Negative externalities and taxes: a contribution to the debate on “junk food”

First published Aug 16, 2009. Updated June 13, 2013

>> Haga clic aquí para la versión en castellano

Alcohol and cigarette products are usually subject to high taxes. This occurs because the economic theory acknowledges that the price of these products does not reflect the true social cost of consumption.

Thus, a Pigovian tax [1] is applied to neutralize the externalities [2] caused by these products in both consumers and society.

Barcelona · Mercat de la Boqueria [Sant Josep]

Barcelona · Array of fruits and vegetables at La Boqueria Market

In this regard, developed countries have begun to consider the option of raising the tax burden of the food low in nutrients and high in saturated fats and carbohydrates, also called junk food as a way to lighten the deficit and in turn combat obesity [3]. If implemented successfully in the case of tobacco or alcohol, why do not tax the junk food and improve the way consumers make decisions about their diet?

In return, during the first half of 2009, interesting reports have been published focused on discussing the aspects of the issue. Thus, Engelhard, Garson and Dorn (July 2009) [4] put the junk food as a major cause of obesity, with direct consequences for the economy through a decline in productivity per worker and increased costs for medical care. United States estimates that medical costs of obesity are $ 700 higher than the costs of a thin person.

However, Yaniv, Tobol and Rosin [5] argue that the implementation of taxes on junk food has technical shortcomings. For example, there are too many possibilities of interpretation to decide what products should be considered within that tax. A hamburger has high levels of fat, protein and calories but these are also necessary for metabolism. In addition, unlike the case of cigarette or alcohol, consumption of junk food does not produce a direct negative externality on the welfare of someone other than the individual’s. Therefore, we must ponder the results of these surveys further to soon begin the implementation of tax measures that directly affect the purchasing decision of consumers.

__________________

[1] A Pigouvian tax is a duty charged on a market activity to correct the market outcome, if there are negative externalities associated with the market activity.
.
[2] In economics, an externality or spillover of an economic transaction is an impact on a party that is not directly involved in the transaction. In such a case, prices do not reflect the full costs or benefits in production or consumption of a product or service.  A negative externality occurs when an individual or firm making a decision does not have to pay the full cost of the decision. If a good has a negative externality, then the cost to society is greater than the cost consumer is paying for it. Since consumers make a decision based on where their marginal cost equals their marginal benefit, and since they don’t take into account the cost of the negative externality, negative externalities result in market inefficiencies unless proper action is taken.
.
[3] An individual is classified as obese based on his body mass index (BMI), which shows the relationship between weight and height as an indicator of body fat. An adult is classified as “overweight” if his BMI is between 25 and 25.9. If his BMI is greater than 30 he’s classified as obese.
.
[4] ENGELHARD, Carolin; GARSON Arthur; DORN Stan “Reducing obesity: Policy strategies from the tobacco wars”, Urban Institute. July 2009.
.
[5] YANIV, Gideon; ROSIN Odelia; TOBOL Yossef. “Junk-food, home cooking, physical activity and obesity: The effect of the fat tax and the thin subsidy”. Journal of Public Economics. June 2009.

Spanish fear

Developments in Portugal and Spain, like those in Greece, are part of a much wider crisis of the European economy.

The crisis in Europe spirals downwards. Political uncertainty over Greece now marches in lockstep with creeping financial failure in Spain. Credit rating agency Moody’s last May downgraded 16 Spanish banks in the belief that they are at an increased danger of collapse should a serious run on the banks begin. The Spanish government denied at that time that Bankia was suffering from just such run. In Greece, around €700m has been taken daily from the banking system since the inconclusive election on May 6.

Bank runs are an inherent problem for the banking system. Banks create long-term loans, but take deposits on a short-term basis. This is how credit is created – banks, in effect, lend out more money than they actually have available. There’s nothing greatly mysterious about this process, and under normal conditions, the difference between the two does not matter greatly. At any point in time the bank can usually access sufficient reserves to cover all the day-to-day demands made by depositors for their cash. For as long as depositors believe that their depositors are safe, the bank is also safe. A bank run occurs when this confidence evaporates. Depositors descend on the bank in a panic, demanding the withdrawal of savings for safer locations – another bank, abroad, or simply shoved under the mattress. But while rational for the individual depositors, this panic – a run on the bank – can bring about the very collapse of the bank they are trying to avoid. Worse yet, panic can spread rapidly throughout the system.

« Over the past 12 months, some $425 billion in deposits have been pulled from banks in Greece, Italy, Portugal and Spain. And about $390 billion in deposits have piled up in core euro countries, particularly France and Germany » (1)

The last public run on an EU bank was in May 2012, with queues forming outside Bankia as worried depositors attempted to withdraw whatever cash they had access to. To avoid this prospect, governments have developed over the years a number of ways to insulate their banking systems from their inherent instability. Governments offer to act as a lender of last resort, promising to ensure banks always have sufficient liquidity – cash at hand – to meet the demands of their customers. Or they may offer deposit insurance, promising to pay out to depositors in the event of a collapse. On May 2007, faced with a run on Northern Rock, Alastair Darling, Labour Chancellor of the Exchequer at the time, made a public statement promising the government’s support for the bank. This restored confidence in the bank’s stability, and broke the run. Governments put these backstops in place to try and preserve confidence in the banking system as a whole. If confidence is maintained, banks are less liable to collapse.

Bank runs can be catastrophic. They heightened the Great Depression of the 1930s, exacerbating the collapse, and possibly were a primary factor in its cause. The European economy was devastated by the collapse of Austria’s largest bank, Creditanstalt, in May 1931. Creditanstalt had spent the preceding years gobbling up smaller, failing banks, while weakening bank regulation hid its bad loans. When a director finally refused to sign off on the bank’s annual accounts, depositors, believing the bank to be insolvent, rushed to remove their savings. The Austrian government stepped in to guarantee bank deposits, hoping to break the panic. But this guarantee merely undermined confidence in the Austrian state itself. Depositors did not believe the country could afford to both stand behind its banks and maintain Austria’s place in the Gold Standard fixed-currency system. The panic spread beyond Austria’s borders: banks in the Netherlands and Poland collapsed in June, in Germany in July. The fear reached the US and UK by mid-summer. The Great Depression was dragged onwards.

_________

(1)    The slow bank run that could still doom Europe, The Washington Post, September 20, 2012

The corporate capture of governments

The G20 — the most powerful summit of world governments — meets tomorrow to discuss the global economic crisis, and who is sponsoring the meeting? Banks and corporations.

No wonder the site of the meeting — the French city of Cannes — is completely locked down to any ordinary citizens, while banks and large corporate CEOs have all access passes to tell our governments what to do.

Corporations and banks have captured our governments, winning vast bailouts after helping to create the crisis. Now they are buying their way into the very meeting that could decide the world’s financial future.

The line between corporate power and responsible government has steadily blurred, undermining our democracies and our economy. Politicians take money from corporations for their campaigns, make policies that reward them when in office, and then take high-paid jobs with them after they leave. It’s venality, plain and simple.

Now Société Générale, a French bank that received a public bailout and has a vested interest in Europe’s financial policy, is an official sponsor of the summit. This bank and 20 other corporations have paid large sums of money in sponsorship for a seat at the table of our governments.

The only way to get policies that protect jobs, tackle speculators and guarantee a fair future for us all is to kick back against the lobbies and prise our leaders away from corporate interests.  The global economic crisis resulted in large part from reckless banks that were no longer regulated effectively by governments because of the control banks stress over our leaders. This corporate capture of government is the major threat today, both to democracy, and to an efficient and fair economy.

