, in 1890 the country’s GDP per capita was, according to data assembled by Angus Maddison[3], about 50% of the level of France, and a little less than one-third that of the UK. The analysis of Greece at that time was little better than that today:

“ … Greece has been characterized throughout the 19th century by structurally weak finances, which has led it to default repeatedly on its public debt. According to the Statesman’s Yearbook, in addition to significant military spending, Greece faces high expenditures on a disproportionately large number of officials for a small undeveloped state. Moreover, since part of Greece’s debt is guaranteed by France and Great Britain, Greece could suspend debt service without the creditors having to suffer the consequences. The French and British budgets would be compelled to pay the coupons.

“By 1890, however, the situation had become critical. At the end of 1892, the Greek Government could continue paying interest only by resorting to new borrowing. In 1893, it obtained parliamentary approval for negotiating a rescheduling with its international creditors (British, German, French). Discussions were drawn out until 1898, with no real solution. It was Greece’s defeat in the country’s war with Turkey that served as a catalyst for resolving the public finances. The foreign powers intervened, including with support for raising the funds claimed by Turkey for the evacuation of Thessaly, and Greece’s finances were put under supervision. A private company under international control was commissioned to collect taxes and to settle Greek spending based on a seniority rule designed to ensure the payment of a minimal interest. Fiscal surpluses were then allocated based on 60% to the creditors and 40% for the government.”[4]

Between 1890 and 1900, Greek per capita income rose by 15% and went on to increase by 18% over the next decade; in 1913, it came to 46% of French per capita income and 30% of the British level, which was then at the height of its prosperity. So this was a success.

Of course, the context was very different then, and the conditions that favoured the guardianship and the recovery are not the same as today: there was no real democratic government in Greece; there was a monetary regime (the gold standard) in which suspensions of convertibility – the equivalent of a “temporary Grexit” – were relatively common and clearly perceived by creditors as temporary; and in particular there was a context of strong economic growth throughout Western Europe – what the French called the “Belle Epoque” – thanks to the second industrial revolution. One cannot help thinking, nevertheless, that the conditions dictated to Greece back then inspired the current decisions of Europe’s officials[5].

Will the new plan finally yield the desired results? Perhaps, if other conditions are met: substantial relief of the Greek public debt, as the IMF is now demanding, and financial support for the modernization of the Greek economy. A Marshall Plan for Greece, a “green new deal”? All this can succeed only if the rest of the euro zone is also experiencing sustained growth.

 


[1] See  Eloi Laurent and Jacques Le Cacheux, “Zone euro: no future?”, Lettre de l’OFCE, no. 320, 14 June 2010, http://www.ofce.sciences-po.fr/pdf/lettres/320.pdf .

[2] See in particular the work of the OFCE on the recessionary effects of austerity policies: http://www.ofce.sciences-po.fr/pdf/revue/si2014/si2014.pdf . Recall that the IMF itself has acknowledged that the adjustment plans imposed on the European economies experiencing public debt crises were excessive and poorly designed, and especially those imposed on Greece. This mea culpa has obviously left Europe’s main leaders unmoved, and more than ever inclined to persevere in their error: Errare humanum est, perseverare diabolicum!

[3] See the data on the Maddison Project site: http://www.ggdc.net/maddison/maddison-project/home.htm .

[4] Excerpt from the article by Marc Flandreau and Jacques Le Cacheux, “La convergence est-elle nécessaire à la création d’une zone monétaire ? Réflexions sur l’étalon-or 1880-1914” [Is convergence necessary for the creation of a monetary zone? Reflections on the gold standard 1880-1914], Revue de l’OFCE, no. 58, July 1996, http://www.ofce.sciences-po.fr/pdf/revue/1-58.pdf .

[5] An additional clue: the German Finance Minister Wolfgang Schäuble insisted that Greece temporarily suspend its participation in the euro zone; in the 1890s, it had had to suspend the convertibility into gold of its currency and conducted several devaluations.




Argentina’s experience of debt crisis

By Augusto Hasman and Maurizio Iacopetta

There is still a lot of uncertainty around the possible paths that Greece can follow in the near feature. One possible path, which may be still averted by the current negotiation, is that Greece will default on the upcoming debt obligations (see graphics here for a detailed list of the upcoming Greek debt deadlines), thus spiraling into a currency and credit crisis and possibly resulting in a “Grexit”[1].

