Wednesday, 11 April 2018

Why Russia is politically and militarily strong while being an economic dwarf

Last week I saw a surprising statistic: the GDP of Russia is of the same order of magnitude as the combined GDP of Belgium and the Netherlands. In 2017 Russian GDP was 1,469 billion dollars (according to the International Monetary Fund). Belgium had a GDP of 491 billion dollars and the Netherlands 824 billion dollars; together $ 1,315 billion. In GDP terms, Russia is only 12% larger than Belgium plus the Netherlands.
This perplexing statistic prompted me to ask why politically Russia weighs so much more in the world than Belgium and the Netherlands, while economically that country is hardly stronger than these two countries bordering the North Sea.
Before answering that question, first some other figures that illustrate how an economic lightweight Russia is. US GDP reached USD 19,362 billion in 2017. With GDP as a yardstick, the US is 13 times bigger than Russia. In the same way, other countries can be compared with Russia. China is economically 8 times larger than Russia; Germany 2.5 times more, France 1.8 more, and the European Union as a whole is 12 times bigger than Russia.
The economic size of a country is one of the most important factors that determines its military and political importance in the world. A large economy is needed to provide the means that gives the country military and political weight in the world. So it is clear: Russia is boxing above its economic weight on the international scene.
The fact that Russia means so little economically implies that the country must exert extraordinary efforts to create a strong military potential. In 2017, Russian military spending  amounted to 61 billion dollars (according to the International Institute of Strategic Studies). The US spent nearly 10 times more, namely $ 603 billion. China spent $ 151 billion on defense. France and Germany together spent 90 billion dollars on defense, 50% more than Russia. And yet all these countries spent a much smaller proportion of their GDP on the military than Russia.
Russia is not a major player in the field of military spending. To have a certain military weight, that country must reserve a much larger share of its GDP for defense than the other countries. To mean something militarily, Russia has to put a heavy burden on its own economy.
I come back to my question: why is it that Russia, which economically is a lightweight, has such an importance politically and militarily? Here is an attempt to answer that question.
First there is the fact that, at the time of the Soviet empire, Russia built up a nuclear arsenal that, together with the USA, gives this country a unique position in the world. This is the position of "Mutually Assured Destruction" (MAD). This means that the country has the capacity to completely destroy the opponent in the event of a nuclear attack on its own territory. No other nuclear power (outside the US) has that capacity today. As long as Russia has such a terrible MAD capacity, it will be politically heavier than its GDP suggests.
Russia is also an important supplier of raw materials, including oil and gas. This gives the country a political lever with regard to Western Europe. It is possible by turning the tap (or threatening to do so) to exert pressure on a number of European countries. However, that effect should not be overestimated. Russia also knows that the use of this weapon will in time encourage European countries to find other sources of supply. The power of Russia is limited in this domain because the country does not have a monopoly in oil and gas.
Finally, and that is my most important point, Russia is powerful because Europe grants that power to Russia. Europe has built up an economic union but not a defense union. The European Union is economically 12 times larger than Russia; A huge potential power. However, this economic power is not converted into military and political power because defense has remained a national matter. By merging their military capabilities, it would be possible for France and Germany to build a credible defense against Russian threats, without having to spend more. The combined military spending of such a Franco-German defense union would be 50% higher than Russian military spending. Enough to offer a counterweight to a Russian dictator whose political and military ambitions in Europe remain unknown.

"Si vis pacem, para bellum" said the Romans. If you want peace, you should prepare the war. Translated to the European situation of today this means that Europe should build a credible defense union. This by itself would reduce the military and political power of Russia.