The Need for Radical Change

THE FUTURE OF MONEY (4/4)

Proposed solutions to the financial crisis tend to involve more regulation and the break up or separation of banking activities, but these merely scratch the surface. The financial sector is not only too big; it embodies massive contradictions. In particular, the social role of finance makes it impossible for monetary authorities to let the system fail. This creates moral hazard on an epic scale, ‘Wall Street socialism’ with massive benefits for the financial elite and costs and liability for the many.

Given that the public nature of money makes the financial system a public liability, there is no case for its private ownership and control. As bank credit issue is the main engine of money creation in modern societies, how that money is issued and circulated is a crucial question. The allocation of that credit determines economic priorities.

Under free enterprise system the only priority is private profit. On this basis global speculative ventures are supported while local, particularly social, businesses are marginalised.

The allocation of credit is only part of the problem, however. The main question must be why the private banking system should have control of the monetary system at all. Historically this was developed through the link between trading money, promissory notes and bills of exchange, which were exchanged for bank credit notes designated in the national currency (legal tender). More recently the system has shifted to ‘sight accounts’, money records rather than cash in hand. The question that needs to be asked is: why is the private issue of notes and coin (counterfeiting) punished by law while the private creation of sight accounts is seen as a natural function of banking?

Capitalistic control of the financial system has played a major trick on the public. Given that bank credit is created out of fresh air, like fresh air it should be a public resource, not a private horn of plenty. Decisions about the allocation of that credit should be made democratically. Private profit should not be the only criterion for money issue.

Nor should all money be issued as debt with the interest charged accruing to the issuing financial institution. Debt-based money builds in a growth dynamic that prevents the emergence of a more socially and ecologically sustainable economic system. Instead money could be issued without debt as grants or interest-free loans. The only reason this is not done is that capitalism has ideologically captured economic reasoning. The right of banks to issue money for profit is not challenged.

If people demand to issue money themselves or demand that social and ecological priorities come first they will be told that ‘this cannot be afforded’. The trick is that the market puts some kind of brake on money creation and allocates it most efficiently. The recent crisis shows that neither of these claims is true. Any money creation by the public is decried as inflationary, while massive inflation of the capitalist financial system was given the euphemism ‘capital growth’. The public were to be grateful for the few portions of taxes that were reluctantly extracted from the financial sector.

In fact, there is no reason why money should be issued through the private banking system. It may be that with money under democratic control the public would vote to give financial resources back to the private sector, but it is more likely that social expenditure would be prioritized. The private sector would then have to re-orient its activities to serving public needs. This could form the basis of an economy in which growth would occur in response to social need, rather than the demand for ever expanding profits. Money circulation would return to the production of goods and services and not the never never land of perpetual financial growth. The idea that the whole of society could secure itself on constantly inflating financial assets is a total illusion.

The financial crisis has revealed the financial system’s enormous power and lack of democratic control. Money and finance, nationally and internationally, must be socially and politically re-embedded to enable socially just and ecologically sustainable economies to emerge. Rather than asking ‘can the financial crisis be the basis of radical change?’ the crisis must be the basis of radical change if we are not to continue on the capitalist financial merry-go-round until we all fall off.

The Contradictions of Privatised Finance

THE FUTURE OF MONEY (3/4)

Financialized capitalism rests on its capacity to create credit to lend to itself to inflate its speculative profits and financial assets. But financial asset inflation is always a pyramid scheme, whose value will collapse as soon as there are no new investors.

Traditionally states had a concentration of financial power through their ability to issue money as currency and tax it back. Capitalism has similar power through its control of financial resources. It creates money and calls it back with interest. This puts a growth dynamic into the economy. More money must come back than has been issued; this in turn demands that more money be created.

The neoliberal rationale for private control of money issue is that the market is more ‘efficient’. This is despite the endemic tendency to crisis in financialized capitalism. People have been encouraged to trust their future security in terms of pensions and savings to the financial markets, which in itself creates the conditions for a boom.

While hedge speculators can make money on rising or falling assets, for most people money can only be made on inflating financial assets such as housing or equities. This requires constant creation of credit to fuel the new buyers, a phenomenon that was clearly seen in the mortgage market. When the market has peaked and no one is willing to take on more credit, or the borrowers can no longer pay, the value of the financial assets must fall. Even in the case of hedge speculators, winners will be balanced by losers.

Why were the banks so desperate to lend money recklessly to home buyers and to develop such complex financial packages? The answer lies in the demand for increased profits to raise dividends and share prices. The bonus strategy of payment in shares also drove this. In such a situation banks engaged in the most profitable aspect of banking, which was also the most risky. It is not without irony that financialized capitalism fell because of its exploitation of the very poor. As capitalism runs out of a market for its goods, services or investments, all that is left is the poor. In the case of financialized capital this was the subprime householder. However, the subprime borrowers did not cause financialized capitalism to fail; the cause was its own contradictions.

Profit-driven banks must always be tempted towards speculation, no matter how many firewalls are put up between deposits and investments. For this reason the calls for narrow banking or smaller banks will not work. As long as the companies running the banks are driven by capitalist values they must be driven by the drive for profit, and therefore risk. This would not be so important if the activities of the privatized banking sector were not a liability on the public. But the financial system is interconnected and the only way to save some parts is to save the whole. The speculative sector can only be separated if the deposit-based sector is not part of the capitalist system and if its credit creation capacity is brought under democratic control.

The private control of banking and finance is fundamentally flawed in that its neoliberal claim to financial freedom is in contradiction to the social foundation of money systems. The crisis has also undermined the claim that through global financialization a substantial portion of national populations can sustain their economic future through appreciating financial assets. Far from ‘rolling back’ the state, the implosion of deregulated finance has directly contradicted the neoliberal case that the market and its money system is a self-regulating process that would be distorted by state intervention.

Under the illusion that money was a neutral representation of the wealth of the market, financial institutions operated far and wide. Financial traders speculated on currencies and borrowed from low-interest countries to invest in higher-interest ones. Claiming that their industry was global they played off countries against each other, demanding favorable tax status or lodging themselves in tax havens. In doing so they undermined the conditions of their own existence, the public authority of money.

A major problem for countries such as Greece or Argentina is that they have considerable problems in raising tax with substantial informal economies and high levels of tax avoidance. Finance may have escaped regulation but it has also separated itself from the legitimization of money through public authority. This led the sector to expand to such an extent that the amounts of money at risk threatened the solvency of countries that had residual responsibility for their activities.

Public Foundations of the Financial System

THE FUTURE OF MONEY (2/4)

The financial system is concerned with the issue and circulation of money. Within capitalism the purpose is to direct money to the most profitable use.

Money is a peculiar phenomenon, real and not real so far. In essence it is a promise. Holding money is a claim on any resources, goods or services that are categorized in money terms. However, for these claims to be realized, the sellers of resources, goods or services must trust in the persistent value of that money.

Historically, money has been made of a commodity that can itself be resold, such as gold, but today it mostly consists of base metal, paper, or merely electronic records. People trust it because convention and experience tells them it will be honored. It is also backed by a public monetary authority as legal tender that has a stated value.

This is critical to public responsibility for money. For example, all monetary activities designated in pounds are collectable from the British banking system (or its international agents). Underlying the whole banking system is the Bank of England. Despite it having been made independent in policy terms, the Bank’s authority rests on the financial viability of the nation in terms of its productivity (GDP) and its ability to collectively assemble money through taxes.