The Greek debt crisis shares some similarity with the Latin American debt crisis of the 1990s and early 2000s. In both Greece and Latin America, debts are mostly bond debts or debts to international institutions. Similarly to Greece, many Latin American countries had become more and more open in the decades before the crisis. The series of financial crises started with Mexico’s December 1994 collapse. It was followed by Argentina’s $95 billion default (the largest in history at that time, although later on Argentina resumed some of the payments), Brazil’s financial crisis (1998-2002) and Uruguay’s default (2002).

Argentina is viewed as benchmark for getting insights on the possible macroeconomic consequences of a Grexit, partly because it abandoned the peg with the dollar as a result of its mounting fiscal crisis. Nevertheless, some have pointed out at marked differences between the two economies, in terms of industry structure as well as trade composition (see here for instance).

Here, we review the different steps followed by Argentina during the crisis and propose some statistics related to developments of key economic indicators in Argentina before and after the crisis. For comparison purposes, we also provide key figures of the Greek’s economy.

Argentina and Greece at time of considerable stress

Greece entered the European and Monetary Union in 2001, meaning an irrevocably fixed exchange rate regime and the adoption of the Euro as legal tender. By early 2010, Greece risked defaulting on its public debt and had to call for a financial rescue to international institutions. On the other hand, at time of the crisis, Argentina had its currency, the peso, ‘immutably’ fixed to the US dollar on a one-to-one basis. As today’s Greek situation, when Argentina defaulted in late 2001, the country’s economy and government were both experiencing considerable stress. 2001 was the third consecutive year of serious recession for Argentina, foreign direct investment had virtually stopped, and inflation, interest rates and the budget deficit all were soaring. The IMF had provided loans to keep the peso stable, on the condition that the government would adopt fiscal and monetary discipline. Argentina’s economic problems became a serious crisis in December 2001, when the IMF denounced the government’s inability to put its financial house in order and suspended its loans. This development was followed almost immediately by a banking crisis and violent public protests that produced a rapid succession of six presidents in two weeks. Figure (1) depicts the behavior of Argentinian key economic indicators before and after the 2001 devaluation. Figure (2) shows the Greek’s indicators since 1998[2]. A quick inspection of the two figures reveals that:

-The magnitude of the decline of Greece’s GDP during the crisis, counting from its highest point in 2008 is roughly the same as that observed in Argentina during a recessionary period before the devaluation: 25%.

– The rise in the unemployment rate has been much more severe in Greece that in Argentina. In Argentina, unemployment, rose from 12.4% in 1998 to 18.3% in 2001 whereas in Greece it went up from less than 10% in 2008 to over 25% to this day. Both in Argentina and in Greece the inflation had been relatively low before the debt crisis; in fact in Greece it has even been negative in recent years. 

The recovery

What is somewhat surprising is what happened in Argentina after the crisis.

First, after a short period of turbulence, the Gross Domestic Product, in constant dollars, began to rise at an astonishing pace of almost 10 percent per year, until the 2007-08 financial crisis. Second, the unemployment rate declined from 18 percent to about 7 percent. Third, the poverty rate went down even below the level observed in the heyday of the pegged exchange rate. But financial indices deteriorated. First the difficulties in accessing external credits and the loss of credibility of the government pushed up the bond spreads from 4000 basis points before the crisis to ten times as much after the crisis. Second, the inflation rate seems to have stabilized at a double digit figure. According to some scholars (see for instance Alberto Cavallo “Online and official price indexes: Measuring Argentina’s inflation” Journal of Monetary Economics, 2012) there has been a systematic attempt by government authorities to greatly underestimate or underreport the inflation rate. Therefore, the GDP gain may not be as high as the one showed in Figure 1. Although the Argentinian economy has gone into a sustained period of growth, it would be unwarranted to make an automatic link between the renaissance of the Argentinian economy and the dramatic conclusion of the crisis with the abandonment of the peg and the debt default.

Some have pointed out that the recovery period coincided with a boom in the price of primary commodities (soybeans), which notoriously account for an important part of Argentinian exports. Clearly the increase in commodity prices has been a windfall for Argentinian agricultural producers with possible trickling effects on the rest of the economy. Yet, the magnitude of the windfall itself can hardly account for the large GDP gains. In fact, soybean was sold in Iowa at an average price of $4.57 per bushel in the year 2000 and at $5.88 in the year 2005. Only since 2010 prices have gone up substantially more, but at that point, the Argentinian economy had already gone through almost a decade of economic boom. Furthermore, the high price of soybeans in the second half of the 1990s (it was $7.32 in 1997) does not seem to have been helpful to avoid the economic depression. The route to recovery in Argentina has been characterized by setbacks, but also by a number of inventiveness that may have played a role in defraying the shock of the crisis.

