25/1/16: Nordic Model: Not Too Heavy Handed on Corporate Profits

Much of the tax debate nowadays has been around tax base erosion and corporate taxes. But the old issue of what to tax: capital or profits is still unresolved. One interesting myth, associated with this debate, is that Nordic countries run a more ‘balanced’ tax system that relies on corporate profit taxes and avoids the problem of so-called harmful tax competition commonly attributed to Anglo-Saxon models where, again allegedly, corporations are treated softly with low tax rates and more benign tax regimes.

Well, a myth is a myth. And a recent paper, titled “Taxing Mobile Capital and Profits: The Nordic Welfare States” by Guttorm Schjelderup (CESIFO WORKING PAPER NO. 5603 NOVEMBER 2015) goes in depth to dispel it.

Per author: “The Nordic countries have traditionally been characterized by an extensive welfare state, a homogenous population and labour force, and redistributive taxation. This has changed in recent years.”

First point of interest is WHY has it changed. Author attributes the change to

• Increased immigration, 
• Ageing population, and 
• “Competition for capital among countries”

These factors “…have put pressures on public finances and the welfare state. These changes can be attributed to the globalization process whereby national economies become more integrated. Economic integration takes place in terms of increasing factor mobility, in particular mobility of capital, and rising volumes of trade in goods and services.”

Now, we have our first lesson: if you run a globally-integrated economy, while you have a modern (aka post-baby boom society) you will see these three factors at play in your economy too. No one’s immune.

“An argument frequently used by political lobby groups is that with free capital mobility corporations shouldn't be taxed at all and that taxing investment income is actually bad for workers. The argument is that if you cut taxes on investment income, more investment is encouraged. More investment means people have more equipment and technology to work with, which should increase the productivity of labour and thus wages and economic growth. Put differently, a tax on mobile capital would lead to an outflow of capital that would cause wages to fall; effectively shifting the full burden of the tax on capital onto workers. It is then better to tax workers directly and levy a zero tax on capital.”

Ok, we’ve heard this before. But is it making any sense?

Per author: “The argument above relies on strong assumptions, among them that labour is immobile and cannot evade taxation, that there are no country specific rents, and that domestic firms are not owned in part by foreigners.” However,

• “If domestic firms, say, are partly owned by foreigners, taxing capital would imply that some of the tax burden is shifted onto foreigners and that part of the welfare state is then financed by foreigners. This alone may warrant a positive tax on investment capital.”
• “If industrial agglomeration is concentrated in one single country, a government may, through a positive source tax on capital, be able to exploit the locational rent created by agglomeration forces and thus increase welfare.”

More importantly, “the zero tax on capital result is also difficult to confirm empirically. Yagan (2014), for example, …finds that it caused zero change in corporate investment in U.S. unlisted firms and that it had no impact on employee compensation. It did, however, have an immediate impact on financial pay-outs to shareholders. Alstadsæter et al. (2015)… find that the Swedish 2006 dividend tax cut did not affect aggregate investment but that it affected the allocation of corporate investment. In particular, …relative to cash-rich firms, cash-constrained firms increased their investments after the dividend tax cut.”

Key, however, is that corporate tax acts as “…a “backstop” to the personal income tax. If a country abolished the corporate tax rate, wealthy individuals in particular would be given an incentive to reclassify their labour earnings as corporate income, typically using offshore corporate structures and escape tax. The corporate tax might also be needed to avoid excessive income shifting between labour income and capital income. Finally, the corporate tax also acts as a withholding tax on equity income earned by non-resident shareholders, who might otherwise escape taxation in the source country.”

Now onto evidence regarding evolution of tax regimes. 

“Countries throughout the world have reduced their corporate taxes in an effort to attract or retain corporate investments. The Nordic countries have pioneered what is commonly known as the dual income tax (DIT). It combines a flat tax rate on capital income with progressive taxation of labour income. One of the arguments in favor of the DIT is that it allows policy makers to lower the corporate tax rate to reduce the risk of capital flight, whilst at the same time tax distributed dividends to personal shareholders.”