As has been shown in Iceland, the people, through the state, are forced to take on financial liabilities created by the private sector. If a company produces a car that ceases to function, the owner does not go to the state asking for a new one. With money, however, this is exactly what the holder of that money will do. People invested in Icesave, the Icelandic online bank, because it offered higher interest. Despite the fact that the bank was linked to a small country of only 300,000 people, investors did not see it as a risky investment.

When the parent bank failed, depositors turned all together to the British government and demanded payment in full. In order to secure the safety of its own banks, the UK lent Iceland the money to repay deposits – a huge debt on the Icelandic people against which they are now protesting.

How could Iceland’s banks have financial commitments several times larger than its economy? Partly this was because the banks took in deposits from around the world, but mainly it was because banks can themselves create money. They do this by issuing bank credit – loans.

Free market has been built on bank credit. Traders and companies have borrowed bank money to set up their businesses. Recently most credit issue has been related to consumption or financial investments such as housing. The illusion is that banks act as intermediaries between savers and borrowers, but that is not so. Banks take in deposits, some paying interest. They also issue loans and charge interest. There is no direct relationship between savers and borrowers.

All deposits are returnable, regardless of what loans are still outstanding. Banks can also lend much more than they have in deposits, traditionally up to ten times more and even more in recent years. This is how financial sectors can explode in total value, eclipsing the productive economy and inflating financial assets.

Recently bank lending has contributed to the vast use of ‘leverage’ to enable the investments of the rich to go even further. Hedge funds, private equity investments and the investment arms of banks use borrowed money to inflate their speculative gambles. Some of these may even be gambles against the banks themselves or the national currency. As more money is issued it floods into the financial system and becomes part of the waves of money looking for a profitable home. As it is impossible to separate the interests of bank depositors or pension holders from financial speculators, in a crisis the whole system must be secured.

In such a crisis, the public groundwork of the money and banking system becomes clear. As all bank-created credit is designated in the national currency, this becomes a liability on the state. The logic would be that such a public liability should also be seen as a public resource. If the people are to be made ultimately responsible for whatever money is issued in their name, should they not have a say about how this money is used?

Far from having democratically controlled access to the process of credit issue, the public, as represented by the state, has itself to borrow from the capitalist owners and controllers of the nation’s money supply or tax money for public expenditure as it circulates. Today more than 95 per cent of money issue is through bank credit. Historically states controlled much higher levels of money issue as coinage. As expenditure on social or public needs are seen as secondary to privatized economic forces, the private sector determines how much public expenditure can, or cannot, be ‘afforded’.

Privatized control of money issue creates the impression that it is the private market that is creating wealth. Certainly it is making money, quite literally, largely through issuing it to itself as leverage to swell speculative trading. Private ownership and control of money issue has created huge differences of wealth. The mass of the people can only hope for a trickle down of economic activity through the consumption of the champagne-swigging traders and increasing numbers of billionaires. On the illusion that the manipulators of money have actually generated the wealth they gamble with, those playing the money markets demand a huge percentage of the product. The levels of pay and bonuses have become so obscenely puffed that they have become an economic ‘gated community’ set apart from ordinary mortals by their wealth. In fact they have stolen what should be a public resource and harnessed it for private benefit.

Finance Is Not Private

THE FUTURE OF MONEY (1/4)

The global economic crisis in progress has naked the contradictions of privatised finance. If taxpayers have to bolster the system when it fails, why should they not also have control over the supply and allocation of money in the first place?

The UN’s Economic and Social Commission for Asia and the Pacific (UNESCAP) painted a grim picture for the region overall in the wake of the global financial crisis

At the height of the financial crisis, the total public financial exposure in rescuing the world’s financial systems was around $15 trillion – a quarter of world GDP. Most of this was not operated, but the existence of public aid prevented a worldwide collapse of financial institutions. This vital role of the public sector has in practice been ignored, as the surviving banks return to the bonus culture, benefiting from reduced competition and additional state support through, for example, quantitative easing/ facilitation (increased money supply).

Not all states could support their bloated financial sectors. Iceland collapsed with financial commitments up to ten times its GDP. Britain, with a financial sector worth around five times GDP, could have faced similar problems. Globally the financial sector eclipses world GDP by at least ten times.

Why do governments feel compelled to spend uncountable billions rescuing the banks and financial sector when other businesses are often left to fail? The answer is that the financial sector is not a private sector at all. It embraces a public function, the issue and circulation of money – something that has been appropriated by private capital.

The contemporary banking and financial system has appropriated this public doings for its own benefit. However, when the financial system goes into crisis, the need to retain this public function means that it becomes a liability on the public, as represented by the state or equivalent monetary authority. As John McFall, chair of the UK Treasury select committee, wrote (Guardian, 9 January 2009):

 ‘After the extraordinary self-induced implosion of the financial system, the future of the market system now rests in the hands of governments. The politicians are the only show in town.’

The financial crisis and the public response have revealed both the instability of the global financial system and the importance of a public monetary authority of last resort.

The latter half of the 20th century saw a rapid growth in the financial sector as people became entangled in debts (particularly consumer debts and mortgages), as collective and public financial security was abandoned in favour of personal investments (particularly pensions), and because there was benefit to be had from inflated financial assets (particularly housing). Even institutional investors were tempted by the promise of higher profits in the most speculative areas, such as hedge funds.

With such a large proportion of the population entangled in the financial system, a demand for public rescue became more likely. A collapse in the financial system is much more threatening to social order than failures in the productive sector. If one factory fails it does not automatically close the rest (they may even benefit from less competition). But if a bank fails the panic threatens to become systemic as people lose confidence in the banking system. This alone was a major reason why states had to get involved.

The need for state intervention has exposed the contradictions of financialized capitalism and its reliance on ‘Wall Street socialism’. A pivotal point was the rescue of the US investment bank Bear Stearns. The US monetary authorities were not only bailing out the retail banks, but finance capital as well. When the US Treasury later tried to isolate the investment sector by letting Lehman’s fail, there were nearly fatal consequences for the banking sector. The financial sector was so interconnected that a crisis of default in the US subprime sector could bring down a relatively small bank in the UK, France or Spain via the functioning of the global money market and the drying up of credit.

Do Reforms Inhibit or Support African Development?

THE AFRICAN GOVERNANCE CRISIS (4/4)

After the analysis of decades  of public sector reform in Africa with special focus on Ghana, one can draw the conclusion that the  external support during the 1980ies has been  vital,  but  to  some  degree  harmful  due  to  a  “faulty  diagnosis  and  prognosis” (1). The African public sector during that time cannot be described as too big, but as expanding. This growth was a direct result from the new-won independence and was therefore a necessary step of taking control.

In order to overcome the economic decline in the 1980ies African states were dependent on foreign investments. While the IMF, the World Bank and individual donors did provide the money, they also set unfitting goals and an unrealistic time schedules. Instead of strengthening the existing system of public administration, Western NPM methods of downsizing, retrenchment and cost cutting were introduced. As has been stated in the above, African states did not have an oversupply of qualified civil servants, but a demand for the latter. Instead of ensuring their loyalty and providing a better education for them, many positions were cut and the crucial increase of salaries was implemented with reluctance (2).