Monday, 18 December 2017

The bitcoin is not the currency of the future

There seems to be no end in sight for the bitcoin bubble. This comes close to the great bubble developments that we have known in history, including the tulip bulb bubble in sixteenth century Holland, the South Sea bubble in the eighteenth century, and many others. These bubbles and today’s bitcoin bubble are always driven by an excessive optimism about the value of some asset and an expectation that the price of that asset will continue to rise in the distant future. But each time these bubbles came to an end and the prices collapsed.
The expectation that the price of bitcoins will continue to rise in the distant future has a lot to do with the belief of many people that the bitcoin, and other "cryptocurrencies", are the money of the future. Nothing could be farther from the truth. In fact, the bitcoin is an archaic currency like gold used to be. Archaic currencies are created by using scarce production factors. Gold had to be digged deep in the ground by using a lot of labor and machinery. Keynes called gold an "barbaric relic".
The same can be said of the bitcoin. Bitcoins are made ("mined" as it is called in the bitcoin terminology by analogy with gold) by using large amounts of computing power. The computers needed to mine bitcoins use a lot of electricity and thus large amounts of scarce energy sources (crude oil, coal nuclear energy, renewable energy sources). According to some estimates, the energy needed to produce bitcoins for one year is equivalent to the energy consumption of a country like Denmark. A phenomenal cost, if we also take into account the external costs, such as the CO2 emissions, associated with the production of electricity.
Although the bitcoin is perceived as the currency of the future, it is in fact, like gold, a currency of the past. The contrast with modern money is striking. Modern money is also called "fiat money" because it is made from nothing. Of course, the production of paper money costs a lot, but we use less and less of it. Instead we use more and more electronic money by making payments with debit and credit cards. Electronic money is produced with minimal use of scarce resources. As the cost of communication continues to decrease, the use of electronic money will become even cheaper in terms of resources needed to produce it. In this sense electronic money, not bitcoin, is the money of the future.
It is possible that technological innovations lead to a further decline in the resource cost of mining bitcoins. But surely, today the handicap of bitcoins in providing a resource-cheap-form of money compares very badly with the existing forms of electronic money that can be produced with small fractions of the cost of bitcoins.
There are, however, other and possibly more serious reasons why bitcoins and other cryptocurrencies have no future as means of payments and units of account, the two essential functions of money. First, as the supply of bitcoins is fixed asymptotically, its generalized use as a means of payment would lead to permanent deflation (negative inflation). The reason is that the world economy is growing and in need of an increasing supply of money to make growing transactions possible. The only way this can be dealt with in a bitcoin economy is by declining bitcoin prices of goods and services, i.e. negative inflation. The quantity theory of money tells us that it could also be dealt with by increasing the velocity with which bitcoins are used, but there is a limit to that possibility. Thus a bitcoin economy would face permanent deflation, not a very attractive situation.
Capitalism is based on entrepreneurs taking risky initiatives. These entrepreneurs are usually of the optimistic type. They expect increasing sales in the future. It is the optimism that drives the dynamics of capitalism. In a bitcoin economy where prices are declining every year this optimism is negatively affected. Price declines lead consumers to postpone their purchases and investors to postpone their projects. It is a world with less optimism and probably less growth.
In order to avoid this problem, cryptocurrencies should provide for a protocol that allows the supply of these currencies to increase in the steady state. A rule à la Friedman where the supply of the currency is subject to a constant yearly growth rate would do the trick. This is not the case of the bitcoin, making this cryptocurrency particularly unfit to function as the money of the future.
There is a second and even more serious reason why the bitcoin is not suitable as a currency. In fact it would be a dangerous currency. If the world turns to bitcoins, banks will start lending bitcoins to households and firms in need of credit. But banking is a risky business. The problem is that as the supply of bitcoins will be fixed, there will be no lender of last (LoLR) support in times of banking crises. And these are certain to occur. Even if the supply of bitcoins or of other cryptocurrencies could be subjected to a constant Friedman growth rule it would not solve this problem.
The LoLR support presupposes that the central banks can create money out of nothing. In a monetary system where the stock of money is fixed (or growing at a constant rate), there is no such LoLR possible. This leads to the prospect of regular banking crises that will lead to failing banks and further negative domino effects on the economy. This is exactly what we observed during the heydays of the gold standard, which was characterized by frequent banking crises leading to deep recessions and much misery. Again, the bitcoin standard, like the gold standard, is something of the past, not of the future.
More generally, the problem of a bitcoin economy is that in times of financial crisis, which one can be sure will arise again, there is a generalized flight into liquidity. That’s when a central bank is needed to provide all the liquidity needed. In its absence, individuals scrambling for liquidity sell assets, leading to asset deflation and insolvency of many. A bitcoin economy does not have this flexibility and therefore will not withstand financial crises. A bitcoin economy will not last in a capitalistic system, which regularly generates financial crises.
Today the bitcoin bubble is sustained by the belief that this cryptocurrency has intrinsic value; a value that derives from the belief that it is the money of the future which in addition will be available in  limited quantities.  When enough people come to the realization that bitcoins and other cryptocurrencies have no future as means of payments, it will be clear that the bitcoin has no intrinsic value, that the “emperor has no clothes”. Then the bitcoin bubble will burst and there will be a lot of handwringing of the speculators who have stepped into the bubble too late.
All this does not mean that the blockchain technology used in cryptocurrencies may not have other important applications. For example, the storage of large data using blockchain technology will make it possible to do so in a decentralized way, opening up a vast array of new applications. The current design of the bitcoin, however, makes it unsuitable as a currency for the future.
The idea that the bitcoin is the currency of the future is very popular with market fundamentalists. These are wildly enthusiastic about the bitcoin because it is created entirely outside the control of central banks. The latter are seen as the source of much evil. The fiat money they create will, according to those fundamentalists, lead to hyperinflation and other disasters.
There is indeed a potential problem with fiat money. Because its production is so cheap, there is the danger that too much of it is produced. That then leads to inflation. However, since the 1990s, many central banks have followed a policy of strict inflation targeting. And that has proved very successful. It has ensured that annual inflation has remained close to 2 percent in the last 30 years in most industrialized countries. In the US, for example, average yearly inflation was 2.35% from 1990 to 2017.
That will not convince the market fundamentalists. They continue to believe that the moment of hyperinflation has yet to come. In addition, for many of them bitcoin has become the symbol of a free market world. A world in which markets unhampered by government controls create great wealth for many. It is also a world in which markets have self-regulating features that prevent financial crises from occurring. Indeed in such a fictional world the bitcoin would provide the anchor of stability. Not in the real world.