But there are “challenges of taxing capital for small open economies. Although the corporate tax share of GDP in most countries is only around 3-4%, it is an important tax because it acts as a “backstop” for the personal tax rate. …The pressures of tax competition are exacerbated by tax planning and income shifting to low tax countries by multinationals. Studies show that multinationals pay less tax than domestic firms and this may give them a competitive edge over domestic firms. The long term effects may be changes in ownership structure that affect competition in markets and make the corporate tax base more tax sensitive. Profit shifting is undertaken through transfer pricing and thin capitalization (excessive debt).” Care to spot Irish trends here? Why, they are pretty obvious.

But back to the Nordics vs Anglo-Saxons arguments. Per paper, “It is interesting to note that the Nordic countries seem to have gone further in terms of abolishing redistributive capital taxes than countries traditionally associated with polices much less tuned to redistribution. Aaberge and Atkinson (2010) shown how income inequality at the top of the distribution has increased in Anglo-Saxon countries, whereas the same rise in top income shares was not experienced by Continental European countries. They find that the Norwegian and Swedish experience over the twentieth century is similar to the Anglo-Saxon countries in that top shares, and the concentration among top incomes have first fallen and then risen. Norway differs from Sweden in that that the top shares rose more sharply in the period 1990-2006. Between 1980 and 2004, for example, the share of the top 1 per cent more than doubled in Norway, but rose less than half in Sweden.”

What are the reasons for these trends?

“Several explanations have been put forward to explain why Norway sets itself apart. The implementation of the 1992 tax reform abolished the dividend tax and lead to a sharp increase in dividends and capital gains among the richest in Norway. Capital taxation in Sweden was less favourable. Substantial oil production in Norway started some 15 years before the rise in inequality, but could still be an explanatory factor due to constrained cash in this sector in the initial phase of production. Capital market reforms with liberalization of interest rates and an upturn in business cycles are also important factors that are hard to disentangle, but they certainly played a role.”

Social impact of tax-linked inequality? “Capital taxation also affects income mobility, and concerns about rising inequality have often been countered by constant changes in the composition of top income earners. If so, the rise in top incomes may not translate into “economic power”. Aaberge et al. (2013) study who enters and leaves the top income groups in Norway in the period 1967-2011. Their main conclusion is that despite large changes in top income mobility over the last four decades, the magnitude of the effect of the changes in mobility on the income shares was moderate.”

What’s the future holds? “Competition among countries to attract mobile capital is a persistent phenomenon and will be a driver towards still lower taxes on mobile capital. A major change from the past, then, is less ability to redistribute, increasing income inequality, and rising immigration from poor countries. In sum these forces may affect trust between members of society. The level of trust is positively linked to economic growth. Herein lies a major challenge for the Nordic welfare states.”

And as an aside, here’s the actual draw on Nordic v Anglo-Saxon patterns in taxation: “In 2004, the classical welfare states in Scandinavia and continental Europe had lower ratios of statutory corporate to wage taxes than the Anglo-Saxon countries (except Ireland). In 2004, the corporate tax rate was only 63% of the wage tax rate for an average worker in Sweden, but 171% of the wage tax rate in the United States. Such differences are in striking contrast to the common perception that social democratic governments (as in Scandinavia and continental Europe) share a higher preference for redistribution, as compared to more conservative and free market oriented types of governments.”

Oops… who’s the neoliberal b*&ch now?..

24/1/16: House Prices, Local Demand and Homeownership Status

House prices bust was a major dimension of the recent Great Recession around the world. Nonetheless, contrary to all evidence, many political leaders have opted to dismiss the adverse impacts of shocks like negative equity (due to price declines and pre-crisis debt ramp ups) and wealth effects on aggregate demand (first order price effects).

An interesting study based on the U.S. data tests the aggregate impacts of house prices changes on consumption, while controlling for homeownership status (renters v owners).

Titled “House Prices, Local Demand, and Retail Prices” and co-authored by Johannes Stroebel and Joseph Vavra (CESIFO WORKING PAPER NO. 5607, NOVEMBER 2015) the study used “detailed micro data to document a causal response of local retail price to changes in house prices, with elasticities of 15%-20% across housing booms and busts. Notably, these price responses are largest in zip codes with many homeowners, and non-existent in zip codes with mostly renters.”

