A History Lesson for Scotland

In Guan's recent post on this blog, "Scotland, sterling and the debt," he notes that Scotland will hold a referendum on independence from the United Kingdom in September 2014. The Scottish Government suggests that an independent Scotland should be in a currency union with the UK. Guan writes:

"There are probably some sound arguments for that: it could take years to join the euro, and much of Scotland’s trade is with rest-of-UK, and vice versa.  

On the other hand, events of recent years have kind of cooled the enthusiasm for currency unions in Europe. It’s not at all clear that it would be a good idea for Scotland to adopt sterling. The UK Government’s position is, sensibly enough, that a currency union would be unworkable without a fiscal and political union, which is kind of absurd when the goal is Scottish independence."

For historical perspective on a potential Sterling Area, we should look back to the Austria-Hungary monetary union of 1867-1918. The monetary union began following the Habsburgs' defeat by Prussia. In "The Logic of Compromise," Marc Flandreau explains that:

"The Austro-Hungarian monetary union was not the result of a monetary marriage but the by-product of a fiscal divorce. Austria and Hungary became in 1867 two sovereign budgetary entities. In the process, they retained a common bank of issue and thus formed a defacto monetary union that would operate until its post-World War I collapse."

A Sterling Area currency union with an independent Scotland would likewise be a product of divorce, not of marriage. An annex to the Scottish Fiscal Commission Working Group's First Report assessing possible currency options for an independent Scotland notes that there are two ways to retain Sterling: through a formal monetary union or through an informal arrangement ("Sterlingisation.") The Scottish Parliament is in favor of the formal monetary union, in which the Bank of England would make monetary policy decisions in consideration of conditions in both Scotland and the rest of the UK.

Scotland's proposed formal monetary union would resemble the set-up in the Austria-Hungary monetary union. At the start of the Compromise, the Austrian National Bank was the sole bank of issue for Austria and Hungary. As Flandreau details, Hungary gained increasing control over the central bank over the years. In 1878 the Bank became the Austro-Hungarian Bank. The Austro-Hungarian Bank inherited its predecessor's balance sheet and became a federal institution, with Managements in both Vienna and Budapest. At least two of the twelve Councillors had to be Hungarian. Over the pre-WWI years, there was "a definite trend in Hungary's formal influence within the common Bank. This trend was also reflected in substantive policies of the Bank...The Austro-Hungarian National Bank transformed itself from being a predominantly Austrian institution in 1867 into being a truly binational institution."

Flandreau explains the political economy behind the transformation at the Austro-Hungarian National Bank:

"Consider a monetary union comprising two parts, a 'large' (Austria) and a 'small' (Hungary) country. The common central bank delivers a range of services that are valuable to both parts, but not equally... If power is proportional to size, the small country has very little control over common decisions. It is bound by the discipline of the union without being able to influence decision-making in a way that would address its own specific interests. Co-operation (that is, participation in the union) is sub-optimal and the small country prefers to quit. Sustained co-operation requires that the large country accepts a decision-making process in which the small country receives a greater voting share than size alone would predict... 

However, it is not clear why the large country should accept this dilution of power. The normal outcome should therefore be secession...[Casella (1992)] shows that if co-operation delivers a number of public goods that are useful to all parts, then the large country may nonetheless accept a reduction of its relative ability to set decisions, since the additional output may compensate for the initial loss."

Flandreau's logic is relevant for a possible Sterling Area. The Fiscal Commission notes that "Over the medium term it may well be in Scotland’s interests to move to an alternative arrangement, should either the performance of the Scottish economy change or the preferences of the people of Scotland change." A "Sterling Area Bank" would have to be acceptable enough to both parts of the Sterling Area to be maintained. In the Austria-Hungary arrangement, Austria had to provide Hungary with considerable incentives to stay on board. Austria was willing to make the necessary concessions because the benefits to Austria of keeping Hungary in the union were sufficiently great. These benefits may have included dynastic and imperial considerations, maintenance of the crown as an international currency, and maintenance of bilateral trade.