The results of these reforms of the public administration of the 1980ies in Ghana and other countries were modest to say the least. From a different point of view, one could even assert that they were modest from a short-term perspective, but fatal in a long-term perspective, because they focused on technicalities in order to save money – that actually weakened the civil service (1) and ignored the core aspects of successful public sectors. While it might make great sense to concentrate on cost-cutting and downsizing of the public administration in Western countries like the UK or  Germany – where  a  certain ethic belief may  be  attributed  to  the  public officials because of centuries of institutionalized rules and norms – African bureaucracies were nowhere near this point of development. If one observes the economic progress of Asian tiger states whose economies greatly strengthened during the past decades, one is also able to attribute this success to strong systems of public administration (3).

As there is no such history in African public management, it seems obvious that an emphasis has to be laid on the establishment of civil service ethics and accountability. One could conclude, that the reforms of the 1980ies in Africa skipped one step, because they  aimed  at  shrinking  something  that  wasn’t  even  stable  to  begin  with.  Only technicalities were at focus. Therefore, one is drawn to argue that reforms from this time period inhibited the development of committed reformers in Africa.

Of course, this statement must be handled with care, as one does not have the possibility of comparison with an African country that did not follow the NPM reforms at all. However, cutting costs at the wrong places led to the “unfolding challenges” (4) African countries encountered during the 1990ies and even in the new millennium. While techniques for more ethical behavior and accountability are decided on, their implementation must be coordinated among the African states. Instead of relying on external help, the more successful countries have to set an example and support  the weak links.

Dealing with these problems, the UN concludes:

“For poor, resource-constrained countries, the reform challenges are daunting, not because the countries do not know what to do, but because they lack the resources to initiate and sustain a comprehensive program of change.” (4)

Financial aid is thus still vital today. But instead of forcing these different systems to adapt Western ideals of public administration reforms, the support should be engaged on the  education  of  civil  servants,  hence  human  capacity  building  and  training.  In combination with a rise of public official salaries, the two core weaknesses identified in this work would be tackled. While the downsizing of the public sector has already taken place, one could attempt to stabilize this system now. Therefore, the current trend of African civil service reform can no longer in any way be attributed with an inhibition of the countries’ development.

On the whole, it has been clear that the reforms of the NPM-wave during the 1980ies did   little   to   promote   sustainable   development   in   African   public   sectors   and consequently in the countries’ economies (1) (2). Despite these negative experiences and the sentiment of wasted money, external support is a sine qua non in Africa now. The necessary strategies can only be implemented after the application of sophisticated analyses and diagnoses and with the involvement of all stakeholders, especially the civil servants in regard to more ethical behavior (2).

Only by doing so, policies – such as the liberalization of markets, vital for a more successful participation in global trade – can be implemented.

In order to highlight the difficulties encountered by Ghana and other African states in establishing an efficient and sustainable civil service resulting in a stronger economic development, this paper concentrated on the introduced governance crisis (2). However, there are of course great inter-dependencies between the public administration and the central government of a country. The best governance system would only get so far without a stable, organized and constitutional government (4). It would be interesting to analyze these realities for African states, as it seems logical that weak governments are another trigger for underdevelopment.

On the whole, one can conclude that reforms of the 1980ies were not customized for African   developing countries and most probably inhibited a quicker economic development. The second  wave of reforms however, is much more focused on the involvement and training of civil servants, which is – as seen in the cases of Developed Countries and Tiger States – crucial for a stable public  administration and economic growth. If provided with the necessary financial aid, reform-committed African states like Ghana could indeed face an overcome of economic underdevelopment.

Related posts:
· The African Governance Crisis (1/4) · A sift inventory of Africa’s development problems
· The African Governance Crisis (2/4) · The Consequences of Reforms on the African Civil Service
· The African Governance Crisis (3/4) · Rehabilitating the African Civil Service
· Millennium Development Goals: Fragile states claim summit outcome off-target

______________

(1) Olowu, B. (1999). Redesigning African Civil Service Reforms. In: The Journal of Modern African Studies 37, 1 (1999). Cambridge University Press.
(2) Adamolekun, L. (2005). Re-Orienting Public Management in Africa: Selected Issues and Some Country Experiences. In: African Development Bank – Economic Research Paper Series No. 81.
(3) Evans, P. (1995). The State as Problem and Solution: Predation, Embedded Autonomy, and Structural Change. In: Politics and Society.
(4) United Nations. (2005). Public Administration and Development – Report of the Secretary General.

Rehabilitating the African Civil Service

THE AFRICAN GOVERNANCE CRISIS (3/4)

The customary  problems  of  public  sector  ineffectiveness  due  to  erroneous  reform movements – leading to a reduction instead of a reinforcement of the system – and the ongoing  danger  of  corrupt  public  officials,  give  reason  to  speculate  about  more successful policies for the reinvention of the African public administration. In order to do so, public service ministers came together in Stellenbosch, South Africa in 2003 to respond to “unfolding challenges” in African public administration (1).

In accordance with some reform approaches of the late 1990ies, the aim of new reforms is to switch to home-grown and demand driven methods directed at specific problems and challenges instead of the donor-pressured goals of broad downsizing and cost- cutting (1). While the UN observes that contemporary reform methods do still aim to improve business and customer satisfaction techniques –“a  carry-over from the early days  of  New  Public  Management”  (1),  intangible  reform  topics   such   as  the implementation of norms and values as well as public service ethics and accountability play a vital role.

Since African countries like Ghana do not possess the financial assets necessary for a much needed rise of public servant salaries, it seems crucial to at least stabilize the employees feeling of normative obligations. Despite negative experiences citizens have encountered with corrupt public officials so far, the latter must still be expected to have a  special  awareness  for  accountability  since  they  belong  to  the  directly  elected government of the country (2). Von Maravic argues that ethics in public management influence the quality of decisions made in public administration as well as the trust the citizen has in the system. (3). Hence, if one could ensure the ethical comportment of public officials, African (and more precisely Ghanaian public administration) could highly improve.

However, at this point another problem must be faced: the lack of resources. In this way, the UN states:

“In many countries, public administration remains weak largely owing to a shortage of human resources and to deficiencies in staff training and motivation.“ (4).

When speaking about the amelioration of African public services, one must be cautious not to attempt to apply the same public sector reform logic to all African countries. The differentiation of Adamolekun provides a possible classification of African states that has been mentioned before when referring to Ghana as a reform-committed country.

The above  table  or  a  similar  one  could  be  used  in  order  to  ensure  a  sustainable improvement  of  African  public  administration  systems.  In regard to this, the UN highlights the necessity of information sharing among reforming African states (4). Implementing the homegrown, but still NPM influenced methods of public sector reform in combination with the support of ethical and accountable changes in countries of the “virtuous circle” could be a first step (5). While the public service ministers all attempt to work on similar criteria they must accept countries like Botswana, Namibia or South Africa as a ‘primus inter pares’and a focal point of orientation. Moreover, it is obvious that foreign investments are still necessary; however one must not repeat the mistakes of the 1980ies and let donor schedules pressure the implementation of reforms.