In other words, not only impacts of house price changes are significant, they are also bifurcated across two types of home occupiers - owners and renters, with renters exhibiting effectively no sensitivity to home prices changes in terms of their demand.

The authors “provide evidence that these retail price responses are driven by changes in markups rather than by changes in local costs. … Markups rise with house prices, particularly in high homeownership locations, because greater housing wealth reduces homeowners’ demand elasticity, and firms raise markups in response. Consistent with this explanation, shopping data confirms that house price changes have opposite effects on the price sensitivity of homeowners and renters.”

Overall, “taken together, our empirical results provide evidence of an important link between changes in household wealth, shopping behavior and firm price-setting. Positive shocks to wealth cause households to become less price-sensitive and firms respond by raising markups and prices.”

So do house prices matter for aggregate demand? They do. Does homeownership smooth or amplify effects of shocks to house prices on the aggregate economy? It appears to amplify them. Should monetary and fiscal policies be asymmetric for areas with high homeownership concentration as opposed to areas with high renters concentration? Yep. Ditto for countries, instead of areas.

Of course, in the Euro area, how does one structure differential monetary policies across countries so diverse as renters-concentrated Germany vs homeowners concentrated Holland or Ireland? Err… can we check that one as yet another problem with Euro architecture?..

24/1/16: European Financial Networks: Prepare for Bloodletting to Commence

A recent paper, titled "Transmission Channels of Systemic Risk and Contagion in the European Financial Network" co-authored by Nikos Paltalidis, Dimitrios Gounopoulos, Renatas Kizys, Yiannis Koutelidakis (Journal of Banking and Finance, gated) tackles a very interesting problem relating to the systemic stability of the European banking system and the bi-directional contagion channels shifting/transmitting systemic shocks between the banks and the sovereigns.

Following the euro area banking crisis of 2008-2012 (with residual effects of this crisis still strongly present in the so-called euro area 'periphery'), financial systems analysts and modellers came to the realisation that a number of key questions relating to overall system stability remain un-answered to-date. These include:

• What determines the intensity with which exogenous shocks propagate in the financial system as a whole (and how this intensity carries across banking systems)?
• How do we "identify, measure and understand the nature and the source of systemic risk in order to improve the underlying risks that banks face, to avert banks’ liquidation ex ante and to promote macro-prudential policy tools"? 
• How do systemic risks arise in the cases where such risks are endogenous to the banking system itself?
• How resilient is the euro area banking system (under improved regulatory and supervisory regimes) to systemic risk?
• How "…shocks in economic and financial channels propagate in the banking sector"? 
• And related to the above: "In the presence of a distress situation how the financial system performs? Have the new capital rules rendered the European banking industry safer? What is the primary source of systemic risk? How financial contagion propagates within the Eurozone?"

As the authors correctly note, "These fundamental themes remain unanswered, and hence obtaining the answers is critical and at the heart of most of the recent research on systemic risk."

Lacking empirical evidence (due to proximate timing of events and their extreme-tail nature) the authors create “a unique interconnected, dynamic and continuous-time model of financial networks with complete market structure (i.e. interbank loan market) and two additional independent channels of systemic risk (i.e. sovereign credit risk and asset price risk).”

Summary of the findings relating to sources of shocks:

1. “…A shock in the interbank loan market causes the higher amount of losses in the banking network”;
2. “…Losses generated by the sovereign credit risk channel transmit faster through the contagion channel, triggering a cascade of bank failures. This shock can cause banks to stop using the interbank market to trade with each other and can also lead banks to liquidate their asset holdings in order to meet their short-term funding demands.”
3. “Moreover, we evaluate the impact of reduced collateral values and provide novel evidence that asset price contagion can also trigger severe direct losses and defaults in the banking system.”

