The myth of GDP (1)

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How to go beyond the gross domestic product?

Pursuing an actual modern reflection of wealth means finding tools to move away from an excessively quantitative, restrictive and accounting outlook to assess the collective performance. Changing indicators of wealth while we amend our way of production and thinking involves rethinking the limits of national accounting as well.

The Satisfaction with Life Index. Blue through red represent most to least happy respectively; grey areas have no reliable data available.

Thirty years to date, GDP per capita has tripled in our developed societies. Why, then, according to all surveys, the welfare of the average Joe has not known the same dynamic? How can we move beyond GDP? How to measure a nation’s progress and wealth ?

New indicators of wealth: a dispute that goes way back.

The first time the indicator of gross wealth was challenged academically came about the 1970s when the Club of Rome casted doubt on the goodness of the concept of growth. Also in 1972-1973 the first Tobin-Nordhaus report — Measure of Economic Welfare — tried to correct the GDP by eliminating what they called defensive expenditures, ie those costs that do not meet net investment: for example repair costs, recycling costs, etc.

It goes without saying that such initiatives aroused the indignation of the national accounts of the moment — criticism that reappeared in the 1990s, since GDP is a taboo indicator, a fetish indicator of human behaviour, a structuring myth as a result of the World War II — a myth displayed as the guidebook of postwar reconstruction from a Keynesian perspective of budgetary programming. Somehow it took so long to implement that one understands well the current reluctance not to put into question: GDP is the monetary indicator par excellence, the result of the added values, a convenient indicator that lets you add units from various sources. It is universal and widespread as it shows the supremacy of production and consumption into our advanced societies.

GDP, a growth model of industrial production after WW II, becoming now obsolete.

Currently, the prevalence of environmental concerns and the primacy of issues related to the culture of services and the economy of knowledge are critical – mostly when foreseeing a change in the assessment criteria of the global accounting aggregate.

The GDP has significant limitations.

Primo: It only takes certain activities into consideration and always around paid work. It neglects significant activities: care of children, housework, voluntary work, political activity: non-monetary activities that allow our civilization to last over time and which count for nothing in the overall aggregate assessment.

Second key limitation: the GDP is little or no sensitive to inequalities in consumption and production sharing.

Third limitation: it is a cash flow indicator, a flow and stock accounting that does not outcome into a balance: you can not produce added value and simultaneously destroy part of natural capital — human and social. Its principle of action is to ‘create assets primarily, and then redistribution will follow.’

That is why it is essential to review the wealth concept while we change our way of thinking. Another accounting logic is possible.

Changing or completely replacing GDP?

There are other indicators in this day and age. From the human development index till the ecological footprint — not to mention Osberg and Sharpe’s index of economic welfare, Ruut Veenhoven’s ranking of quality of life and happiness or the Catrice Jany’s social health index.

Other indicators are concomitant, such as the administration of physical resources, the aggregate indicator of the ecological footprint and the adjusted net savings – though the latter, as a simply monetary concept, suggests a poor vision of sustainability: roughly speaking, a country can pursue a sustainable development path even when its natural capital is deeply exhausted.

Stay tuned.

Financial crime is routine in some major banks


An HSBC subsidiary is in the news for helping wealthy clients to evade millions in taxes. So what else is new? Lots of big banks have been fined for corrupt practices in recent years.

In the headlines last week: a Swiss-based private banking subsidiary of HSBC, one of the world’s biggest banks, has been found to have had a lucrative practice focused on systematically helping thousands of wealthy clients to hide looted money and dodge taxes – including dictators, arms dealers, and other unsavoury characters.

Are you the least bit surprised? So many big banks have paid huge fines for various forms of major financial crime in recent years, it’s impossible to keep track of them all. The pertinent question isn’t whether one or two big banks have routinely engaged in criminal practices as a core element of their business models.

The question is whether there are any that haven’t.

Is better tougher regulation the answer?

“Much better, tougher, properly enforced regulation is necessary in order to prevent these kinds of problems,” says Gustav Horn, head of the Düsseldorf-based Institute for Macroeconomic Policy.

But people have been saying that for decades, and the scandals continue.

The global financial crisis of 2007-8 was caused by the cumulative impact of years of fraudulent mortgage banking in the US. Hundreds of billions of dollars of worthless “liar loans” and “ninja loans” were given to people who couldn’t afford them.

The “sub-prime” loans were bundled by the thousands into mortgage-backed securities –a type of bond which gives its owners the right to receive the combined cash flows from the underlying mortgages.