Related posts:
· The African Governance Crisis (1/4) · A sift inventory of Africa’s development problems
· The African Governance Crisis (2/4) · The Consequences of Reforms on the African Civil Service
· Millennium Development Goals: Fragile states claim summit outcome off-target

______________

(1) African Press Organization. (2008). 6th Conference of African Ministers of Public Service Opening Remarks.
(2) Solinski, H.M. (1993). Ethic-conscious outlook behavior in public administration in Switzerland. Considerations and suggestions for the introduction of an ethics understanding based on the American experience. Reports and contributions of the Institute for Business Ethics at the University of St. Gallen.
(3) Von Maravic, P. (2009). Ethical challenges in administrative action. 5/4/2009.
(4) United Nations. (2005). Public Administration and Development – Report of the Secretary General.
(5) Adamolekun, L. (2005). Re-Orienting Public Management in Africa: Selected Issues and Some Country Experiences. In: African Development Bank – Economic Research Paper Series No. 81.

The Consequences of Reforms on the African Civil Service

THE AFRICAN GOVERNANCE CRISIS (2/4)

 “Since the late 1980s, many African countries have been reforming their civil services (…) Unfortunately, these reforms have not been very successful because of faulty diagnosis and prognosis. They have failed to tackle the major problems confronting African civil services.” (1)

Before the analysis of African public administration reforms can be undertaken, one must remember that the landscape of Africa’s civil service was not build from scratch. With its independence from British colonial rule, countries like Ghana inherited a system of public management that fulfilled tasks of “assuring the continuity of the state and maintaining law and order” (2). However, the civil service was doomed to re-orientate after independence in order to follow national interests instead of the ones of former colonial rulers. The African Development Bank thus asserts  that  an  enormous  expansion  of  the  civil  service took  place  until  the  grave economic decline at the  end of the 1970ies leading to a full-scale development crisis (2). This is when reforms of the civil services this paper aims to concentrate on were launched. Ghana shall be utilized as a hands-on example in this work, because it may be identified as a reform-committed country (2) that demonstrates strong efforts to rehabilitate its public service despite tremendous economic shortfalls. Therefore, a lack of commitment can be dismissed as a possible inhibiting factor to a successful development of Ghanaian public administration.

The goal of the following chapter is thus to properly understand why policies from the 1980ies aiming at the economic stabilization and development of African states such as Ghana have shown little success (1). One of these policies is the liberalization African markets (3). Taking this as the initial point of  this  work’s  analysis,  one  is  more  likely  to  comprehend  the  nature  of  reforms launched  during  the  1980ies.  The question whether the latter actually inhibited or actually reversed Ghanaian administrative, hence ultimately economic progress shall now be at focus.

NPM-Waves in Africa

Influenced by donor countries providing the necessary financial support for reforms (4), the ideal of New Public Management began gaining ground as a leitmotif for reforms in Ghana and other SSA countries. In general one can follow Bamidele Olowu in asserting that “African civil services [were] originally modeled on their metropolitan precursors.” (1). Although New  Public Management does not  translate  into  the  same  dogmatically  closed  catalogue  of  instruments  in  every country, in this work NPM shall be understood as a business interpretation of administrative action, hence a trend toward micro economic behavior in public management.

According to Peter Evans, this phase of reforms in developing countries may be seen as market-centered (5). After decades of viewing the state as the ultimate instrument of development, reforms in the 1980ies were initiated under the sentiment of negative experiences with the central government, hence a thrive for a reduction of the state.

As mentioned before, Ghana like many other African countries experienced a great expansion of the civil service sector after the 1960ies (1). After the global oil crisis, African economic decline and the ideal of a business-oriented reform wave  of  the  public  administration,   this   growth  of  the  state  was  to  be  ended (2). Donor countries provided African states with the necessary financial aid for the cutback of civil services (4). To make this more accessible, one must look at some exact data, in this case from Ghana.

The shrinking of the Ghanaian public administration was tackled through a myriad of reforms steps. The most important ones for the analysis in this paper are as follows. A grand movement of organizational restructuring led to a reorganization of government ministries eliminating four agencies during the reform efforts. Hence, seemingly unnecessary agencies were cut.  Another method, which was very well received by donor countries, was Ghanaian retrenchment. The core goal of this policy may be seen in the cutback of unneeded civil servants in order to shrink the countries’ public administration system. Therefore, Ghana reduced its civil servants from 131 089 in 1990 to 80 000 in 1995 (1).

Despite the reduction of civil servants, the payment of the latter was to be increased. Therefore Ghana foresaw decompressing wages and providing higher salaries for public managers. While information on the actual increase varies depending on the source, it is safe to say that actual salaries in Ghana did not rise significantly. Although still higher than for many African countries, the increase during the reforms in Ghana was modest (2).

These three aspects of Ghanaian public sector reform are sufficient for the following line of argumentation. However it shall be noted that Ghana was also at the forefront in regard to privatization and decentralization of public services (1). Due to its British past and organizational influence, reforms like the latter were faster implemented than in other African countries (1).

Evaluation of the NPM Reforms in Africa

The crucial part now lies in the evaluation of the New Public Management reforms and their effect on policy-making capabilities of the African civil service.

As mentioned above, the size of the Ghanaian public administration was decreased in regard to the number of agencies as well as the number of employees. Donor countries favored this approach due to  the conviction that a smaller public sector would work more  efficiently  as  for  instance  experienced  in  the  UK  (3). Moreover, the state’s involvement was seen as one of the core problems in developing countries after the 1970ies (5), thus the idea of a roll back of the state was widely popular (6).

However, the African civil service was never abnormally big in comparison to other regions (1).

      Figure 1: Government Employment as a Percentage of Population (various recent years)

Source: Olowu, 1999, p. 9.

As visible in the above chart, the central as well as the local government in sub-Saharan Africa is much smaller than the OECD average. While the observation that there was an enormous growth of the latter may very well be correct, this must be viewed as a post- colonial necessity. It seems rather logical that a growing economy must increase its public administration capacities. In regard to the number of public employees, the UN states that the African public administration “is significantly understaffed in professional and managerial areas, and perhaps overstaffed in semi-skilled and unskilled areas.” (4).

Therefore, one must conclude that a reduction of Ghana’s civil service at all levels was contra-intuitive and defeating the purpose of a more effective public administration.

The retrenchment in the civil service in general has proven to be more costly than expected in the beginning. More precisely, the research on the proper identification of cost saving possibilities mostly exceeded the actual ex-post cost saving (1).

Ghana is once again a perfect example for this miscalculation as the country actually encountered cumulative losses as a result from downsizing in the 1980ies. Although  Ghana  has  been  classified  as  a  committed  reformer,  the  former  head  of Ghanaian civil service, Robert Dodoo asserted his dissatisfaction in regard to the reform movement. According to him, the reason for the lack of improvement of the country’s development lay in the “donor time-tables, agendas and conditionalities” (7). While external support was necessary and vital for an improvement of the African  civil  service  the  provision  of  money  came  with  unreasonably  short-term expectancies.  It  does  not  seem  surprising  that  a country in  danger  of  loosing  all monetary  support  decides  to   hustle  through  a  reform  and  risk  less  successful implementation instead of the loss of crucial financial aid.

There are two core weaknesses to be identified after this ex-post evaluation of the first part of African civil service reforms: (1) the way reform was embarked upon, along with (2) the goal of the reform.

The first point has been made quite clear with the previous statements of Robert Dodoo. The pressure for success coming from donor countries was in no way beneficial for the improvement of the Ghanaian civil service. As one of many, Ghana had agreed to reduce the cost of the public sector and implement questionable structural adjustment programs: “This was an explicit condition for financial support from the International Monetary Fund and the World Bank.” (2). Although the size of the civil service was reduced, the results in cost saving were modest.