According to Flandreau, then, monetary compromises are determined by bargaining power.  It is not clear to me whether the bargaining power dynamics between Scotland and the rest of the UK would be suitable for sustained cooperation. As commenter Absalon says in response to Guan's post, "Scotland would not need the permission of England to continue to use sterling any more than Panama and Ecuador need American permission to use the dollar. Of course, Panama and Ecuador have no say in setting the policies of the Fed." If an independent Scotland wanted some amount of power in a supranational or joint shareholder central bank, it would need enough bargaining power. Bilateral trade is one consideration. Guan describes another attempt to assert bargaining power:

"The argument of the Scottish National Party-led government is that the British pound and the Bank of England (name notwithstanding) are “assets” of the United Kingdom. Assets and liabilities of the United Kingdom should be split up among the constituent countries, and if rest-of-UK refuses to divide the sterling 'asset', then Scotland would refuse to assume its share of the liabilities—the UK national debt."

In Austria-Hungary, Austria was directly responsible for the pre-1867 common debt. Hungary paid an annuity corresponding to a one-third share. (Unlike in the Eurozone, no "stability pact" was signed.) But it took more than just the desire for Hungary to pay its share of the common debt to hold the currency union together. Times were very different during the Austria-Hungary currency union, so there are limits to the lessons that can be drawn. But the union did manage to exist without a formal fiscal union. In many ways, it was beneficial for Hungary. Scotland would like to enjoy similar benefits, but it may not have the necessary bargaining power that Hungary had.

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This is my last post on Not Quite Noahpinion before it reverts to Noahpinion. I really appreciate the opportunity to post here for the past few months and thank you all for reading and commenting. I'll be working on my dissertation and (at least occasionally) posting on my own blog. Keep in touch. 

Happy Thanksgiving!

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Is Obama anti-business?

The Economist has two articles (one, two) on whether Obama is "anti-business." According to both, business leaders are increasingly convinced that this is the case. The Economist writers can't figure out exactly why these attitudes exist, though...and since The Economist is probably the newsweekly that is read most by the business class, if they don't know, who does? The notion of Obama as anti-business, it turns out, is not really supported by the facts:

No matter that other Western politicians have publicly played with populism more dangerously, from France’s “laissez-faire is dead” president, Nicolas Sarkozy, to Britain’s “capitalism kills competition” business secretary, Vince Cable (see article); no matter that talk on the American right about Mr Obama being a socialist is rot; no matter that Wall Street’s woes are largely of its own making...

A president who truly wanted to wage war on business would have hung onto GM, not rushed to return it to the private sector. Card check has not been pushed. The finance bill, though bureaucratic, is not a Wall Street killer. With the exception of a China-bashing tyre tariff and a retreat on Mexican trucks, Mr Obama has eschewed protectionism. A lot of government cash has flowed to businesses, not least through the stimulus package. And above all his policies have helped pull the economy out of recession.

and:

Yet does Mr Obama really have a case to answer? Certainly, some of the wilder allegations by some businesspeople should never have left the 19th hole. Mr Obama has consistently made it clear he favours a mixed capitalist economy. The big incursion of the state into finance took place on his Republican predecessor’s watch. And although he doubtless went further than a McCain administration would have done to help GM and Chrysler survive, he has stuck to his pledge to return them quickly to private ownership. He used this year’s state-of-the-union message to commit himself to helping corporate America double its exports, and has appointed a council to propose ideas for promoting more innovation...

Moreover, the main reason so many American bosses are down in the dumps is the sluggish economy. Mr Obama inherited the recession from his predecessor, and the economy has recovered, somewhat, since then. Besides, it was corporate America, in the shape of the Wall Street banks, that was largely to blame for the depth of the recession. It might have helped Mr Obama’s relationship with business if he had gone on less about “shameful bonuses” on Wall Street; but some shame was surely in order.

Even a Republican administration would have been obliged to reform financial regulation, and, though there is a lot to quibble with in the Dodd-Frank act, the administration responded to requests from Wall Street to kill some of the more alarming reform proposals from Democrats in Congress.