Bank runs

 At the end of November 2001, rising worries about a peso devaluation and a deposit freeze, increased overnight interest rates sharply. Additionally, spreads between US Treasury bonds and Argentine government bonds increased by 5,000 basis points.  In order to stop the effects of a bank run, the Minister of Economy Domingo Cavallo announced a freeze on bank deposits. As in Greece, this measure considerably reduced the capacity of depositors to withdraw and manage their bank deposits. The deposit freeze had even accentuated the feeling among the population that a crisis was going to explode, and a series of demonstrations surged along the country. Subsequently, the IMF announced a cut of its support to Argentina, as it had failed to meet the conditions tied to the rescue program and Argentina lost its last source of funding. With a total amount of almost USD 22bn in 2000 and 2001, Argentina was the largest debtor the IMF had at the time. In the protests and raiding that followed, 24 people died. President De La Rúa and his cabinet resigned soon after these events.

Claims after the currency devaluation

 The government decided to ‘pesofy’ the loans at a rate of A$1 (Argentinean peso) for each dollar (USD) owned by banks and A$1.4 for each dollar deposited in a bank. Alternatively, people could get a government bond (Boden 2012), that paid A$775.12 for a nominal of USD$100, when the official dollar was 4.35A$/USD. A less attractive bond was issued the following year: it paid A$930 for a nominal of USD$100 but could only be converted at 8.95A$/USD.

 Massive use of money-bonds

 In 2001, different Argentinean provinces started to print their own quasi-currencies, several emergency bonds (technically called Treasury Bills for Debt Settlement) issued between 2001 and 2002. They were created as a way of alleviating the enormous financial and economic crisis that occurred in Argentina in 2001. These bonds were considered a “necessary evil” that initially allowed to cover the absence of money circulation. While at first the issuing of these quasi-currencies was controversial, it later gained acceptance partly because of the size of the issue and partly because of the magnitude of the crisis. These bonds circulated in parallel to the Argentinean peso. They could be used to pay some taxes, shopping and even salaries. As the pesos, they were denominated in different values 1, 2, 5, 10, 20, 50 and 100 to facilitate transactions (nominally equivalent to a Convertible Peso). The most popular bond was the Patacon that was issued in Buenos Aires. This bond had an interest rate of 7% and there were two series (Series A maturing in 2003, while the B in 2006). It is estimated that the total issue amount for the Patacons only reached 2.705 millions. Once the economic recovery of Argentina started in late 2003, the government honored 100% the principal of these outstanding bonds, and even the interests were eventually paid. Up to 13 quasi-currencies were issued by different provinces during that period.

Credit

 Figure (1) shows that in Argentina the “Sovereign Bond Interest Rate Spreads, basis points over US Treasuries” has been growing for the last 18 years showing the difficulties Argentina has had in accessing to international credit market. The difficult access to foreign funding has pushed the Argentinean government to get financed internally through the central bank, retirement funds and the tax agency. The high inflation that resulted from this policy (close to 26%, unofficial measures) has made the use of local credit extremely expensive for companies and households. However, as Argentina started posting large surpluses on the fiscal and current accounts after the default and large devaluation of the peso, access to foreign finance became less urgent. Argentina took a hardline approach against creditors. By 2010, 92% of the Argentine defaulted debt had been restructured. However, ongoing litigation by holdout creditors could lead to a new Argentine default in the near future.

In conclusion, the Argentina exit from the debt crisis through a default did not have long lasting dramatic consequences on real activities as many had anticipated. The crisis meant a transfer of wealth from depositors to debt holders and promoted exports. After an abrupt decline, GDP quickly started its ascent and the country experienced high rates of growth in the 2000s, which reduced significantly unemployment.

Nevertheless the period right after the devaluation was characterized by political instability, large macroeconomic fluctuations and social revolts. The political stability that followed, might have played a role in sustaining growth, but the rate of inflation climbed at double-digit figures and the various price control mechanism introduced by the government have created a lot of frictions in the business sector. Finally, the increasing isolation of the government from the international political arena partly, due to the outstanding litigation with international lenders, could, in the long run, have negative repercussion on trade.

 

F1_post20-07

F2_post20-07

 



[1] “Grexit” is a combination of “Greece” and “exit” and refers to the possibility of Greece leaving the Euro area.