Thursday, 19 October 2017

Why Facebook should be taxed and how to do it

The new information technologies have created a whole range of companies that have become extremely profitable. The most successful ones are in the list of the top ten most valuable companies in the world. Valuable here means the monetary value of all outstanding shares of these companies; their capitalization as economists call it.
Alphabet (better known as Google), Amazon, Microsoft, Facebook, Alibaba, are each worth $ 400 billion or more in the stock markets. They produce hardly anything tangible. They "make" information. These information companies are extremely successful. They also give rise to new problems.
The most salient characteristics of information companies is that the marginal cost of the information they produce is zero. To make a YouTube movie you have some fixed costs, such as a camera, a laptop and an Internet connection. But once the video has been made, you can broadcast it without increasing costs. Whether there are 10, 100 or 100,000 viewers of the movie does not change the costs of the movie producer anymore. The marginal cost (the cost of one additional unit viewed by someone) is zero.
That’s not all. The more viewers the moviemaker reaches, the more valuable his YouTube movie becomes. If he/she reaches an audience of, say, 1 million viewers, advertisers will be interested and will be willing to pay the creator of the video for placing ads. The more viewers there are, the more the advertiser is willing to pay. The YouTube producer thus produces something that has a marginal cost equal to zero and a marginal revenue that increases with the number of viewers. The more people reached with the movie, the richer the moviemaker gets without having to do something special.
Such a business model creates a number of problems. The first one is that information companies create a lot of economic value without the use of many production factors. You hardly need employees to generate a lot of income. Facebook with a capitalization of $ 400 billion employs 21,000 people. Walmart, which has a capitalization of 220 billion, has 2.1 million employees. Thus Facebook that is almost twice as large in terms of capitalization than Walmart counts only one percent of the number of employees of the latter. This means that a very high level of economic value is distributed to very few people. An inequality time bomb.
A second problem has to do with the fact that the people who join such an information platform (for example Facebook) actually give away information about themselves for free. This information becomes more valuable as more people join the platform. The big data on private information makes it possible to place highly targeted ads. The dream of all advertisers.
So companies like Facebook produce information that generates a lot of revenue using as ”raw material” the private information that they acquire for free from their users. They are great money machines generating huge wealth that hardly has to be shared and can be kept by the happy few in these companies.
Such a situation is untenable. More and more economic value is distributed to less and less people. What can be done about this? Here is my proposal. Facebook realized $ 26 billion in advertising revenue in 2016. This revenue was actually made possible thanks to the free "raw material" of the information provided by Facebook users. The government could apply a tax of 50%, for example, assuming that at least half of that income is due to the free information. That means 13 billion dollars. There are now about 1.23 billion Facebook users. So that means (rounded) $ 10 per user and per year. That seems to me to be a good estimate of the yearly value of the information provided by the individual user to Facebook.
So my proposal becomes: a 10-dollar tax per user to be paid by Facebook. Zuckerberg will be a little less rich after this tax, but will still have a lot of money left.
There are many issues with such a proposal. It should preferably (but not necessarily) be coordinated internationally. Not an easy thing. There is also the issue of what the government should do with the revenue. One possibility would be to return 10 dollars to the Facebook users every year. Alternatively, the government could use the revenue to invest in education, the environment or sustainable energy.