So the model does support the view that “the Sovereign Credit Risk channel dominates systemic risks amplified in the euro area banking systems and hence, it is the primary source of systemic risk.” Which is quite interesting from a number of perspectives:

• Firstly, we tend to think about the Global Financial Crisis as a mother of all systemic crises and we tend to attribute the degree of disruption in the crisis to the origins of the crisis shocks: the financialisation of the ‘bubbles’ in real assets (e.g. real estate), leading to liquidity crunch and then to solvency crunch. We think of the sovereign shock channel as being in play only because of banks-sovereign link. And we think that the second order contagion from the sovereign to the banks is secondary in magnitude to the GFC. It appears that things are much more complex and inter-connected both in terms of direction of contagion and orders of disruption caused.
• Secondly, we tend to ignore the relationship between the banks bailouts, QE programmes and equity markets. We think of them as related, but separate acts, e.g.: banks bailouts require funds which are supplied via sovereigns which need to obtain financial resources, which they do via QE, which simultaneously lowers the cost of investment and increases valuations of equities. But the problem is that we also have direct QE —> Equity valuations —> Banks balance sheet pathways. Just as asset prices collapse or illiquidity can trigger a liquidity run by the banks and defaults and losses within the banking system, so are asset prices increases can lead to improved liquidity conditions for the banks and improved banks balance sheets.
• Thirdly, the study provides “…novel evidence that systemic risk in the euro area banking system didn’t meaningfully decrease as it is evident that shocks in the three independent channels -interbank market, sovereign credit risk, asset price risk- trigger domino effects in the banking system.” Which sort of tells us what we suspected all along: the entire ‘firewalls have been built’ brigade of European politicos is eating hopium by truckloads. There are no ‘firewalls’. There are bits of wet cardboard stuck into the cracks and a perennial hope they stay well moisturised by occasional rains. 

Now, let’s give it a thought: since the end of the crisis, we’ve been told that solution to the problem of preventing future crises and alleviating the costs of those that still might happen is more coordination, harmonisation and integration of banking systems under the watchful eye of ECB. In other words, more internationalisation of domestic banks - more linking between them and banks operating in other economies within the Euro area. What does evidence have to say on that? “…we find that the cross-border transmission of systemic shocks depends on the size and the degree of exposure of the banking sector in a foreign financial system. Particularly, the more exposed domestic banks are to the foreign banking systems, the greater are the systemic risks and the spillover effects from foreign financial shocks to the domestic banking sector.”

Ya wouldn’t! No, ya couldn’t! But… baby… we had firewalls and we had EBU and more interconnected system of Euro area-wide banking supervision… and we now have?.. err… Yep, in the words of the authors: “Finally, the results imply that the European banking industry amid the post-crisis deleverage, recapitalisation and the new regulatory rules, continues to be markedly vulnerable and conducive to systemic risks and financial contagion.”

24/1/16: Improving on a Poor Base: Dublin in Global Financial Centres Rankings

Based on the Global Financial Centres 2015 rankings, Dublin is currently occupying a rather poorly 46th place - an improvement on 52nd in 2014, but still in a league of relative minnows like Casablanca, Istanbul, Bangkok et al. 

It is worth noting that Dubai is in a respectable 16th place. Of course, one can occasionally hear Irish development agencies staff bragging about how Dubai was always keen on copying Irish IFSC experience… well, apparently they’ve copied it better than we built it. 

Dublin does a bit better when pitched against European counterparts, ranking 11th in Europe alongside other tax havens of Jersey, Guernsey, Gibraltar and Isle of Man. But Luxembourg - a place of similar standing to Ireland on tax and other issues is ranked six place ahead of us.

Sadly, we do not get into top 12 in any (repeat, any) of sub-indices, including the ones we claim such a strong position in: human capital and business environment. What’s up, dudes?! Ah, well, it turns out the world is a competitive place and having Prime Minister who chirps about ‘best little country…’ is just not enough.

So moar diesel… folks… that IFSC engine is purring out smoke… 

24/1/16: Unobserved Ability and Entrepreneurship

Yesterday, I posted some links relating to non-Cognitive Skills, contextualising these into the Gig-Economy related issues. Here is another interesting study relating to human capital and linking unobserved (and hard to measure) ability to entrepreneurship.

From the policymakers' and indeed investors and other market participants perspective, the question of why do some individuals become entrepreneurs is a salient one.