[2] The plots are generated using World Bank data, except for the level of 2013 Greek debt/GDP ratio, which is taken from Eurostat.




Is Greece in the process of divorce?

By Jérôme Creel

The ongoing Greek saga is looking more and more like an old American TV series. JR Ewing returns to the family table feeling upset with Sue Ellen for her failure to keep her promise to stop drinking. Given the way things are going, a divorce seems inevitable, especially if Bobby sides with his brother and refuses to help his sister-in-law any longer.

Just like in Dallas, addiction to a potentially toxic substance, public debt, is plaguing Europe’s states and institutions. Analyses on Greece focus mainly on debt-to-GDP ratios. On these terms, Greece’s public debt-to-GDP ratio rose from 2011 to 2014: European public opinion can therefore legitimately question the ability of the Greek people (really the Greek state) to curb spending and raise taxes. A divorce is inevitable. But if we look at the amounts involved, the situation seems somewhat different.

Between 2011 and 2014, Greece’s public debt decreased by 39 billion euros according to Eurostat. Seen in this light, the Greek state is making a real effort. But this obscures the aid of the creditors. The Greek state has in fact benefited from the restructuring of its debt, including a partial but important default on its public debt to its private creditors. According to Jeromin Zettelmeyer, Christoph Trebesch and Mitu Gulati, the amount of debt for which the Greek state was forgiven was on the order of 100 billion euros. Without this aid, the amount of Greece’s debt would have increased between 2011 and 2014 by 61 billion euros (100 billion minus the aforementioned 39 billion). This is not nothing for a country like Greece. However, note that Greek debt accounts for only 3.5% of the euro zone’s total public debt.

Furthermore, how were the other EU countries faring at the same time? No better! The addiction to public debt, if we can indeed speak of addiction, is general. The public debt of the EU and the euro zone rose by 6 GDP points, or by 1400 billion and 800 billion respectively. By comparison, the increase in the Greek debt is a drop in the ocean. Germany’s public debt rose by 68 billion euros, Italy’s by 227 billion, Spain’s and France’s by 285 billion respectively, and the United Kingdom’s by 277 billion pounds, or 470 billion euros, again according to Eurostat. Relative to their respective GDPs, Spain’s debt increased by almost 30 points, Italy’s by more than 15 points, France’s by 10 points, and the UK’s by nearly 8 points. Only Germany has seen its debt ratio go down, thanks to stronger economic growth.

Paul de Grauwe  recently insisted on the fact that Greece’s debt is sustainable: given the various debt restructurings already undertaken, the public debt-to-GDP ratio of 180% would be roughly 90% in present value, i.e. after having accounted for future interest payments and scheduled repayments, some of which are in a very distant future[1].

Economists, including in this case Paul de Grauwe, use the state’s intertemporal budget constraint to understand the sustainability of public debt. Rather than using a retrospective approach, the public debt can be analysed from a prospective approach. If the following year’s debt depends on the present debt, then by symmetry, the present debt depends on the following year’s debt. But next year’s debt will depend on the following year’s debt, by iteration. Ultimately, the present debt depends on the debt of the following year and on and on until the end of time: it depends on future debts. But these future debts also depend on future public deficits. The intertemporal budget constraint thus expresses the fact that today’s public debt is equal to the sequence of future public deficits and to the final debt (that at the end of time), all expressed in present values.

In contrast to businesses and households, the state is supposed to have an infinite time horizon, which makes it possible to reset the present value of the debt at the “end of time” to zero. We can then say that the public debt is sustainable if future governments provide adequate public surpluses to pay off that debt. This is possible after periods of high public deficits, provided that these periods are followed by others during which governments accumulate budget surpluses. Given the extension of the maturity of Greek debt and the low level of future interest payments, the budget surplus required to repay the current debt is low. Paul de Grauwe concludes that Greece is subject to a liquidity crisis rather than a sovereign default crisis. So, again according to Paul de Grauwe, what is needed is to adjust the fiscal austerity plans and forthcoming reforms to the actual level of the public debt, which is substantially lower than the level being used as the basis for negotiations between the Greek state and the “institutions” (ECB, Commission, IMF). In other words, the “institutions” can loosen their grip.

The “Greek case” can thus be relativized and the divorce put off. Sue Ellen’s addiction is less exceptional than it seems at first glance.