The sub-prime MBSs were polluted with fraudulent ratings to give investors the false impression that MBSs were very safe investments, and sold off to suckers –including to some German Landesbanken, French, Spanish and Italian state-owned regional banks, who naively believed the US rating agencies’ AAA ratings for subprime MBSs, and lost billions as a result.

It’s not clear that even the well-known problem of bad MBS origination has been put permanently to bed, despite the memorable crash it caused just seven years ago. IMF economist Miguel Segoviano was lead author of a 2013 IMF working paper on mortgage securitization, entitled “Securitization – Lessons learned and the road ahead”. He echoes Horn’s “better regulation” theme – but points to an inherent difficulty in achieving it.

“We [the IMF report’s authors] believe that a high-quality loan origination process is paramount. Loan originators have to be held responsible for fraudulent originations,” says Segoviano. “Rating agencies, servicers, and trustees have to fulfil their functions. Those kinds of market participants, who are often forgotten in the discussion, need to be remunerated sufficiently so they do their job.”

But banking is a vast, complex business, with countless thousands of deals done behind closed doors every day, including deals deliberately structured to escape the attention or even comprehension of regulators. How are regulatory agency workers, incomparably fewer in number than deal-doing bankers, supposed to achieve proper implementation of regulations, no matter how well they’re remunerated?

Is HSBC a rogue bad actor? Hardly!

The new revelations of HSBC misconduct stem from a whistle blower, Herve Falciani, who downloaded incriminating files from HSBC computers in 2008. A detailed evaluation of Falciani’s material by ICIJ, the International Consortium of Investigative Journalists, was released last week, showing a pervasive pattern of deliberate professional collusion in financial crimes.

The bank has responded to the scandal with a statement claiming that “the compliance culture and standards of due diligence” [before 2008] at its Swiss private bank “were significantly lower than today.”

Well, maybe. Other units of HSBC have been in the news recently too. HSBC Holdings PLC, the corporate parent, and HSBC Bank USA paid $1.9 billion in fines under a deferred-prosecution agreement with a US court in 2012. The fines allowed HSBC to avoid criminal prosecution for helping Latin American drug cartels launder at least $881 million in dirty money, among other crimes.

Don’t lose sleep worrying about the impact of that fine on HSBC’s dividend flow to the bank’s wealthy shareholders: the $1.9 billion represent less than two months’ profit for HSBC. The bank has an estimated 57 million clients world-wide, and assets of at least $2.7 trillion. The shareholders will be fine.

Now let us watch again to Margin Call, the very accurate J.C. Chandor’s film, a sort of follow up to Inside Job, which depicts a great insight into the fall of Wall Street through the key people at an investment bank, over a 24-hour period, during the early stages of the financial crisis.

And I am thinking now about the sleepless nights spent by our next door, “little” and efficient banker to fulfil his role honestly and grant us credit lines to keep running … honestly.

The Art of Waste Management (2)

Key Benchmarks for Assessment

There are a number of concepts about waste management which vary in their usage between countries or regions. Some of the most general, widely-used concepts include:

1. Waste Hierarchy: The waste hierarchy refers to the “3 Rs” reduce, reuse and recycle, which classify waste management strategies according to their desirability in terms of waste minimization. The waste hierarchy remains the cornerstone of most waste minimization strategies. The aim of the waste hierarchy is to extract the maximum practical benefits from products and to generate the minimum amount of waste (Wikipedia 2008).

2. Extended Producer Responsibility (EPR): This is a strategy designed to promote the integration of environmental costs associated with products throughout their life cycles into the market price of the products (Organisation for Economic Co-operation and Development 1999).Extended producer responsibility imposes accountability over the entire life cycle of products and packaging introduced on the market. This means that firms, which manufacture, import and/or sell products and packaging, are required to be financially or physically responsible for such products after their useful life. They must either take back spent products and manage them through reuse, recycling or in energy production, or delegate this responsibility to a third party, a so-called Producer Responsibility Organization (PRO), which is paid by the producer for spent-product management. In this way, EPR shifts responsibility for waste from government to private industry, obliging producers, importers and/or sellers to internalise waste management costs in their product prices (Hanisch 2000). A life-cycle perspective is also taken in Extended Producer Responsibility (EPR) frameworks: “Producers of products should bear a significant degree of responsibility (physical and/or financial) not only for the environmental impacts of their products downstream from the treatment and disposal of their product, but also for their upstream activities inherent in the selection of materials and in the design of products” (Organisation for Economic Co-operation and Development 2001). “The major impetus for EPR came from northern European countries in the late 1980s and early 1990s, as they were facing severe landfill shortages. EPR is generally applied to post-consumer wastes which place increasing physical and financial demands on municipal waste management” (Environment Protection Authority New South Wales 2003).