Identifying the causal relationships between external conditions, systems and policy environments, as well as behavioural and other drivers of entrepreneurship is of great value for setting policies and systems for enhancing the rate of entrepreneurship creation in the economy. A recent paper, titled "Unobserved Ability and Entrepreneurship" by Deepak Hegde and Justin Tumlinson (Ifo Institute at the University of Munich, April 20, 2015) attempts to answer to key questions surrounding the formation of entrepreneurship, namely:

1. Why do individuals become entrepreneurs? and
2. When do they succeed? 

The authors "develop a model in which individuals use pedigree (e.g., educational qualifications) as a signal to convince employers of their unobserved ability. However, this signal is imperfect…" So far - logical: upon attaining a level of education, and controlling for quality of that education (complexity of degree programme, subject matter, quality of awarding institution, duration of studies, attainment of grades etc), a graduate acquire more than a sum of knowledge and skills attached to the degree. They also acquire a signal that can be communicated to their potential employer that conveys they lateen (hidden) abilities; attitude toward work, aptitude, ability to work in teams, ability to work on complex systems of tasks etc.

Problem is - the signal is noisy. For example, a graduate with 4.0 GPA from a second tier university can have better potential abilities than a graduate with 3.7 GPA from a first tier ranked university. But that information may not be clearly evident to the potential employer. As the result, there can be a large mismatch between what an applicant thinks their ability is and what their CV signals to the potential employer.

In the paper, theoretical model delivers a clear cut outcome (emphasis mine): "…individuals who correctly believe their ability is greater than their pedigree conveys to employers, choose entrepreneurship. Since ability, not pedigree, matters for productivity, entrepreneurs earn more than employees of the same pedigree."

The authors use US and UK data to test their model prediction (again, emphasis is mine): "Our empirical analysis of two separate nationally representative longitudinal samples of individuals residing in the US and the UK supports the model’s predictions that

• (A) Entrepreneurs have higher ability than employees of the same pedigree, 
• (B) Employees have better pedigree than entrepreneurs of the same ability, and 
• (C) Entrepreneurs earn more, on average, than employees of the same pedigree, and their earnings display higher variance."

Point C clearly indicates that entrepreneurs earn positive risk premium for effectively (correctly, on average) betting on their ability over their pedigree. In other words, the take chance in themselves and, on average, win. The real question, however, is why exactly do their earnings exhibit higher variance - is it due to distributional effects across the entrepreneurs by their ability, or is it due to risk-adjusted returns being similar, or is it due to exogenous shocks to entrepreneurs incomes (e.g. tax system-induced or contractually-structured)?

These are key questions we do not yet address in research sufficiently enough to allow us to understand better what the Gig-Economy and entrepreneurship in modern day setting imply in terms of aggregate consumption, investment, household investment and decision making by entire household in terms of labour supply, educational choices (for parents and children), etc.

As some might say... it's complicated...

24/1/16: High Yield Bonds Flash Red for Growth

An interesting regularity in the markets observed by JPM research: High Yield debt as a lead indicator of recessions… and of equities…

Self-explanatory…

Some more academic links on the high yield bonds forward prediction of business cycles:

• Via credit risk channel: Wang, Pengfei and Miao, Jianjun, "Credit Risk and Business Cycles" (September 8, 2010)
• Via productivity channel: Estevão, Marcello M. and Severo, Tiago, "Financial Shocks and TFP Growth" (Janurary 2010). IMF Working Papers, Vol. , pp. 1-35, 2010
• Via yield curve shape: Peña, Juan Ignacio and Rodríguez, Rosa, "On the Economic Link Between Asset Prices and Real Activity". Journal of Business Finance & Accounting, Vol. 34, Nos. 5-6, pp. 889-916, June/July 2007. 

23/1/16: Russian External Balance 2015

At the end of 2015, based on the preliminary estimates of 2015 balance of payments statistics from the Central Bank of Russia, Russian trade volumes with the rest of the world stood at just under 2010 levels. This is hardly new, as 2010 values of trade - both for exports and imports of goods and services - have been breached back in 3Q 2015. This erases gains between 2010 and 2013 (with 2013 posting all-time record high volumes and values of trade flows)

In 2015, exports revenues fell more than 30% in USD terms and 17% in Euro terms year on year. Imports expenditures fell 35% in USD terms and 22% in Euro terms. Perhaps somewhat surprisingly, 4Q figures came in broadly in line with annual figures. This is surprising due to imports and exports-lifting seasonal effects.