 


[1] After 2015 and 2019, which will involve substantial repayments from the Greek state, the “difficult” years will then be situated beyond 2035 (see the amortization profile of Greece’s debt in Antonin et al., 2015).

 




Do separated fathers bear a greater sacrifice in their standard of living than their ex-partners?

by Hélène Périvier OFCE-PRESAGE

The recent study published by France Strategy on the sharing of the costs of children after a separation has caused a stir (see in particular Dare feminism, Abandoning the family, as well as SOS Papa [all in French]). The study analyses the changes in the standard of living of both the former spouses, taking into account the interaction between the indicative scale for child support and the tax-benefit system. This approach is stimulating, as it endeavours to see whether the redistribution effected through the welfare state fairly and equitably deals with the costs of the child borne by each former spouse.

It is reported that after separating, the living standards of the two former partners fell sharply. In addition, simulations of typical cases “indicate that as a result of applying the scale [the indicative reference scale provided to judges] under existing social and tax legislation, the care of children causes a significantly greater sacrifice in the standard of living of the non-custodial parent than of the custodial parent”. In other words, separated fathers are making a greater sacrifice in their standard of living than are the mothers, if the judge were to apply the indicative scale to the letter. But according to the Ministry of Justice the scale is not applied by judges, as both situations are always very specific. So the study looks at what the standard of living of the separated parents would be if the scale were applied, and not at their actual standard of living. However the table of results presented in the note on the front page is titled, “Estimating the loss of living standards incurred by the parents of two children (as a percentage compared to the situation with no child, calculation net of state aid)”. Someone reading this quickly could easily think this was the real situation of separated parents.

Even though the study is based on the scale for support payments and not on the decisions of the judges themselves, it raises a relevant question. But the results are weakened by significant methodological problems: the concept of the sacrifice in the standard of living does not take into account the gender division of labour and its impact on mothers’ careers; the typical cases highlighted are not necessarily representative (in particular concerning marital status prior to separation); using the equivalence scales [1] leads to conflating the “household standard of living” and “the individual standard of living”; and finally, an approach based on maintaining the child’s standard of living would have led to a completely different result. Ultimately, proposing the micro-simulation model as an aid to the judges’ decision-making seems somewhat premature in light of these criticisms.

On the concept of “a sacrifice in the standard of living” 

In all the cases simulated, the separated parents’ living standards go down relative to their situation as a couple (assuming unchanged income). This result is consistent with other recent work, such as Martin and Périvier, 2015; Bonnet, Garbinti, Solaz, 2015; and the report of France’s Family Council (the HCF). A separation is costly for both parents due to the loss of economies of scale (e.g. two homes are needed instead of one, etc.). In addition to the decline in living standards for each parent, the authors calculate the “sacrifice in living standards” experienced by the parents after the separation.

The “living standard sacrifice” is supposed to be calculated by comparing the cost of the child to the disposable income that the parent would have had if there were no child. However, the living standard sacrifice made by the mother with custody of the child (or the father, respectively) is actually calculated by comparing the child’s cost with the standard of living of a single woman without children with the same salary level as the separated mother (and the same for the father).

This method cannot be used to estimate the “living standard sacrifice”, since forming a couple and a family are accompanied by a gender division of labour, which has been widely documented in the literature and which implies that the separated wife has a salary level, and more generally a career, that is different from what she would have had if she had remained single with no children. If a woman senior executive living in a couple stops working in order to look after the children and then the couple separates, the concept of the “living standard sacrifice” would imply a significant gain in the quality of life for this woman, since the cost of the children would be relative to the RSA minimum income, whereas she would have received a higher salary if she had not had children because she would have continued to work.

In other words, the proper counterfactual, that is to say the situation with which we must compare the level of the separated parent so as to assess the living standard sacrifice that she (or he) suffers, should be the income that the woman (or man) would have had when separated (taking into account their individual characteristics) if she (or he) had not entered a couple and if she (or he) had not had children. By doing this, the calculations would have led to a significantly greater sacrifice by the woman than that calculated in the study. Here we see the need for an economic approach that integrates the behaviour of agents, compared with an accounting approach.

Atypical typical cases?

The authors used the micro-simulation model Openfisca to simulate different situations and assess the loss in living standard by each former spouse after the separation.