3. Polluter Pays Principle:  In environmental law, the polluter pays principle is the principle that the party responsible for producing pollution should also be responsible for paying for the damage done to the natural environment. With respect to waste management, this generally refers to the requirement for a waste generator to pay for appropriate disposal of the waste. Polluter pays is also known as extended polluter responsibility (EPR). This is a concept that was probably first described by the Swedish government in 1975. EPR seeks to shift the responsibility dealing with waste from governments (and thus, taxpayers and society at large) to the entities producing it. In effect, it internalises the cost of waste disposal into the cost of the product, theoretically meaning that the producers will improve the waste profile of their products, thus decreasing waste and increasing possibilities for reuse and recycling (Wikepedia 2008). Organisation for Economic Cooperation and Development defines extended polluter responsibility as:
A concept where manufacturers and importers of products should bear a significant
degree of responsibility for the environmental impacts of their products throughout the product life-cycle, including upstream impacts inherent in the selection of materials for the products, impacts from manufacturers’ production process itself, and downstream impacts from the use and disposal of the products. Producers accept their responsibility when designing their products to minimise life-cycle environmental impacts, and when accepting legal, physical or socio-economic responsibility for environmental impacts that cannot be eliminated by design (Organisation for Economic Co-operation and Development 2001).

4. Zero Waste: This is a philosophy that aims to guide people in the redesign of their resourceuse system with the aim of reducing waste to zero. Put simply, zero waste is an idea to extend the current ideas of recycling to form a circular system where as much waste as possible is reused, similar to the way it is in nature (Wikepedia 2008). Zero waste requires that we maximize our existing recycling and reuse efforts, while ensuring that products are designed for the environment and having the potential to be repaired, reused, or recycled (“What is Zero Waste? 2004). The zero-waste strategy is to turn the outputs from every resource-use into the input for another use, or in other words outputs become inputs. An example of this might be the cycle of a glass milk bottle. The primary input (or resource) is silica-sand, which is formed into glass and formed into a bottle. The bottle is filled with milk and distributed to the consumer. At this point normal waste methods would see the bottle disposed in a landfill or similar, but with a zerowaste method the bottle can be saddled with a deposit, at the time of sale, which is redeemed to the bearer upon return. The bottle is then washed, refilled, and re-sold. The only material waste is the wash-water, and energy loss has been minimized. Zero Waste is a goal, a process, a way of thinking that profoundly changes our approach to resources and production. Not only is Zero Waste about recycling and diversion from landfills, it also restructures production and distribution systems to prevent waste from being manufactured in the first place. In addition, the materials that are still required in these re-designed, resource-efficient systems will be recycled back into production (Roper 2006: p. 326).

· Ackerman F 1997. Why Do We Recycle?: Markets, Values, and Public Policy. Washington: Island Press.
· Alan B 2007. The Self-Sufficiency Handbook: A Complete Guide to Greener Living. New York: Skyhorse Publishing Inc.
· Castell A, Clift R, Francae C 2004. Extended Producer Responsibility Policy in the European Union: A Horse or a Camel? Journal of Industrial Ecology, 8: 4 – 7.
· Hanisch C 2000. Is Extended Producer Responsibility Effective? Environ Sci. Technol, 34: 170 -175.
· Organisation for Economic Co-operation and Development 2001. Extended Producer Responsibility: A Guidance Manual for Governments. Paris, France. From Organisation for Economic Cooperation and Development fact sheet about EPR:<;
· Roper W 2006. Strategies for building material reuses and recycle. International Journal of Environmental Technology and Management, 6: 313 – 345.
· The Economist, Weekly, June 7, 2007 “The truth about recycling” <;
· The League of Women Voters 1993. The Garbage Primer. New York: Lyons & Burford, pp. 35-72.
· Tierney J 1996. Recycling Is Garbage. New York Times, Daily, June 30, 1996, P. 3.
· Tong X., Lifset R, Lindhqvist T 2004. Extended Producer Responsibility in China: Where is Best Practice? Journal of Industrial Ecology, 8: 6-9.
· Wikipedia 2008. Recycling. Website 2008 <http://>;
· Winter J 2007. A world without waste-The ‘zero waste’ movement imagines a future where everything is a renewable resource. The Boston Globe, pp. 1-3. From LexisNexis database: Website 2008 <https://>;
· Zero Waste California Fact Sheet 2004. What is Zero Waste California?  From Website 2008 <http:// gov/WhatIs.htm>