But why reduce the African public administration at all? As demonstrated with the graph, the African civil service was in no way bigger than ones from many other states. While it was indeed expanding after the colonial rulers granted independence, this was a vital step toward a functioning economy and a sustainable development of countries like Ghana. State and market building are mutually dependent; hence a strong state in combination with a functioning market could be seen as the more adequate policy for Africa at this delicate time (3).

The World Bank itself states that

‘An effective  state  is  vital  for the  provision  of the  goods and  services  – and  the  rules  and institutions – that allow markets to flourish and people to lead healthier, happier lives. Without sustainable development, both economic and social is impossible.’ (8)

The problem  of  the  1980ies  believe  that  effectiveness  would  be  achieved  through downsizing is  made clear in the above. However, it now becomes tangible that the effects of the 1980ies reforms may very well have resulted in lacking capabilities to implement crucial policies for the countries’ development, i.e. the liberalization of markets. If there are too few agencies and employees to oversee the realization of liberalization, this process is doomed to fail.

The third reform step that shall be evaluated here is the alteration of salaries in the civil service. While there was indeed some increase in the salaries of civil servants in Ghana, they are still stunningly low (1).  When being confronted with unattractive   employment   opportunities, the reaction of workers is universally comparable. High-qualified human capital either leaves the country in order to find better-paid jobs or the employee opens him – or herself to corruption. A report by the IMF shows a strong correlation between wages in public administration relative to wages in manufacturing: “It is estimated that government wages needed to be 2×8 (…) times higher to make corruption negligible.” (The Economist 1997, Reasons to be venal).

Corruption is another major weakness of African public administration and must be seen as another NPM-influenced repercussion (1). Peter Evans asserts in this regard that methods of personalism and plundering at the top levels of African civil service destroy all possibilities of rule-governed behavior in the lower levels of public administration (5). More precisely, in order to make a living less qualified officials go along the example set at the top.

Another fatal repercussion of corruption for these countries is not only the waste of financial  resources,  but  also  the  cancelation  of  international  aid  programs  as  a punishment (5). Weak public administration with corrupt officials therefore results in a vicious circle for the whole country.

After evaluating the three vital reforms in Ghana, the downsizing of the public sector as well as an insufficient rise of civil servant salaries, in the following, this paper aims at observing some of the latest reform movements. By doing so, the goal is to make a recommendation as to where the development of the Ghanaian and African civil service should be headed in order to guarantee more capable ways of implementing policies for an improvement of the countries’ development.

Related posts:
· The African Governance Crisis (1/4) · A sift inventory of Africa’s development problems
· The African Governance Crisis (3/4) · Rehabilitating the African Civil Service
· Millennium Development Goals: Fragile states claim summit outcome off-target

______________

(1) Olowu, B. (1999). Redesigning African Civil Service Reforms. In: The Journal of Modern African Studies 37, 1 (1999). Cambridge University Press.
(2) Adamolekun, L. (2005). Re-Orienting Public Management in Africa: Selected Issues and Some Country Experiences. In: African Development Bank – Economic Research Paper Series No. 81.
(3) Chaudhry, K. A. (1993). Myths of the Market and the Common History of Late Developers.
(4) United Nations. (2005). Public Administration and Development – Report of the
Secretary General, Sixtieth Session.
(5) Evans, P. (1995). The State as Problem and Solution: Predation, Embedded Autonomy, and Structural Change. In: Politics and Society.
(6) Goldsmith, M. J. & Page, E. C. (1998). Farewell to the British State? In: Public Sector Reform by Jan-Erik Lane. London: SAGE Publications.
(7) Dodoo, R. (1996). The Core Elements of Civil Service Reforms. In: African Journal of Public Administration and Management
(8) World Bank. (1997). World Development Report. New York: Oxford University Press

A sift inventory of Africa’s development problems

THE AFRICAN GOVERNANCE CRISIS (1/4)

Index of African Governance Human Development

Index of African Governance Human Development © European Statistical Laboratory

The underdevelopment of developing countries and the attempted overcome of the latter are at heart of international debates ever since development politics began gaining ground in world politics in the 1960ies. Today, African states receive special attention in regard to possibilities of an amelioration of their economic status quo.

Core problems  of  these  so-called  Least  Developed  Countries  (LDCs)  are  a  highly restricted  access  to  basic  human  needs  such  as  food,  water,  energy  resources  or medicine.  Moreover “social services and infrastructure have largely collapsed  owing  to  a  lack  of  resources  for  their  upkeep.”  (1). Although the Millennium Development Goal aiming at a worldwide reduction of extreme poverty by 50% is expected to be reached until 2015, this data must be considered with caution in regard to Africa. While countries such as India or China, who are also targeted by the UN agenda  do  indeed  face  an  incredible  improvement  of  public  wealth,  sub-Saharan countries are at risk of being left behind permanently. More precisely, the UN today expects goals such as the reduction of extreme poverty to be reached in Africa no sooner than in 150 years (1).  This vicious circle of underdevelopment is well highlighted in the Human Development Index. From the 1980ies until the end of the millennium 13 of 22 countries that suffered large setbacks were African (1). Among a great number of possible explanations for this economic disaster, one of the most plausible ones is the conviction that “governance and public administration  weaknesses,  [and]  the  failure  to  reflect  poverty  concerns  in  budget allocations…” (1) generate economic gaps. This analysis thus aims to demonstrate that so far weak governance institutions are one of the main causes for the above-depicted underdevelopment of some African countries.

But how exactly does the public administration system of sub-Saharan LDCs affect their (economic) development?

Many theories regarding the economic improvement of these poorest countries have been launched and abolished. Sub-Saharan Africa (SSA) has been at the receiving end of a myriad of developmental experiments ranging from modernization concepts to self-help and good governance approaches. The core train of thought driving these, mostly Western models of development, has been the ideal of market liberalization (2) as  a  motor  for development.  But  what  is  often  forgotten  when  dealing  with  the  approach  of  free markets is the vitality of  strong governance institutions. Kiren Chaudhry and Peter Evans acknowledge that market building and state building must go hand in hand (2)(3). More precisely, they hereby avert from the idea of a simple roll back of the state of New Public Management (NPM) reforms launched during the 1980ies (4).  The UN General Assembly corroborates: “With challenges of poverty and growing inequality (…) organized and constitutional Government becomes the only guarantee of personal and collective security.”  (1).

Although development aid or development strategies in general may have fallen into some disgrace during the last decades due to little trickle down effect and images of corrupt African leaders wasting  Western money for their personal pleasure,  increased  financial  aid  might  be a sine qua non at this crucial time of development of African governance institutions. A lack of financial resources leads to dramatic human capital flight in the African public administration (1). Further, NPM-like cuts in administrative resources in order to minimize the size of African public management could have led to a setback and to less development in the target countries.

The reforms of the civil sector in Africa so far have been mainly concerned with technicalities, such as the reduction of the size and the cost of the public sector (5).

However, this approach fails – as I shall argue later in more detail – to comprehend the crucial task of building lasting human and institutional aptitudes.

This contribution therefore aims to concentrate on the civil service sector of underdeveloped sub-Saharan countries. Questions such as: ‘What kind of reforms were implemented?’ must be answered before diving into the complex task of evaluating the latter and discussing a different approach to possible improvement in the civil service, hence in the countries’ development. Thus, in a first step, this paper will focus on some major reforms in reform-committed African countries such as Ghana and underline the weakness of the attempts to change the system of public management (6).

A second step will then be dedicated to suggestions of a new direction for the handling of the African public administration.