I think these are separate issues that can be resolved and that do not stand in the way to tax Facebook and other information companies (e.g. Google, Amazon) that use private information freely and transform this into a fabulous money machine that benefits only a few. 

Wednesday, 4 October 2017

Catalonia and Brexit: the same nationalism

The British Prime Minister, David Cameron, will not enter the history books as an enlightened leader. However, when in 2014 he had to decide to allow the Scottish referendum, he used his brain and opened the door for the referendum. It took place on September 18, 2014. Only 45% of the Scotts voted for independence.
The contrast with the referendum in Catalonia could not be greater. The Spanish Prime Minister Rajoy stupidly decided to use violence to prevent a referendum in Catalonia, despite the fact that a peaceful referendum would most probably have led to a similar outcome as in Scotland. Spain and Catalonia are now on collision course; a situation that could have been avoided if the Spanish Prime Minister had not suffered from dogmatism and a degree of nationalism equaling in intensity the Catalan version.
The Catalan nationalists now have been given a fantastic boost thanks to Rajoy's stupidity. The TV images of Spanish robotic police officers hitting old and young to prevent them from voting create a perception of an oppressed people fighting for their freedom.
Nothing could be further from reality. The Catalans are not an oppressed people. They have a high degree of autonomy. They can organize their own education in their own language. No obstacles exist for the cultural development of Catalonia. It is the most prosperous region of Spain. Barcelona is a bustling city like no other in Spain. The Catalans are heard at the regional, national and European level. The image of an oppressed people is ludicrous.
Catalan nationalism is of the same kind as British nationalism that led to Brexit. It is based on a number of myths.
The first myth is that there is an external enemy. For the Brexiteers these are the European authorities (the European Commission, the European Court, etc.), which impose their arbitrary will on Britain. For the Catalan nationalists the enemy is the Spanish government oppressing the Catalan people.
The second myth is that the people who fight for their independence have a clearly defined identity. The task of national politicians is to listen to the will of the people. There can be only one voice. There is no room for different and opposing voices. The British government is now calling for patriotism. The opponents of Brexit are not true patriots.
The third myth is that independence will generate unsuspected economic prosperity. When the people “take back control” they will have the tools to achieve maximum economic prosperity. That is today the argument of Brexiteers like Boris Johnson. When Brexit will be realized (preferably as soon as possible), Britain will have achieved its true destiny. "Global Britain" will take over from the protectionist EU. Great Britain will merrily conclude free trade agreements with the rest of the world, which will lead to unprecedented prosperity. A similar argument of more prosperity for an independent Catalonia is heard from Catalan nationalists today.
The reality is that globalization undermines national sovereignty. This happens in many ways. One example. Large multinationals blackmail national governments in Europe, with the result that corporate taxes decline almost everywhere. In no country, however, is there a will of the people in favour of reducing these taxes. Yet this is the outcome because governments act as national entities. Were they to decide jointly on corporate taxes in Europe, multinationals would be unable to blackmail these governments and there would be no creeping decline in corporate taxes.
Another example. International trade today is not influenced so much by tariffs but by non-tariff barriers. Large countries decide about standards and the regulatory environment that will govern trade. There are now essentially three countries, the US, the EU and China that can aspire to decide about the nature of these standards and rules. The other countries play no role in this game. Thus when Great Britain exits from the EU so as to gain more sovereignty (“to take back control”), this gain is only formal. In fact its real sovereignty declines. Obviously the same holds for Catalonia.
We arrive at the following paradox in a globalized world: when nationalists pursue more formal sovereignty they achieve less real sovereignty of the people. They want to take back control and they end up with less control. That’s what Great Britain will end up with. That’s also what the Catalan nationalists will achieve if they pursue their nationalistic dreams.
This paradox has a corollary: when countries in Europe renounce formal sovereignty this leads to more real sovereignty of the peoples of Europe. 

