Spanish Roulette - Gambling with OPM

Spain is famous for its lotteries and the devotion of its people for gambling. Therefore, we shouldn´t be surprised if the recent labor reforms ( Essentially deep cuts of social and labor rights) announced by the Spanish government look, more than anything else , as a huge gamble. Yes, a gamble but with a twist : They pay , We win... what is called gambling with Other´s People Money ( “OPM”) or what I would  call " The Spanish Roulette". I will try along the next few paragraphs to explain the lik between gambling and policy 

First of all a few words on Gambling : Gambling does not fit into the traditional definition of a rational economic behavior. Why is that ? The explanation is simple : The chances to win ( a lottery, for example ) are generally too small in comparison to the cost of the ticket. So when facing an unfavorable perspective a "rational" person would prefer not be involved. Some would even claim that gambling is basically an unfair business, but no one would doubt that the “non rational” gamblers are fully aware of the expected losses. Under normal circumstances the bets and the chances to win or loose are transparent and measurable ( for example , the chance to win in a roulette is 1/37).

However, the level of “non rational” behavior can reach new highs. For example when the gambler pays for a lottery ticket without knowing the odds and /or the winning price. I guess that even the most heavy gamblers would avoid such lottery. However there might be one small exception : If the ticket is paid by someone else, while the prize goes into the gambler´s pocket, gambling turns to be the most rational game in town. Playing with OPM ( Other´s People Money) is the most lucrative business.That is the business the Spanish Governemt is developing trough the labor reform.

This OPM gambling game is precisely what the Spanish Government announced : The denominated “Labor Reform” is equivalnet to a "bet" : The reform includes the loss of labor rights such as the lower severance pay, the introduction of an almost arbitrary right to fire, the abolition of collective agreements ( if a company FORESEES lower sales along 9 months..... ) and more. In “Gambling” terms, the cost of the ticket of the national lottery is clear and palpable on particular and collective terms , exclusively on the working class.

Now, any political ( or economic ) decision that involves huge social or economic certain cost should be weighted against future benefits for the Spanish society ( Example : Churchill´s “Blood Sweat and Tears “ was the price, but the reward was Victory) Otherwise, how can we evaluate the Reform? For example, is there any minimal level of unemployment reduction that justifies the reform? What is the timetable to begin to have some positive results? Did the Government elaborate a “Plan B” in case the actual plan does not work ? And so on....

So I looked around to see whether any important politician and / or economist ( BTW most of them supporting the reform) can enlighten our way with clear and measurable objectives. Unfortunately the only thing you can hear from them are pathetically vague slogans such as “ A step in the right direction”, or “The results of the reform will not immediate, it will have a medium term “ or “ The rationalization of the Spanish labor market “ and so on. So the benefits for the huge sacrifices are not so clear , lets say not existing from a practical perspective. An if there are , please show us …..So isn´t it fair to denominate the new gambling scheme “ The Spanish Roulette”?

As a matter of fact such behavior is typical for politicians which always avoid serious commitments to prevent future critics ( if the results are less than expected) and leave room for maneuver. Fair Enough. However, what really surprises is the reaction of the vast majority of my colleagues, the Economists. We are trained to evaluate figures and facts, and in case we deal with uncertain situations ( such as the future) the discipline developed tools ,models and probabilities to assess the benefits of uncertain economic scenarios . Therefore aby automatic support (or disapproval) of a policy measure without clear figures or model is closer to the field of beliefs and religion than to the field of a social ( although inaccurate ) science.

Is the support for vague and not quantified promises the result of a shallow, not critical thinking of my fellow economists ? Or maybe this is not a question of professional competence, but the recognition that the “Spanish Roulette” scheme will be always “rational” as long as the ticket for the lottery is paid by OPM ( especially the working class) ? I will leave these open questions for the reader to answer.

We Are All Marxian Now

As the crisis  goes on, it becomes evident that the European “Fiscal Austerity “ was just the foreplay. The real game ahead is "Competitiveness " ( especially in the Southern  periphery countries).

Fiscal Austerity is an accepted dogma in Europe and its implementation   is already depressing demand (ex. Spain unemployment to 22+%) . “Competiveness” is the private dimension  of a restrictive economic policy with its support for  wage cuts as a prerequisite to restore balance in the Continent (with the obivious implications on consumption and demand). However many economists, including some who dissapprove the Public Austerity policy, support the wage reduction policy as a substitute for "internal devaluation" in order to restore the economic European balance.