In a last step, this paper then aims to draw a conclusion and answer the initial question whether public sector reforms in Africa so far actually inhibit or support development.

Related posts:
· The African Governance Crisis (2/4) · The Consequences of Reforms on the African Civil Service
· The African Governance Crisis (3/4) · Rehabilitating the African Civil Service
· Millennium Development Goals: Fragile states claim summit outcome off-target

______________

(1) United Nations. (2005). Public Administration and Development – Report of the Secretary General. Sixtieth Session.
(2) Chaudhry, K. A. (1993). Myths of the Market and the Common History of Late Developers.
(3) Evans, P. (1995). The State as Problem and Solution: Predation, Embedded Autonomy, and Structural Change. In: Politics and Society.
(4) Goldsmith, M. J. & Page, E. C. (1998). Farewell to the British State? In: Public Sector Reform by Jan-Erik Lane. London: SAGE Publications.
(5) Olowu, B. (1999). Redesigning African Civil Service Reforms. In: The Journal of Modern African Studies 37, 1 (1999). Cambridge University Press.
(6) Adamolekun, L. (2005). Re-Orienting Public Management in Africa: Selected Issues and Some Country Experiences. In: African Development Bank – Economic Research Paper Series No. 81.

High Food Prices Endanger Food Security

Along with officers from the Food and Agriculture Organization, mankind is only two bad seasons away from a disaster on a global scale.

This spring already, the previous year’s deficient harvests contributed to the social unrest in North Africa. Even though the World Bank asserts that rising food prices have not initiated the protest movement in the Arab world, the price ramble however contributed to an intensification of tensions. Exploding prices are a main headache for political and economic decision-makers across the globe. One thing is clear: A search for solutions needs to be made a top priority.

The developments in the markets over the past year certainly give full reason for concern: Within the past decade, prices for agricultural goods rose by 83 percent. In 2010, inclement weather proved a major challenge for food security: In the spring, heavy rainfall in Canada destroyed a quarter of the wheat harvest. During the summer drought and bushfires in Russia, the Ukraine and Kazakhstan lowered yields. In China drought and sandstorms have made life difficult for farmers ever since last spring and significantly decreased their income from wheat sales. In early 2011, strong snowstorms threatened winter wheat plants in the leading export nation, the United States. In the southern hemisphere in 2010, La Nina led to drought and losses for soya beans and maize plantations. Floods in Australia made half of the planted wheat there unfit for human consumption. The wheat price has doubled since last summer. Lower wheat supplies led consumers to switch to maize. The maize price shot up by 73 percent as a result in the second half of the year. Meanwhile numerous Mediterranean countries like Egypt, Algeria, Morocco, Lebanon, Jordan, Libya, and Turkey have engaged in panic-buying and hoarding large stocks of wheat. China is expected to follow suit sometime later in 2011. This will further push up prices in the world markets. It is not only climate change and the bad weather that is responsible for the increasing shortage of food stuffs. In many emerging countries, changing consumption patterns – especially increased reliance on meat as a dietary source – encourage prices escalate. Moreover, additional agricultural land is lost to planting crops for biofuel instead of food stuff. According to the International Food Policy Research Institute, one third of the price rise needs to be attributed to the increasing use of grain as a biofuel.

Despite these disquieting numbers, it is not predictable that the United States, the European Union, or Brazil will in the short-term abandon their biofuel projects. Neither can consumption patterns worldwide easily be changed. The developments observed therefore point that supply shocks caused by bad harvest today can more easily upset the delicate balance in the increasingly globalized food chain. Structural changes render it difficult for the system to deal with such shocks at the present time. In order to prevent further upset on the supply side, much more investment in agriculture is needed today. It is necessary to be better prepared for the challenges posed by climate change. It is high time to coordinate on a global level in order to stabilize agricultural markets in such a manner that external supply shocks will not automatically lead to systemic consequences and social unrest.

Shadow banking: still big, still dangerous (3)

A lot of attention has been focused on the work of traditional banks amongst the recession. But according to some measurements traditional banks lent only 40% of the money in the economy prior to the credit crisis. Shadow banks were responsible for the other 60% of lending and securitized a large portion of those loans.

The part of the financial system that lends the most money to Americans remains
almost untouched by regulation. It’s shadow banking, as Paddy Hirsch explains.

There is a strong consensus that the main fault which led to the current crisis was the total deregulation of the banking system. A banking system which in recent decades created a parallel clone to conventional banking, fully interconnected to global financial system, but disconnected from real economic activity. That parallel universe that found the financial industry to carry out the traditional role of linking savers with borrowers, had a huge increase in recent decades, as shown by the blue line on the graph. That is what is known as the “shadow banking system.”

This system is in the heart of the current financial turmoil and, according to the latest report of the New York Fed, is still larger than the traditional banking system. According to Fed data, there are still U.S. $ 16.000.000.000.000 (16 billion) sloshing around the financial system of the U.S. banks, polluting the world banking. The figure is greater than the entire GDP of the United States and it is remarkable to note its powerful boost since the 80s.

The shadow banking system gave rise to many of the issues that triggered the current crisis, and the report offers a detailed look at how the system did its job. First, the volume of credit grew bigger on the shadow banks than in retail. Before the crisis outbreak the shadow banking system had a $ 20 million liabilities compared to $ 10 billion of retail bank. Securitized loans, CDOs, CDS, the market for mutual funds, stock bubbles, are at the heart of this great legal fraud that allowed the existing self-regulation, as it provided huge inflows of money to keep the system moving.

The fragility of the system was demonstrated when its brutal collapse arose. But while the housing market crash was only the catalyst of the financial crisis, the sharp phase of the crisis was defined as a bank run on the shadow banking system in late 2007 and early 2008. Anticipating the crisis, all investors and lenders tried to recover their money at the same time. This is because on the shadow banking system – in contrast to retail banks – money is only paper – i.e. not backed by any real assets. Hence the strong bank run that sank Bear Stearns and Lehman Brothers before the monetary authorities were aware on what was happening in the market, despite Fannie Mae and Freddie Mac were knock down already. The fall of Lehman, in any case was the warning sign that the whole system collapsing and that the breakdown was imminent.

Fed specialists realized overdue this great market failure and the dangers that most of the system operates without any regulation. The bottom line is that if shadow banking is vulnerable too to financial runs that can produce a collapse of equal or greater magnitude than the retail bank runs, then it is reasonable to consider that shadow banks should also be regulated. Their failure has provoked a colossal damage to the entire world economy.

Related Posts:
Part 1 – Financial turmoil and global unemployment.
Part 2 – Ponzi Scheme and Global Finance.

______________________________

Ponzi Scheme and Global Finance (2)

For decades the whole U.S. economy has been structured as a pyramidal fraud under the “Ponzi scheme”.

>> Haga click aquí para la versión en Castellano.

Since the U.S. is the dollars printer, it generated a huge bubble which in turn ramified into a huge debt that cripples the world today. The financial mess that we now live, whether it is a tsunami or a perfect economic storm, is the result of unsuitable monetary and fiscal policies of the dominant reserve currency. As a blogger assesses in connection with a talk by Robert Solow: “The lesson that should be drawn is therefore that the real economy should be somehow shielded from the instabilities of the financial system.”