Furthermore, the writers of the two articles are divided on what Obama could possibly do to seem more business-friendly; one heartily endorses the idea of tapping a CEO to replace outgoing economic advisor Larry Summers, the other dismisses this as a superficial PR move. It's not surprising that the writers don't know what to recommend; if you don't know the disease, how can you know the cure? In the end, both are forced to the same conclusion: Barack Obama is perceived as being anti-business because he smells like a socialist:

[Obama] has some rhetorical form as an anti-business figure—unlike the previous Democrat in the White House, Bill Clinton, who could comfortably talk the talk of business. Mr Obama’s life story, as depicted in his autobiography and on the campaign, was one of a man once mired in the sinful private sector (at a company subsequently bought by The Economist), who redeemed himself only by becoming a community organiser; his wife had a similar trajectory. There are the endless digs at Wall Street and Big Pharma, not to mention the beating up of BP. He remains a supporter of “card check”, which would dispense with the need for secret ballots in establishing a trade union. His legislative agenda has centred on helping poorer individuals (the health-care bill, part of the stimulus bill) or reining in banks (the financial-reform bill). The only businesses he has rescued are the huge union-dominated General Motors and Chrysler.

and:

[A]s a person with first-hand experience of Mr Obama’s decision-making points out, the “atmospherics really do matter”. The mere perception that the administration is anti-business is “starting to make the bosses of Fortune 500 companies more risk-averse,” says a billionaire who used to run one of America’s leading internet firms...

As for Mr Obama, when he meets businesspeople at fund-raisers and the like, he too often shakes hands and moves on, leaving them feeling he was more interested in a photo-op than a conversation. He caused offence and disbelief a while back by turning up for a meeting with a group of prominent chief executives and then reading to them from a teleprompter.

I think that this story is basically right. Businessmen fear Obama simply because he is not one of them. Obama comes from an academic and nonprofit background, and has in the past been sympathetic to socialist ideas. Even though his actions have been broadly pro-business, his identity is as a guy who comes from sectors whose attitudes are often inimical to industry. The fear among the business class - the "uncertainty" that one article claims is now starting to hurt the real economy - is simply the fear that, at any moment, Obama will revert to his roots and start madly swinging the wrecking ball of socialism through the American private sector.

I personally believe this fear is ungrounded. Obama is an obviously a guy who is inclined to listen to the "experts" on basically everything, and on business issues those "experts" are people who are far more sympathetic to the business class than Obama was in his youth. And I also believe that "uncertainty" over Obama's potential metamorphosis into a socialist Comrade Hyde is far down the list of things holding our economy back.

That said, however, I think it's counterproductive to allow this myth to persist at a time when other types of social strife (think: Tea Party vs. blacks and Hispanics) threatens to strain America to the breaking point. We do NOT need businessmen flooding the racist Tea Partiers with cash simply because they're scared that Obama will go all commie on 'em. And so Obama would do well to make friends with America's business class.

How can this be done? I think the second article has some good ideas about image management. Start dishing up pro-business rhetoric in speeches (and confine anti-business rhetoric to criticism of the finance industry). Have regular candid meetings with business leaders, and take their concerns to heart. Establish regular liaisons between the administration and the business community. Start trumpeting the pro-business nature of policies like export-promotion and research support that are already pro-business in substance.

Also, there are pro-business policies that are pretty obviously good for the country. Our corporate tax needs to be cut from 35% to 20% (with the revenue replaced by personal income tax or value-added tax). Cutting corporate tax is something that a series of Republican presidents has somehow managed to avoid even suggesting, so there's a big opportunity there; and, conveniently, it's something that will help poor people (low-wage workers and consumers) just as much as rich people. This could be a big winner for Obama.

But in the end, whatever happens to the Obama administration, this issue shows that America suffers from a sectoral divide that we should find a way to heal. For too long, many in academia and the nonprofit sector have viewed private business activity as inherently suspect and disreputable; profit is often denigrated and frowned upon. Listening to rhetoric I've heard from some (certainly not all!) academic and nonprofit sector workers, I'm not surprised that U.S. businessmen fear a president who comes from that walk of life. Until we recognize, as a nation, that all of our sectors are important for national prosperity, class warfare of this type will hamstring sensible policy at the highest levels.

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Democrats have many good ideas. Republicans have no ideas whatsoever.