Lets see a few quotes

Diverging competitiveness among EU nations: Constraining wages is the key Mickey  Levy , Chief Economist of Bank Of America
“..The policy implications (for Europe EF)  are clear. Realigning real wages with productivity in Greece, Italy, Portugal, and other EU nations is as important, if not more important, than required fiscal austerity. However, this will be easier said than done.” 
(http://www.voxeu.org/index.php?q=node/7536 


Interview with W. Buiter City´s Chief Economist
“ The only thing Spain can do is radical reforms, a more flexible labour market and much lower real labour cost”. These are the clear terms   expressed by Mr Willem Buiter, City`s Chief Economist   about the reality of the Spanish economy, on which he openly speaks about in pessimist terms..."   (Translated from “El Mundo January 29th 2012)   

The message is clear: “Realignment,” “Reform” "Lower labour costs" with the objective to gain Competiveness. This is a serious challenge : we are not dealing with  a proposal  coming from an interested part (such as employers) which can dismissed as a "Class warfare" statement. The proposal carries the seal of professional, neutral  economists  and as such should be analyzed with analytical tools .

First comment : The analytic  focus on labour ALONE is deeply wrong from a 21-century economic perspective ( it is RIGHT from a Marxist perspective... we´ll deal with that later ) .  Past Economists like 19 century D. Ricardo developed the concept that prices (the basis for competitiveness, as in the end you compete with prices and costs) are the sum of   production factors. Back to Econ 101? 

 Labour+ Capital (Earning included) + Land= Cost  

 Therefore those who claim that the Spanish economy (in our case) is not competitive should present a comprehensive analysis of the cost and efficiency of ALL production factors. Otherwise, it is a partial and misleading analysis.

Second Objection :  Even if we maintain the  focus on labour, the actual figures simply do not corroborate the conclusion of our  Economist. Lets have a look on figures taken from the OECD statistic database  (2010)

Item	Unit	Spain	Germany	Ratio (Germany/Spain)
GDP	Million  Euros	1,062,914	2,476,800
Work Force	Thousands	18,890	38,471
Overall Labor  Compensation	Million   Euros	516,799	1,261,380
Ratios
Productivity ( GDP / Workforce)	k Euros	56.3	64.4	1.14
Average Wage (Labor Compensation / Workforce)	k Euros	27.4	32.8	1.20

As can be seen from the table, the German average worker is more productive than his Spanish counterpart by 14%, but he also earns more, app. 20% more. In other words, if comparing the labour component, the Spanish employee can be competitive with the German worker, and she got a 6% edge on  cost level. So how it comes that Germany is considered more competitive than Spain?   

First of all, we should analyze the relations between both the countries and the rest of th world . Second, we just analyzed the labour component in price, so  in order to get a comprehensive picture we must add Capital (and Rent) . The result might be that the Spanish problem is a too high CAPITAL return in comparison to its productivity and not Labor. 

This is the big TABOO nobody wants to deal with , as it is always easier to accuse the working people for being non productive or earning too much (which in our case fits with racist stereotypes…) . 

Least and not last:  The assessment which considers labour as the main cost generator (as the above economist do) , THE real engine behind values, and  as such THE “key to competiveness” is nothing new to the Economic analysis. . As a matter of fact this is an updates version of the “Labour Theory of Value”, the 19^th century idea developed up to its most “pure” level by  …Karl Marx!.

The idea that Labour is the sole value generator of the commodities (including Capital) became under Marx’s   hands a tremendous analytical tool he used to develop a deep social criticism. I doubt that this is the intention of the Wage Cut advocates, but in a certain way they could claim that after decades of ideological debates, WE ARE ALL MARXIAN NOW.    

On Competitiveness and Salaries - A European Note

Most mainstream economists agree that the deteriorating condition of the Euro is the outcome of the differences between the EU countries . The perception the Union as it was formed actually deepened the structural economic “imbalances” between a thrifty “North ” and a profligate “South," while lacking the correspondent policy tools which counterbalance those deficiencies .

The "imbalances" and the proper short run policy response have generated a heated debate among the political and economic circles in Europe. Needless to say that any outcome from the European deliberations will have an impact not only on the Continent but on the global economy. However, there is almost no doubt that for the medium and longer run , the “South” must restore its “competiveness” in order to avoid a second round of economic imbalances. So “Competiveness” is THE core issue to be resolved.