The typical cases are used to understand the complex interactions between the tax-benefit system and, for the subject matter here, the indicative scale of child support payments. The criticism usually made of typical case studies is that they do not reflect the representativeness of the situations simulated: so to avoid focusing on marginal cases, data is added about the frequency of the situations selected as “typical”. With respect to the distribution of income, in three-quarters of the cases the women earn less than their male partners (Insee). What would be needed is to look at the distribution of income between spouses before the break and see what are the most common cases and then to refine the operation by retaining only those cases where the judge sets a support payment, i.e. in only 2 out of 3 cases (Belmokhtar, 2014).

Likewise, focusing on the case of a couple with two dependent children is not without consequences[2], since with only one dependent child the amount of family benefits falls, meaning that the social benefits received by the mother would be lower (in particular the family allowance is paid only starting from the second child) as would her standard of living. Statistics provided by the Ministry of Justice indicate that the average number of children is 1.7 in the case of divorces and 1.4 in the case of common-law unions (Belmokhtar, 2014).

Finally, nothing is said explicitly about the marital situation prior to the separation: marriage or common-law?

– Either the authors are considering married couples. In this case, if the salaries of the ex-spouses are different (case 4 described as “Asymmetry of income”), how is the loss of France’s marital quotient benefit (quotient conjugal) distributed? After divorce, the tax gain resulting from joint taxation is lost: the man then pays a tax amount based on his own salary and no longer on the couple’s average salary. This additional tax burden hits his living standard, and the “living standard sacrifice” calculated for the divorced father would then partly reflect the loss of this marital quotient benefit, and not the cost arising from the expense of a separated child.

– Or the authors consider only common-law couples, which seems to be the case given the vocabulary used – “separation, union, separated parents, etc.” – but then this brings back the criticism about the representativeness of the typical cases, since more than half of the court decisions regarding the children’s residence are related to divorces (Carrasco and Dufour, 2015). Moreover, the support payments set by the judge are all the more distant from the scale in the case of a separation and not a divorce, which limits the scope of the study.

On the proper use of equivalence scales

Equivalence scales are used to compare the living standards of households of different sizes, by applying consumption units (CU) to establish an “adult equivalent”. These scales are based on strong assumptions that do not allow the use of this tool in just any old way, i.e.:

– that individuals belonging to a single household pool their resources in entirety;

– that people belonging to the same household have the same standard of living (the average standard of living is calculated by dividing the total household income by the number of household CUs). This assumption flows from the first; the standard of living is equated with well-being.

Equivalence scales give an estimate of the additional cost linked to the presence of an additional person in a household. They say nothing about the way in which resources are actually allocated within the household. This is due to the hypothesis that resources are pooled, which is questionable (see in particular Ponthieux, 2012) and which leads to attributing the household’s average standard of living to each individual member. A couple has 1.5 CU. In fact, a couple A in which the man earns 3 times the minimum wage (SMIC) and the woman 0 times the SMIC would have the same standard of living as a couple B in which both earn 1.5 times the SMIC. This method can be used to compare the average living standards of two households, but not the living standards of the individuals who compose them. The woman in couple B probably has an individual standard of living that is higher than the woman in couple A, due to her greater bargaining power given the equal wages earned. So comparing the average living standards of the couple with the living standards of the individuals when the couple separates is misleading.

Likewise, to assess the financial burden represented by the children for the separated mother, for example, the authors apply the CU ratio linked with the children out of the total household CUs to the woman’s disposable income (salary minus the taxes paid, plus the benefits received and the support payment by her ex-partner for the two children in her care). But there is nothing to say that the separated mother does not allocate more resources to the children than is estimated by the CU ratio (with regard to housing, for example, she might sleep in the living room so that the kids each have their own room).

The methodological criticisms made of equivalence scales limit their use (see Martin and Périvier, 2015). They are not suitable for comparing the living standards of individuals, but only the living standards of households of different sizes.

What about the child’s standard of living?

There is not much literature estimating the standard of living of separated parents. To fix CUs per child in accordance with the marital status of their parents (in couples or separated), the authors rely on an Australian study that leads them to increase the CU attributed to children once the parents are separated. The cost of a child of separated parents is higher than that of a child living with both parents. They opt for the following formula:

– a child living with both parents corresponds to a CU of 0.3;

– a child living with the mother in conventional custodial care is 0.42 CU and 0.12 for the non-custodial father, i.e. 0.54 total CU for the two households.