This is a partisan post. Which is not to say I'm writing this because I like Democrats better in general. I just like Democrats better right now, because they have ideas to fight our country's problems. Republicans do not.

Note that this was not always the case. In the Reagan era, Republicans had a lot of ideas, and Democrats largely promised more of the same. Voters seemed to realize this when they made their choice. but Republicans dropped the mantle of the "party of ideas" about a decade ago, and show no signs of picking it back up.

What are the main problems facing our country today? Well, there's the ongoing depression. Republicans' best idea has been to cut unemployment benefits, which reduces structural unemployment slightly but raises cyclical unemployment a lot. We are not in a recession because people have suddenly decided that they don't want to work; people are looking for jobs, and simply not finding ones that match their skills.

Then there's that long-term deficit. A simple breakdown shows that most of that deficit comes as a result of the Bush tax cuts; reversing these cuts would help stabilize our public finances (though in the long run, big cuts in Medicare are needed as well). But Republicans absolutely refuse to rescind those unsustainable tax cuts. Instead, if they are in power, they will probably just threaten to shut down the government unless Obama comes up with ideas for big spending cuts; then, if Obama capitulates (and he is kind of a capitulating sort of dude), the GOP will slam him for the very same spending cuts they forced him to make.

And then there's health care. Republicans have essentially no ideas for how to cut healthcare costs, unless they decided to support Medicare cuts, which they are afraid to do. When pressed, Republicans suggest tort reform and "allowing people to buy health insurance across state lines"; the former is a good idea but a drop in the bucket, and the latter is basically a meaningless red herring.

Financial reform? Republicans recognize the moral hazard problem - the idea that implicit government promises of bailouts encourage banks to take crazy risks - but they have no solution to this other than to have the government say, very sternly, "We won't bail you out the next time!" Which is a laugh, because yes you will, and you know it.

And finally, there's energy. Republicans have nothing on this. "Drill here drill now"? Not a solution, since that oil can and will be sold anywhere. What else? Deafening silence.

Compare this to the Democrats.

On the depression: Democrats are split on additional stimulus spending, but they definitely favor rebuilding our infrastructure, which is important in the short-term (because it adds to demand) and the long-term (because it improves our competitiveness). They favor having the Fed do more quantitative easing (printing money and buying stuff), although legislators cannot tell the Fed what to do. These ideas are good, although the other thing I think we need to do - pressure China to immediately revalue its currency - is unlikely to happen.

On the deficit: Democrats favor rescinding the Bush tax cuts. This is the right thing to do, since those tax cuts were unsustainable. In the short and medium terms that will make a huge difference, but in the long term we'll need to contain health care costs and cut health care spending a lot. This, sadly, is something Democrats are not yet talking about much.

On health care, Democrats finally switched us to a universal coverage nation. That was an important first step - it removed the division of the country into health-care "haves" and "have-nots," which should make future cost-cutting measures more politically possible. It implemented various small cost-control measures, any of which could be ramped up hugely in a few years if it is found to work. This is almost certainly the best health care fix that we could expect in the short term; it remains to be seen if the Dems will come through with serious cost-control ideas in the future.

On financial reform, the Democrats have had a bunch of good ideas, many of which - a resolution authority to reduce the moral hazard problem, a consumer protection agency to reduce lending scams, rules on derivative trading to cut unnecessary complexity from the system - are in the process of being put into law, thanks to Dems and no thanks to the GOP. And on energy, Democrats are correctly investing in alternative energy technology.

Now, I am not saying that I agree with all of the Democrats' ideas. A cap-and-trade system, for example, seems pretty pointless to me (especially since U.S. emissions are falling anyway). And on some issues (China trade, health cost control) they need to go much farther. Nor is having a lot of ideas automatically good; Chairman Mao had a whole little red book full of bad ideas.

But the point is that the Democrats' ideas are mostly good ones. They are a clear improvement over the status quo - ballooning deficits, a collapsing health care system, a bloated unproductive financial sector, vulnerability to peak oil. The Republicans offer no such improvement. They have no ideas whatsoever.

For this reason, stumping for the Democrats in the fall elections is not partisan, and it is not ideological. It is simply patriotic. A vote for a Republican is, at this juncture, a vote for sclerosis and decline.

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