As exports shrunk less than imports, current account surplus actually rose both in level terms and relative to GDP. At the peak trade year of 2013, current account surplus was USD35 billion, rising to USD58 billion in 2014. 2015 preliminary estimate puts full year current account surplus at USD66 billion. Relative to GDP, current account surplus rose from 1.7% in 2013 to 5.4% in 2015.

These are remarkable figures, reflective of both devaluation of the ruble, the ability of the economy to take on imports contraction, and the relative resilience of exporters. Exports of goods and services were down massively, still, from USD593 billion in 2013 to USD389 billion in 2015. While trade balance in Goods fell from USD182 billion in 2013 to USD146 billion in 2015, trade deficit in services shrunk from USD58 billion in 2013 to USD37 billion in 2015.

The key to overall balance improvements, however, was in the category of “Other Current Account” - covering foreign earnings expatriation from Russia - here the deficit of USD89 billion in 2013 fell to USD76 billion in 2014 and to USD43 billion in 2015. Similarly, on the balance of payments side, “Fictitious Transactions” line of balance - covering Russian corporates exports of capital from Russia - fell from USD27 billion in 2013 to USD9 billion in 2014 and USD 1 billion in 2015. Balance of payments for Private Sector also improved, dramatically, with deficit of USD63 billion in 2013 ballooning to a deficit of USD152 billion in 2014 before falling to a deficit of USD57 billion in 2015.

BOFIT provides a neat summary table of latest Balance of Payments breakdown figures for 2013-2015:

Source: BOFIT

23/1/16: Corporate Profits v GDP: Not a Good Sign

One interesting relationship in recent weeks has been flashing red: the relationship between annual nominal GDP growth rates for the U.S. and the reported growth rates in corporate profits for non-financial corporations. 

Source: Author own calculations based on data from Fred

As shown in the chart above, growth rate in non-financial corporations’ profits has recently dipped below zero, posting -4.26% reading in 3Q 2015. The last time corporate profits took a nose dive was in 1Q 2014. Over the last four U.S. recessions, corporate profits growth rates have been a relatively consistent lead indicator of troubles brewing ahead.

Things are not exactly on a healthy side. While two quarters separated by more than a year of positive data may be just a glitch, it is worth noting that since 1989 on, there have been no period in which a recession was not preceded by decline in corporate profits, sometimes (1991 case) as far out as 2 years ahead.

But you can take my word with a grain of salt, so here’s Citi Index of corporate profits… 

Bloomberg headline that accompanied it: “Global earnings downgrades haven’t been this bad in 7 years”.

Ah, the repaired world…

23/1/16: Financial Globalisation and Tradeoffs Under Common Currency

A paper I recently cited in a research project for the European Parliament that is worth reading: "Trilemmas and Tradeoffs: Living with Financial Globalization" by Maurice Obstfeld. Some of my research on the matter, yet to be published (once the EU Parliament group clears it) is covered here: http://trueeconomics.blogspot.com/2016/01/19116-after-crisis-is-there-light-at.html and see slides 5-8 here: http://trueeconomics.blogspot.com/2015/09/17915-predict-conference-data-analytics.html.

This is one of the core papers one simply must be acquainted with if you are to begin understanding the web of contradictions inherent in the structure of modern financial flows (in the case of Obstfeld's paper, these are linked to the Emerging Markets, but much of it also applies to the euro).


The paper "evaluates the capacity of emerging market economies (EMEs) to moderate the domestic impact of global financial and monetary forces through their own monetary policies. Those EMEs able to exploit a flexible exchange rate are far better positioned than those that devote monetary policy to fixing the rate – a reflection of the classical monetary policy trilemma.” The problem, as Obstfeld correctly notes, is that in modern environment, “exchange rate changes alone do not insulate economies from foreign financial and monetary shocks. While potentially a potent source of economic benefits, financial globalization does have a downside for economic management. It worsens the tradeoffs monetary policy faces in navigating among multiple domestic objectives.”

Per Obstfeld, the knock on effect is that “This drawback of globalization raises the marginal value of additional tools of macroeconomic and financial policy. Unfortunately, the availability of such tools is constrained by a financial policy trilemma, [which] posits the incompatibility of national responsibility for financial policy, international financial integration, and financial stability.”