There is little hope on a quick return to fiscal and monetary discipline everywhere. At present, each and every one is in the midst of the storm without a compass or rudder. And we should not expect to keep banging with the oars. Nobody has accurate answers on the future action plans. What is known is that in January there were 550 000 unemployed again in the U.S., and that the rate will go on rising until year end. The Obama administration would give rise to 250,000 jobs per month – this figure is lower than job destruction – so employment will get higher, with the impact this has on the demand and consumption.

The Ponzi scheme developed in the financial markets have collapsed. And the culprits are still handing out awards such as the $37 billion that were distributed to top executives in December 2009. That’s why we lost faith in the financial system. And the famous phrase that comes on every dollar “In God We Trust” is now the subject of derision when for every dollar you give many people a few cents.

More than 40 years ago the economist Jacques Rueff, anticipated that an “uncontrolled U.S. deficit could destabilize the entire global economy.” Rueff ‘s vision was that issuing the U.S. reserve currency could incur in massive and unlimited deficits, forcing as well the creation of money in other countries to accumulate dollar reserves that, once entrenched, would come back to the U.S. in order to earn interests and give extra occupation to the greenbacks printer.

Now, the only clear way to stabilize the world’s economy and control social over-running is the creation of a world central bank and the return to a single reserve currency. For centuries gold was this reserve currency, allowing internal reckoning and external deficit control without losing real resources. It is not a matter of coming back to gold standard but to prove an anchor currency satisfying the requirement to provide a secure and stable environment – while allowing countries with the real concern of full employment. A reserve currency that can help bringing stability to a system that has collapsed and which repair will take a lot of time. If you do not believe it, look at this interactive graphic.

The Ponzi scheme collapse plunges dollar and the US economy

During the last decades, one of the main driving forces of global economic prosperity was the increase in debt and in financial design of the Ponzi scheme. Much of the growth occurred since the 80s but mainly from the 90s, was driven by the generous credit lines to governments, businesses and consumers used along this support. Well, no doubt, the crush of Ponzi scheme and the subsequent shadow banking system, have set in motion the collapse of the United States.

With the Ponzi scheme, a large number of people stretched to such limits debt choking the burst. For many, debt allowed the biggest party on earth – as through the “crazy years”, that period of loose waste in the 20s, which ended abruptly with the Great Depression in 1929. In those roaring years, the optimism of inventions like the airplane and the radio generated a huge level of debt aimed rather at waste than at investment. Hence, one of the causes of that crisis is endorsed by slam on brakes to credit and by the strong increase in the interest rates propelled by the Fed as a way to contain the waste. We already know how that ended: the entire economy collapsed and it took ten years and a World War to recover.

Today, things are awfully similar. The economic system based on debt was greatly dependent on it to create a parallel economic system, which from the shadows, swallowed us all. Except that the New York Fed was slow to take seriously the problem of parallel banking system, discovering that, before the crisis broken in July 2007, the shadow banking liabilities were twice the real banking charges –  70% of world’s GDP.

That is why this crisis is severe enough and will be here a while. So do not be surprised if dollar continues to slide down. That’s what’s coming. Fixing the Yuan to the dollar was the sole breadwinner in the last two years. However, a dose of that poison named indebtedness, may help resolve things if applied rigorously in generating employment. No way to do it however even though employment is the only variable that can boost demand and begin to move ahead the real economy machinery.

The collapse of the shadow banking system has paralyzed the first economy in the world: the U.S. certified unemployment is 10% (the real climbs to 17%), retail sales plummeted, and property sales have fallen to their lowest level in 50 years. United States faces a deficit of $ 1.6 trillion, a debt of $ 16 trillion and a total debt of $ 60 trillion.

With these data, there is no system that works, mainly if it has been for massive bad habits and waste. United States is in the early stages of a financial implosion that will make history. Since late last year, Europe saw the markets were obsessed with the sovereign debt crisis of the European countries. Well, we now enter a new phase: the alarm bells of the global economy big ship just starting to sink.

Related Posts:
Part 1 -  Financial turmoil and global unemployment.

______________________________

even though

Financial turmoil and global unemployment (1)

This August marks another anniversary of the origin of financial chaos that swept the world in overall unemployment drift.

>> Haga click aquí para la versión en Castellano.

Unemployment rate 2009 © Publico.es

Abandoning the gold standard on August 15, 1971 is closely linked to the mass unemployment experienced by industrialized countries. Until then, the dollar was as close as possible to gold, and all nations were trying to maintain a constant balance between exports and imports. Most countries devised ways to export more than they imported, so as to accumulate gold reserves or, otherwise, U.S. dollars – according to the treaty of Bretton Woods in 1944 – could be exchanged for gold.

Unlike the rest of the world, America was not particularly concerned about maintaining a balance between exports and imports since, as under the Bretton Woods Agreement, the US would pay export deficit sending more dollars to creditors. As it was the sole source of international currency, the U.S. had a clear advantage over the rest of the world: it was the only country that could pay its debts by printing money. Something that the rest of the world did not matter a little: the dollars were a seductive line of credit that allowed access to the key casino in the market. No one took into account that the gadget also had limits.

So it was when, at the end of the Second World War, more than 20,000 tons of gold that the U.S. owned dwindled year by year while many countries (especially France) insisted convert dollars for gold. This situation came to an end in 1970 when two unexpected phenomena put the U.S. government on the wrong foot: the upcoming oil crash (a situation that forced the U.S. to import oil instead of export until then) and the adverse outcomes of war in Vietnam. Both events brushed away the US gold reserves and pushed the country to bankruptcy. The benefit it had to hide its bankruptcy was clear: being the owner of the dollars printing press.

In the early months of 1971, Henry Hazlitt and Paul Samuelson urged the Richard Nixon administration to devaluate the dollar sharply as it would need to increase the amount of dollars it would take to get an ounce of gold from the U.S. Treasury. But Nixon did not take their advice into consideration and followed the suggestion of Milton Friedman who advocated the idea to let floating freely the dollar and eliminate the dollar-gold convertibility into  – as the international currency was worth at the very back offered by the U.S. government, the global economic locomotive. Thus Sunday morning August 15, 1971, Richard Nixon declared the dollar-gold inconvertibility, so he unilaterally broke the Bretton Woods agreement.

Since then, the whole world trade has been accomplished using the dollars printed by the U.S. Treasury, which is nothing more than fiat money, i.e. easy papers. Up until then, international trade was valid as it was backed by gold; from that moment onwards, trade depends on a fiat money produced by the major press in the world. The consequence of that fateful day was that all countries (that could do so) began to accumulate dollars as an unrestrained U.S credit expansion – without the restrictions imposed by Bretton Woods. The rest of the world had to accumulate dollar reserves and these reserves had to be ever increasing, since the slightest sign that a country’s reserves fell, woke currency speculators who could attack that country’s currency and destroy it with a sharp devaluation.

The increasing flow of dollars throughout the world prompted the global credit expansion, which only stopped the speed in August 2007, after exhausting all instances of what is called the ponzi scheme (1). The international banking elite always strove to devise mechanisms for higher profits and to extend credit. A provision that was released from the restriction of having to pay international accounts in gold, and that scored the U.S. trade boom.

Until the ’70s, a poor country like China had no interference with world trade: it sold low and bought little. The globalization of the 80s, provided by this extension of counterfeit money, offered great facilities to companies in search of cheap labor, they set up their factories in China. This was the beginning of the industrialization process that began in the U.S. and went on with Europe. A process which destroyed jobs in the industrialized countries as never seen before. A no return pathway.
______

(1) A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.

Related Posts:
Part 2 -  Ponzi Scheme and Global Finance.