The Art of Waste Management (1)

Pigou, the economist who wanted to tax the smog

Cecil Arthur Pigou (1877-1959)

Cecil Arthur Pigou (1877-1959)

Founder of the Polluter Pays Principle, the English economist Arthur Cecil Pigou comes out of the shadows.

British Petroleum assumed responsibility for the oil disaster occurred in April 21 2010 in the Gulf of Mexico. The explosion of the floating platform released tons of oil and threatened the entire U.S. Gulf Coast. BP noted that the Polluter Pays Principle (PPP) did not suffer further discussion. This principle is based on measures adopted since forty years to prevent the damage inflicted on nature by the producers, repair them in case of accident or punish them for violations.

This principle of polluter pays arouse as such in the work of an English liberal economist Arthur Cecil Pigou (1877-1959). As a supporter of regulation by the markets, the founder of the Economics School of Cambridge noted that, left to themselves, these markets suffer from imperfections. For example, they do not take into account the “external” costs of products, such as pollution. In The Economics of Welfare (1920), he developed the idea that an economic agent whose activities generate negative externalities makes the community to support a cost higher than it supports as a private agent. Rather than banning the activity, it was necessary to discourage putting a price on its negative effects. This was to be paid in the form of taxes that would eliminate the gap between the private cost and the social cost of this activity. Pigou proposed e.g. to introduce such a tax on emissions from London smokestacks to fight against smog.

This same reasoning led him to advocate a compulsory health insurance: what one pays to stay healthy, for example, by vaccinating, has positive externalities on the environment which yet does not participate in the expenses. This positive externality therefore deserved to be distributed equitably.

By the time they were issued, these ideas have not been successful. A proposed tax could frighten the economic establishment, yet close to Pigou for his views on the flexibility of labor markets and hostility to regulation of wages. Regarding left-winger economists and thinkers, they excluded that pollution — considered a crime — could be any bargain, as if a polluter stopped being left when becoming a payer. Having also objected to John Maynard Keynes, whom he was professor, Pigou found himself in the shadow of the glory ousted by his prestigious student and friend.

The increase of environmental risks and environmental accidents in the second half of the twentieth century, however, brought his reflections on the front of the stage. Faced with threats to ban their dangerous activities, or a highly restrictive state control, farmers have gradually agreed to take responsibility in this area and consider the management of adverse consequences of their productions. In 1972, the OECD erected the polluter-pays basis for the protection of the environment. In 2003, the European Parliament did the same, following what several countries did before — Germany, Denmark and Switzerland.

Meanwhile, a derived concept, the Extended Producer Responsibility (EPR), stated that « producers of products should bear a significant degree of responsibility (physical and/or financial) not only for the environmental impacts of their products downstream from the treatment and disposal of their product, but also for their upstream activities inherent in the selection of materials and in the design of products ».

These words, which seem commonplace today, took almost sixty years to be heard.

The CO2 tax, introduced in countries such as Sweden and Switzerland in 2008 and 2009, is the quintessential example of a « Pigouvian » tax. It is not about an income tax because the entire collection is redistributed to citizens (through medical insurance). It is rather a save incentive as it rises fuel prices. Without any ideological opponent confessed, the carbon tax has many practical issues however: as it makes consumer to bear the responsibility for pollution, it faces strong political obstacles. Many countries prefer CO2 emission quotas instead, allowing trading on an international market for quotas established by the Kyoto Protocol in 1997 — signed and ratified by 187 states to date.

If the concept of responsibility was installed in people’s minds, and if the economic explanatory of externalities proposed by Pigou found an echo within the political left, there is yet no international system that institutionalizes the application form as to guarantee the neutrality and impartiality. The concept occupies many researchers — as many skeptics who are ready to set off the alarms at the slightest attempt.

A Pigou Club, founded in 2006 by the American Republican economist Gregory Mankiw, ensure the sustainability of pigouvism in its various interpretations. It includes, among its sixty members, well-known economists like Paul Krugman, Nouriel Roubini, Ralph Nader or Jeffrey Sachs; politicians like Michael Bloomberg and Al Gore; and even the actor William Baldwin. They all support the principle of a gas and/or a CO2 tax, and any form of eco-tax to internalize the same social and environmental costs of energy. Some of them, not all, call for offsetting tax cuts on income or sales.