This, of course, is quite interesting. Value of own (independent) tools beyond flexible exchange rates rises with globalisation, which normally incentivises more (not less) activism and interference from domestic (or regional - in the case of monetary integration) regulators, supervisors and enforcers. In other words, Central Banks and Fin Regs grow in size (swelling to design, fulfil and enforce new ‘functions’). And all of this expensive activity take place amidst the environment where none of can lead to effective and tangible outcomes, because of the presence of the second trilemma: in a globalised world, national regulators are a waste of space (ok, we can put it more politically correctly: they are highly ineffective).

Give this another view from this argument: ‘national’ above is not the same as sovereign. Instead, it is ‘national’ per currency definition. So ECB is ‘national’ in these terms. Now, recall, that in recent years we have been assured that we’ve learned lessons of the recent crisis, and having learned them, we created a new, very big, very expensive and very intrusive tier of supervision and regulation - the tier of ECB and centralised European Banking regulatory framework of European Banking Union (EBU). But, wait, per Obstfeld - that means preciously little, folks, as long as Europe remains integrated into globalised financial markets.

Obstfeld’s paper actually is a middle ground, believe it or not, in the wider debate. As noted by Obstfeld: “My argument that independent monetary policy is feasible for financially open EMEs, but limited in what it can achieve, takes a middle ground between more extreme positions in the debate about monetary independence in open economies. On one side, Woodford (2010, p. 14) concludes: “I find it difficult to construct scenarios under which globalization would interfere in any substantial way with the ability of domestic monetary policy to maintain control over the dynamics of inflation.” His pre-GFC analysis, however, leaves aside financial-market imperfections and views inflation targeting as the only objective of monetary control. On the other side, Rey (2013) argues that the monetary trilemma really is a dilemma, because EMEs can exercise no monetary autonomy from United States policy (or the global financial cycle) unless they impose capital controls.”

Now, set aside again the whole malarky about Emerging Markets there… and think back to ECB… If Rey is correct, ECB can only assure functioning of EBU by either abandoning rate policy independence or by abandoning global integration (imposing de facto or de sure capital controls).

Of course, in a way, bondholders’ bail-ins rules and depositors bail-ins rules and practices - the very sort of things the EBU and ECB’s leadership rest so far - are a form of capital controls. Extreme form. So may be we are on that road to ‘resolving trilemmas’ already?..

Have a nice day... and happy banking...

23/1/16: Non-Cognitive Human Capital

In my 2011 paper on the role of Human Capital in the emerging post-ICT Revolution economy, human capital will simultaneously:

1. Play increasingly more important role in determining returns to technical and processes innovation;
2. Become more diverse in its nature - or more diversified - spanning measurable and unmeasurable skills, traits, knowledge, attitudes to risk and innovation, capabilities etc.; and
3. Form the critical foundation of entrepreneurship and core employment base in the so-called Type 1 Gig-Economy - economy based on contingent workforce compered of highly skilled, highly value-additive professionals.

An interesting paper relating to the matter, especially to the last point, is a recent IZA Working paper (October 2015) titled “Non-Cognitive Skills as Human Capital” by Shelly Lundberg.

Per Lundberg: “In recent years, a large number of studies have shown strong positive associations between so-called “non-cognitive skills” — a broad and ill-defined category of metrics encompassing personality, socio-emotional skills, and behaviors — and economic success and wellbeing. These skills appear to be malleable early in life, raising the possibility of interventions that can decrease inequality and enhance economic productivity.”

Lundberg discusses “the extensive practical and conceptual barriers to using non-cognitive skill measures in studies of economic growth, as well as to developing or evaluating relevant policies. …There is a lack of general agreement on what non-cognitive skills are and how to measure them across developmental stages, and the reliance on behavioral measures of skills ensures that both skill indicators themselves, and their payoffs, will be context-dependent. The empirical examples show that indicators of adolescent skills have strong associations with educational attainment, but not subsequent labor market outcomes, and illustrate some problems in interpreting apparent skill gaps across demographic groups.”