Thus the cost of a child of a separated parent is 80% higher than that of a child living with both parents. It is likely that most separated parents do their best to keep the lives of their children unchanged after a separation. An approach that seeks to maintain the child’s standard of living makes it possible to take this into account. By increasing the cost of children by 80% when they live with both parents, and redistributing this in proportion to the CUs allocated for the children of separated parents, the custodial parent has a greater loss in living standard than that of the non-custodial parent (see the Table). This method is also questionable because it applies the additional CUs of children of separated parents over children living in couples to the monetary cost calculated in the case of a couple raising the children. But if this approach is chosen, then the result is reversed.

Table_post06-07_English-corrige

Any statistical analysis is based on assumptions used to “qualify” what we want to “quantify”, which is inevitable (either because we do not have the information, or for reasons of simplification and to facilitate interpretation). Assumptions that are too strong, results that are too sensitive, and perfectible methodologies are the daily lot of researchers. Providing insights, asking good questions, opening up new perspectives, feeding and feeding off of contradictions – this is their contribution to society.

The study published by France Strategy has the merit of initiating a debate on a complex subject that is challenging for our tax-benefit system. But the answers that it gives are not convincing. While the authors acknowledge that, “The interest of these simulations is above all illustrative,” they nevertheless also want that “at least they provide judges and parents with a tool to simulate the financial position of two households that have resulted from a separation by integrating the impact of the tax-benefit system”. This seems premature in view of the fragility of the results presented.

 


[1] To compare the standard of living of households of different sizes, equivalence scales are estimated from surveys and using a variety of methods. They are used to refer to an “adult equivalent” standard of living, or a “consumer unit” (CU). From this perspective, the standard of living of a household depends on its total income, but also on its size (number and age of its members).

[2]  While Figure 7 of the working document summarizes the situations by the number of children, in the note the focus is on the case with two children.




What is a Left economics? (Or, why economists disagree)

By Guillaume Allègre

What is a Left economics? In an opinion column published in the newspaper Libération on 9 June 2015 (“la concurrence peut servir la gauche” [“Competition can serve the Left”], Jean Tirole and Etienne Wasmer reply that to be progressive means “sharing a set of values and distributional objectives”. But, as Brigitte Dormont, Marc Fleurbaey and Alain Trannoy meaningfully remark (“Non, le marché n’est pas l’ennemi de la gauche” [“No, the market is not the enemy of the Left”]) in Libération on 11 June 2015, reducing progressive politics to the redistribution of income leaves something out. A Left economic policy must also be concerned about social cohesion, participation in social life, the equalization of power, and we could also add the goals of defence of the environment and, more generally, leaving a fair legacy to future generations. Paradoxically, if the Left must not a priori reject market solutions (including the establishment of a carbon market), the de-commodification of human relations is also part of core left-wing values. The authors of these two columns insist that it is the ends that count, not the means: the market and competition can serve progressive objectives. This is not a new idea. The merchants of the 18th century had already understood that holding a private monopoly could allow them to amass great fortunes. Tirole and Wasmer draw on more recent debates, including on the issues of taxis, housing, the minimum wage, the regulation of the labour market, and university tuition fees. Their conclusion, a bit self-serving, is, first, that more independent evaluations are needed, and second, that our elected representatives and senior officials need to be trained in economics.

Does the Left define itself by values? To accept this proposal, we would need to be able to distinguish clearly between facts and values. Economics would be concerned with facts broadly speaking and would delegate the issue of values to politics. Disagreements about facts would be exaggerated. Political differences between the Left and the Right would be only a matter of where to put the cursor on values or preferences, which would be independent of the facts. According to this viewpoint, the instruments need to be designed by trained technicians, while the politicians just select the parameters. The Left and the Right would then be defined by parameters, with progressives more concerned about reducing inequality and conservatives more concerned about the size of the pie. In this scheme, disagreements among economists would be focused on values. Paradoxically, the examples used by Tirole and Wasmer are the subject of important controversies that involve more than just values: economists are very divided over the liberalization of the taxi business, the level of the minimum wage, and the possible introduction of university enrolment fees. There are important disagreements, even among progressive economists.

Why the disagreement? There are fewer and fewer disputes over the facts, strictly speaking. The system of statistics has made considerable progress. However, pockets of resistance remain. For example, on taxis, it is difficult to know who holds the licenses and the prices at which they were acquired, even though these are very important issues. If the vast majority of licenses are held by people who received them for free, then increasing the supply via private cars with drivers (“VTC”) poses no real problem of fairness. On the other hand, if most licenses were acquired on the secondary market at exorbitant prices (up to 240,000 euros in Paris), then the question of compensation arises. Buying 17,000 licenses at 200,000 euros apiece would cost the State 3.5 billion euros just for the licenses in Paris. This problem cannot be dismissed with a simple, “of course these are often expensive” (see “Taxis vs chauffeur-driven private cars: victory of the anti-innovation lobby?”).