Tuesday, 28 March 2017

Brexit creates window of opportunities for the EU

The British government has officially started the "divorce" procedure from the European Union. This procedure must be completed within two years. In April 2019 the UK will cease to be a member of the EU.
Most divorces are painful affairs mainly because an agreement has to be found on who pays whom. The same will be true for the divorce of Great Britain and the European Union. The European Union intends to present a stiff bill to the British Government. According to some estimates this could go up to 60 billion euros. The hard line in the Conservative government of Theresa May does not want to pay a cent. These are the people who during the referendum campaign promised that Brexit would create massive budgetary means to be used to save the National Health Service from bankruptcy.
Between 0 and 60 billion there are many numbers waiting for a possible compromise. But the latter will be very difficult because the hard camp in the British government considers each number above 0 as an act of treason to the British people.
The Brexit Ministers continue to repeat that a new trade agreement between the UK and the EU is easy stuff and can be completed in two years, at least if the Europeans are "reasonable". If they are, they will see that it is in their own interest to meet British demands. If they don’t it will be proof of their vindictiveness.
The British demands are derived from the very successful referendum slogan: "to take back control of our borders, our laws and our money." This means full control over immigration; the end of the jurisdiction of the European Court of Justice on British soil; and not a penny more for Europe. The prime minister has made it clear that the first two demands cannot be negotiated away. About the third one a compromise is possible but no one knows how much negotiating space the British prime minister has.
These UK demands imply that the UK excludes itself from the internal market. The UK government, as the representative of a fully sovereign nation, will therefore have to negotiate a new trade agreement. And like any trade agreement this will drag on for years. As a result, one can say with great certainty that in April 2019 there will be no trade agreement between the UK and the EU.
What is striking in this drama is that under the spell of nationalism the British government has based its policies on a big illusion. It is the illusion that, as in the past when Britain ruled the waves, it can be fully sovereign and freely trade with the rest of the world without having to accept rules that are decided elsewhere. This was possible when Britain was the master of the world and decided about the rules that the other nations would have to accept to trade. Today, however, Britain is a small country. Its GDP is only 15% of the EU’s GDP. If this small country wants to trade with the European Union it will have to accept the rules that are decided on the European continent, not in Britain. If it wants to trade with the rest of the world, it will also have to accept rules drawn up elsewhere. It will be a painful awakening for the British who have been misled by their government into believing that they can have free trade and full sovereignty.
For the EU Brexit creates a window of opportunities. When the British joined the European Community in 1974 their intention was not to make Europe stronger. On the contrary, the British strategy was to weaken the European integration effort from inside. Since their accession the British governments have opposed attempts to apply majority rule in the union, and instead have tried to force an inter-governmental approach where each country maintains a veto power. The British entered the European house not to strengthen it, but to halt its further construction and even to deconstruct it.
The fact that Britain now leaves the house creates new possibilities to take steps towards further integration. In the tax field, for example. This is an area where,  at the insistence of Britain (but not only Britain), veto power of national governments has been maintained. As a result, multinational companies have exploited the lack of coordination in setting corporate income taxes to blackmail individual governments. This has led to a race to the bottom where major multinationals pay almost no taxes, although they profit from public goods provided by European governments. This problem can only be solved by jointly deciding about corporate income taxes. This will not be easy, as there are other countries that benefit from not having a common approach to taxation (Ireland, Luxembourg). But at least the major obstacle to a common policy will have been removed.
Thus the decision by the UK government to leave the European house should be welcomed by EU-member states instead of being deplored. It creates a window of opportunities for further integration on the European continent. This window of opportunities, however, can only be exploited if the EU makes her negotiating position clear. This should be one in which the EU recognizes that the UK wants to be fully sovereign. The EU therefore should make it clear that this makes UK access to the internal market impossible. This is not a choice of the EU but the logical consequence of the UK’s quest for full sovereignty.
Business lobbies both in the UK and the EU will push for a different outcome. One in which the UK will be allowed to enjoy exceptions to the rules governing the internal market while maintaining access to it. The EU should resist these lobbying efforts. Failing to do so will open the door for other nations to do similar “cherry-picking”. This would undermine the integrity of the union and would contribute to its disintegration.