From where he is, Arthur Cecil Pigou watches his new friends with an ironic satisfaction. We guess, behind his mustache, the pleasure of victory.



· Cecil Arthur Pigou, The Economics of Welfare, Library of Congress (U.S.), 2009
· Organisation for Economic Co-operation and Development 2001. Extended Producer Responsibility: A Guidance Manual for Governments. Paris, France. From Organisation for Economic Cooperation and Development fact sheet about EPR:<> (Retrieved February 2010).

Measuring different dimensions of food security

food-security1Food security in terms of the prevalence of undernourishment indicator is a measure of dietary energy deprivation. As a standalone indicator, the prevalence of undernourishment indicator is not able to capture the complexity and multidimensionality of food security, as defined by the 2009 Declaration of the World Summit on Food Security: “Food security exists when all people, at all times, have physical, social and economic access to sufficient, safe and nutritious food, which meets their dietary needs and food preferences for an active and healthy life.”

Based on this definition, four food security dimensions can be identified: food availability, economic and physical access to food, food utilization and stability (vulnerability and shocks) over time. Each food security dimension is described by specific indicators. Measuring the complexity of food security is part of a broader debate that currently takes place in the preparation process of the post-2015 development agenda.

Food security and its four dimensions

Stability: exposure to short-term risks may endanger long-term progress

Two types of indicator have been identified to measure the extent and exposure to risk. Key indicators for exposure to risk include the area equipped for irrigation, which provides a measure of the extent of exposure to climatic shocks such as droughts, and the share of food imports in total merchandise exports, which captures the adequacy of foreign exchange reserves to pay for food imports. A second group of indicators captures risks or shocks that directly affect food security, such as swings in food and input prices, production and supply. The suite of indicators covers a number of stability measures, including an indicator of political instability available from the World Bank.

A thorough and comprehensive review of stability measures is not possible here because of space constraints.

The content that follows takes a limited and more focused look at two important aspects of stability, namely those that pertain to food supply and food price stability.

The recent vagaries of international food markets have moved vulnerability to food insecurity to the forefront of the food policy debate. However, newly available data on changes in consumer prices for food suggest that the changes in prices on international commodity markets may have had less impact on consumer prices than initially expected. Where world price shocks induced high domestic volatility, food producers risked losing the inputs and capital they had invested. The low capacity of small-scale producers, such as smallholder farmers, to cope with large swings in input and output prices makes them risk-averse, lowers their propensity to adopt and invest in new technologies and ultimately results in lower overall production.

Together with swings in prices, food supplies have seen larger-than-normal variability in recent years. However, there is also evidence that production variability is lower than price variability, and that consumption variability is smaller than both production and price variability. Among the main regions, Africa and Latin America and the Caribbean have experienced the widest fluctuation in food supply since 1990, while variability has been smaller in Asia. Variability in food production per capita was greatest in Africa and Latin America and the Caribbean.

The vulnerability dimension of food security is increasingly cast in the context of climate change. The number of extreme events such as droughts, floods and hurricanes has increased in recent years, as has the unpredictability of weather patterns, leading to substantial losses in production and lower incomes in vulnerable areas. Changeable weather patterns have played a part in increasing food price levels and variability. Smallholder farmers, cotters and poor consumers have been particularly badly affected by these sudden changes.

Climate change may play an even more prominent role in the coming decades. Mitigating its impacts and preserving natural resources will be major objectives, especially in connection with the management of land, water, soil nutrients and genetic resources. Improved management of natural resources should focus on reducing variability in agricultural outputs and increasing resilience to shocks and long-term climate change.

The pressing need to improve natural resources management extends well beyond agriculture. Forests and trees outside forests play a large part in protecting soil and water resources. They promote soil fertility, regulate climate and provide habitat for wild pollinators and the predators of agricultural pests. They can help stabilize agricultural output and provide protection from extreme weather events.

According to FAO’s Global Forest Resources Assessment 2010, 48 percent of the world’s forests (330 million hectares) are managed specifically to address soil and water conservation objectives. They not only provide a wide range of nutritious foods on a regular basis, but they also help protect access to food in the form of dietary supplements during times of poor yields, natural calamities and economic hardships.


Read the full report at this link

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

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

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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