What is competiveness all about? The idea behind the “competiveness” theorem is that the last decade brought about excessive wage increases in the South which eventually caused the loss of a competitive edge vis a vis the North and the rest of the World. The result was the formation of unsustainable massive deficits , private and public as well. . Therefore , as we are told , THE logical solution is to reduce wages and / or improve productivity to avoid these deficits and financial crisis. Is it's so? Are really wages and salaries the real reason for the crisis?

One way to analyze the issue is to compare identical products and see their costs structure and selling prices : A product is sold for a price and the cost is divided between labor and capital and profits ( 50, 50). If Labor cost increases, lets say to 60 , and you want to maintain the 50 profit, the price must increase to 110 . (In that case the RELATIVE weight of labor also increases).

The same logic applies to the national economy: GDP, the “product” of an economy is roughly split between its "costs" i.e. Labor in the form of wages and Capital in the form of interests, amortization and profits . If the labor share increase, it means that in relative terms the worker take a bigger slice of the economy ( and vice versa) .

The following graph which compares two representative countries ( Spain vs. Germany) i.e. the typical “North” and “South” Economies in terms of salaries and labor share speaks for itself

Based on data extracted on 07 Dec 2011 from OECD. Stat ( Annual Income Share real ULC)

The interpretation of the graph is very simple. Any competitive misalignment between the two countries cannot be attributable ONLY to the Labor costs. I will make use of a simple numerical example to illustrate the point: Suppose that in the 80 a German and a Spanish car car were both sold at 10 k Euros. In such case workers got Ap. 7500 Euros ( “labor share”) of it and Capital got the balance, i.e., 2,500 E . If there was no change in the relative prices, in 2007 workers received only Ap. 6,400 Euros and capital 3,600 . Now, if Spanish cars became more expensive and lost competiveness, lets say 11k, part of the blame for the price increase MUST be attributable to Capital as they got for sure more than 3600 ( in our case 3960 E)

In other words, what the figures tell us is that any competitive loss, if there was any such phenomenon of the Spanish economy was necessarily, among other factors the outcome of higher profit rates. Therefore the burden of any alignment process should be bear ALSO by Capital. The calls to reduce salaries in order to restore competitiveness are economically wrong and morally flawed, as Capital enjoyed a 30 years period of a genuine Bonanza.

This graph also tells us something about the importance of adopting a cross borders perspective. If the European working people adopted a pan European perspective, for example by advocating the increase of labor share in each and every country instead of adopting a sort of national perspective, all the working people, including the Germans ( and the rest of economy as well…) could gain from such common stance. But let´s leave that for another blog ….

And Stress for All

Public institutions tend to emphasize the importance of financial stability. It is not just a matter of intentions but a regular use of huge public resources to guarantee the stability of the system. And since the “markets” are considered as the main reflection of the true state of financial business, the stabilization of the financial markets became a top priority of policy makers.

A few examples can show the magnitude of that policy: Ultra light interest policy rates, modified accounting rules to prevent a full disclosure of the real situation of the financial system, purchase of financial assets (“QE2”) above their market prices, design and financing of bailout deals etc. etc. We are told that the reason behind such deep intervention is that the financial markets are the blood stream of the economy as the main transfer mechanism of resources between individuals and companies. As such, they need stability in order to permit their normal functioning and to guarantee that investors willingness to take risks.

As a matter of fact, the stability is just anther good deal for the finance markets since in such mechanism they share the risk with the rest of the citizens but enjoying the benefits of profits.Well, if that privilege was conceded to any citizen I wouldn´t comment about it. However, the way the other production factor “labour”, is being treated in a 180 degrees opposed way to the above stability: Stress.. Stress and more Stress. You can hear about it all over the world: In Wisconsin (US) the administration is engaged in cutting social right and benefits, a measure applauded by “pundits” as the first step to install private sector norms in the public service( i.e. less union and less rights). Or the ECB Chairman ( and who handles Billions of Euros per moths to bankrupt banks) declaring that wage increase in Europe would be “madness”… or Spain´s labour reform aimed to reduce social rights,…. Or UK budget cuts and massive layoffs.

With just a few examples we´ve seen that there is a basic dichotomy in the way Capital and Labour are treated by the institutions, although there is no real apparent reason for that different treatment, at least not from Economic theory point of view. Moreover, a different treatment create distortions that tend to reinforce themselves up to a point that they are not sustainable anymore. What is the reason for the different treatment? Since the the basic foundation of any fair social system is equality, that very important question should be rendered to a second place. If the first step toward justice and equality is “Stress for all”… so be it.