From the Gig-Economy point of view, development of all (cognitive and non-cognitive) skills requires time and resources. In traditional workplace setting - of old variety - some of these resources and time allocations are supported / subsidised by employers (e.g. gym memberships, formal paid time off, formal paid career breaks, formal 'team building' activities, actual employer-paid training and education, employer-supported psychological wellness programmes for employees, and so on). In a Gig-Economy setting, these are not available, generally, to contingent workers.

Aside from having impact on contingent workforce skills and human capital, there are more 'trivial' considerations that should be put to analysis. Take, for example, health and psychological well-being. If a contingent workforce using company fails to assure the latter for its contingent workers, who is liable for any damages caused by over-worked, over-stressed, psychologically unwell contingent worker to the company clients?

Again, setting aside humanitarian, social and personal considerations, this question has implications for businesses using contingent workers:

• Insurance costs and coverage for businesses;
• Legal costs and coverage for business;
• Reputational risks for businesses;
• Counter-party risks for businesses; and so on

In a world where there is no such thing as a free lunch, Gig-Economy based companies should seriously consider how they are going to deal with potential costs of disruption from the Gig-Economy type of employment to life-cycle work practices and financial wellbeing of their contingent workers.


Note: More on the subject of non-cognitive skills and human capital:

• Early childhood: "Non Cognitive Skills and Personality Traits: Labour Market Relevance and their Development in Education & Training Systems" by Giorgio Brunello and Martin Schlotter, IZA DP No. 5743
• Early childhood and education: "Formulating, Identifying and Estimating the Technology of Cognitive and Noncognitive Skill Formation", by Flavio Cunha and James Heckman, University of Michigan Working Paper.
• Adult development: “Do Sporty People Have Access to Higher Job Quality?” by Charlotte Cabane, DIW working paper, 2010. 
• Related to sports and extracurricular activities: “Sports and Child Development” by Christina Felfe, Michael Lechner and Andreas Steinmayr, IZA Working Paper, 2011. And “Unemployment Duration and Sport Participation” by Charlotte Cabane,International Journal of Sport Finance, un-gated version ftp://mse.univ-paris1.fr/pub/mse/CES2011/11049R.pdf from 2011.
• Income effects: “Income Comparisons and Non-cognitive Skills” by Santi Budria and Ada Ferrer-i-Carbonell, DIW Working Paper, 2012.

23/1/16: Poland's Sovereign Risk Troubles

With what appears to be a political-motivated downgrade by the S&P on January, from A to BBB+, with steady outlook, Poland’s sovereign and macro risks have been pushed to the top of news flow. Meanwhile, Moody’s rates Poland A2 (stable) and Fitch A. However, as noted by Euromoney country risk recent assessment, the sovereign risks turmoil that accelerated over the last few weeks has been building up for some time now.

Euromoney Country Risk (ECR) survey shows that by the end of 2015, Poland’s political risk score dropped to 20.06, “the lowest it has been since ECR launched an updated methodology in 2011”. More interestingly, “Poland’s political risk score has been declining – indicating increased risk – since 2011.”

Worse, per ECR: “the drop in Poland’s political score from 20.17 in September to 20.06 in December combined with a fall in its economic risk score from 19.38 to 19.27 over the same period, contributing to a decline in its overall score to 65.62 from 66.93. Poland, which enjoyed a ranking as the 29th safest country in the world in September, dropped four spots in rankings since the yearend survey.

Here is ECR’s summary of scores for Poland, including some recent moves:

It is interesting to see Poland significantly underperforming Slovakia:

Overall, given that both Slovakia and Hungary have, over recent years, adopted a series of reforms that severely undercut effectiveness of institutional checks and balances over the power of the executive, the reaction of ratings agencies and European authorities to Poland following the same route suggests growing concern and nervousness in Europe over all and any national experimentation with populist and/or non-conformist (to EU 'standards') policies.

Not being a fan of the current Polish leadership, I find myself in Poland's corner: in a democratic setting, it is people, not Eurocrats, who should decide on their future institutions.

20/1/16: "Немного фантастики. Где у России остался потенциал роста”

My latest column for Slon.ru covering the topic of how Russia can jumpstart growth through targeted reform of its Special Development Zones and clustering environment: https://slon.ru/posts/62652.