While the facts are in little dispute, the disagreement often comes down to what matters. Should we put the emphasis on a lack of equal outcomes or a lack of equal opportunity? Should we count real estate gains when examining inequalities in capital? Should we be concerned about relative poverty or absolute poverty? Should we worry about inequality between households or between individuals? All this reflects that disagreements are not just a matter of where you put the cursor, but the prioritization of goals that are sometimes complementary and sometimes contradictory. The very way the system of statistics is constructed is not to produce pure facts but instead results from a logic that dictates that what you measure is the representation of a norm. But this norm is in fact reductive (it excludes others), so much so that the measure has meaning only from when we agree on the norm’s value: the measure is never neutral vis-à-vis values.

This vision of an economic science that can distinguish facts from values ​​is too reductive – it is often difficult to distinguish between the two. For example, depending on whether we measure the impact of tax policy on individuals or on households, the policy may be characterised as redistributive or as anti-redistributive. Often there is no easy solution to this problem, because it is difficult for the statistician to know how incomes are actually being shared within households. The current solution for measuring living standards and poverty is to assume that resources are fully shared within the household, regardless of the source of the income (labour income from one or another member, social welfare, taxation, etc.). Yet numerous studies show that for many households this assumption is false: empirical studies show that spending depends on who provides the resources, with women spending a larger portion of their income on the children.

Does the free character of the higher education system make it anti-redistributive? To public opinion this is obvious: the students come from wealthier families and will receive bigger salaries than those who don’t study, while everyone pays taxes, including VAT and the CSG wealth tax. This seems to be true if we think about it at time t. On the other hand, if you consider the life cycle the issue becomes more complicated: many students do not get high-paying jobs. School teachers, artists and journalists are often highly educated but make lower-than-average wages. For them, paying income tax is more advantageous than paying enrolment fees. Conversely, many people who have little education receive large salaries. Over the life cycle, having higher education paid for through income tax is redistributive (see “Dépenses publiques d’éducation et inégalités. Une perspective de cycle de vie” [“Public expenditure on education and inequality. A life cycle perspective”).

Should we measure income at the household level or individual level? Over the life cycle or at a given point in time? These examples show that what is measured by economists usually depends on a norm. This does not however mean that the measure is completely arbitrary and ideological. In fact, social science measurement is neither entirely normative nor merely descriptive: facts and norms are intertwined.

Economists do not reason simply with raw facts. They develop and estimate behavioural models. They do this to answer the question, “What if …?” What if we increased the minimum wage, what would be the impact on employment and wages at the bottom of the scale? You could classify the answer to such questions as facts. But unlike facts in the strict sense, they are not directly observable. They are generally estimated in models. However, the disagreements over these “facts” (the parameters estimated in the models) are very important. Worse, economists tend to greatly underestimate the lack of a consensus.

The parameters estimated by economists have meaning only within a given model. However, the disagreements between economists are not just about the parameters estimated, but the models themselves, that is to say, about the selection of simplifying assumptions. Just as a map is a simplification of the territory it represents, economic models are a simplification of the behavioural rules that individuals follow. Choosing what to simplify is not without normative implications. The best map depends on the degree of accuracy but also on the type of trip you want to make: once again, facts and values are intertwined. Differences between policies are not simply parametric, but arise from different representations of society.

Thus, contrary to the conclusion of Tirole and Wasmer, economic evaluations cannot be simply left to objective experts. In this respect, economists resemble other social scientists more than they do physicians: in fact, agreement on what constitutes good health is easier than on what constitutes a good society. Economic evaluations must therefore be pluralist, in order to reflect as much as possible the diversity of views in a society. What separates us from implementing the reforms needed is not a pedagogical deficit on the part of the experts and politicians. Nor is it simply a problem of educating the elite. There is obviously no agreement among the experts on the reforms needed. However, the economic reforms are often too technical to submit to a referendum and too normative to be left to the “experts”. To resolve this problem, consensus conferences and citizens’ juries seem relevant when the subject is normative enough to care about the representativeness of the participants and technical enough that we need to seek informed opinions. In economics, these kinds of conferences could deal with the issue of the individualisation of income taxes or carbon offset taxes. In short, economists are more useful when they make the trade-offs explicit than when they seek the facade of a consensus.