Andrew Scott: Economic decisions are made by politicians

Posted: July 3, 2012 by jennroig in English, Interviews
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Andrew Scott is currently a Non-executive Board Member of the British Financial Services Authority (FSA). He is also Deputy Dean at London Business School (LBS), and a Fellow of the Centre for Economic Policy Research and Scientific Chair of the Euro Area Business Cycle Network.

For whoever holds any interest on news about the global economy and finances, the Euro crisis has turned into a difficult thread to follow, mostly due to the complexity of the economic and political relationships between member States, and the fact that every new day brings a new twist to the drama.

Meanwhile, stallment of economic growth in countries like China or India are another source of stress. Considering the significance of both topics, in order to better understand the interests at stake, and to which possible scenarios all this set of circumstances could lead, Andrew Scott accepted to explain his opinions and predictions about the European crisis and the expected Chinese mortgage crisis. He exmphazised on how these two events could affect on developing economies.

Many agree on the idea that the European crisis is fiscal on the surface but essentially political. How do you see it and what could the possible outcomes be?

There’s a referendum in Ireland going on to decide whether or not the country will remain in the eurozone. The elections in Greece have also added a lot of tension to the discussion of whether or not the austerity measures will finally be applied there and if Greece will be kicked out. Within this scenario, it all depends on how it all plays out, no one really knows what’s going to happen with the European crisis. It all depends a lot on the politics. The economics of it is quite straight forward.

I think there are four possible outcomes. One is they managed to go through and everything stays as it is, which I think it’s unlikely. One is they verge to the disaster in the long run and completely breaks up, then again that’s very unlikely. One is you get Greece and possibly other countries but definitely Greece to leave, others that stay in get a much tighter Euro system, much more fiscal control and fisical union. The other option is that actually Greece, Ireland , Portugal and Spain will be forced to leave, and it’s left with a much narrower number of countries, the core Euro countries, who by and large are similar and will strengthen the fiscal union and fisical union and carry on. That’s the much more likely outcome.

If we talk about Greece, I think it will leave quite soon, and Spain is getting into significant problems. It really depends on how these things will play out. There’s a way in which Greece can leave, in a peaceful way for Greece. I think the big worry it’s Spain, it has a very bad growth. It’s in the worse fiscal position, it struggles to fund what it’s a large banking system. If Spain gets stuck with a major crisis, that has very important ramifications. Very important repercusions to the euro area because it’ll make the growth in the euro area very weak. It could lead to a very nasty recession.

Spain will put a lot of strains on global banking systems. The Spanish banks have significant presence globally. They are significant in the UK, they are significant in Latin America. So what will happen to Spanish banks will have global repercusions as well.

For sure things could go very bad in Europe. Its problems are that it could find itself unable to fund its banks, to fund its deficits. In that situation Spain has a major crisis, the major banking crisis. The European GDP will be very adverse. Then in South America would be funding pressures.

So, would those countries with the strongest connections to the Spanish government and economy suffer as well?

Latin America, out of actually all the regions in the world, is currently in the best place to do well in the next few years, but also the one with the major exposure to Spanish banking. That exposure could be handled brilliantly by Spanish banking system because Latin America has been very profitable. I think if it was not for that exposure in Latin America, the Spanish banks could be in a worse situation. But the worry is always that when the mother bank in Spain has a problem, they could take that funding to replace the gap there.

From your perspective, what measures could relieve and finally resolve Europe’s situation?

In terms of the Euro crisis, the economics of this crisis is pretty straight forward. The questions is what politicians want to do about it.

We can solve the euro crisis by getting rid of Greece, we can solve it by issuing Euro bonds, and recapitalizing the European banking systems, at the European level. The question is: would the Spanish want that to happen? And would the Germans want to pay for it?

I think the problem is the disconnection between governments and the banking sector, because the banks are not governments property, but governments need to bailout the banks. But you cannot cut out the banks problems and the governments’ debt problems. I think what we are seeing here at the moment it’s the Spanish banks, the Greek banks, the Cipriot banks are not able to borrow money, and the privates are pulling money out and they are putting money into the German banks, or the UK banks, and this is causing a huge amount of stress within the euro area. But I think there might be some change in the European politics, a move toward the idea that there won’t be more Spanish banks but European banks. And therefore we might have a European regulator and a European capitalization of the banks.

You are seeing the ECB beginning to push this agenda. I think Merkel must realize that austerity on its own is not going to work, that perhaps austerity combined with banking default might be better. I still think is not good enough but I think that’s possibly the next step they might take.

Of course, no one even considers the possibility of Germany pulling out of the Euro. However, it looks like it was Germany against the rest of the world, in terms of this Eurozone crisis and the austerity measures. Why is Germany pulling so hard to enforce its agenda, and what would give up leaving the Euro? Why is that idea so impossible?

I think there’s Germany and a handful of other countries who could exist together quite comfortably, without having to worry about a fiscal union because they are all competitive for the kind of exchange rate, and they wouldn’t need to borrow money. It’s Germany, the Benelux countries, Austria, they would be part of the small group of countries that could survive with Germany. The problem is that there’s also a small group of countries that really need Germany to bankroll Western Europe, and that’s why you may think it’s Germany against everybody else.

But the fact is that Germany is actually doing quite well. It’s doing better now that it was before the crisis. That’s because of a couple of things. One is China, it is doing quite well, but also the euro is kind of too low for Deutsch markets, so German exports are quite competitive at the moment.

And whether Germany could leave the euro, it would have two substancial problems. The first it’s for Germany to leave the Euro, it would have to introduce the Deutsch Mark and the Deutsch Mark will rise very sharply, it would rise by 20%, 30% and that would have a strong knock out effect on German exports. Second it is that German banks lended lots of money in Euros, and when they introduce the Deutsch Mark it which will rise a 20% or 30%, that debt would grow in Deutsch Marks. So the German banking system would be in trouble. So it’s not easy for the Germans to leave, which is one reason why they’ve been prepared to put money in, I think at the end of the day the Germans are unlikely to pull out on their own, but they might be quite aggresive by trying to make some countries to leave.

At the Asia Pacific Summit 2011, you stated that a real estate crisis could explode in China on the long run. Why do you see that coming? 

It has happened already. Chinese real estates appliances are falling, they are not as high as they used to. There’s a lot of money that flows into America. And when America couldn’t back up the economy, then prices got higher, such as the prices of oil, gold, also German capital bonds are becoming very high. So the fact is that there is a lot of money looking for a home, and wherever that money goes, it creates a small bubble.

The one place it went to previouslym it was China’s real estate. I think the Chinese were also very keen to allow it, there were no worries about whether European and America’s economies could slowdown. But it did, so their exports would slow so they had to switch from exports to domestic demands.

So China wants to get domestic demand increases. They would like to have the Chinese consumer spending more, but it’s very hard to suddenly get the Chinese consumer to spend more. That’s a long term plan. They need to get wages to rise, get consumers to borrow more. So in the short term what the Chinese can do it’s to get the local governments and the banking sector all of which is under state control to basically finance what the real estate is doing. So you see a lot of money going into real estate. But now they need to stop doing that. I think in the long term the Chinese market can take that, but what we saw was too much built too soon. One of the ironies was, in response to America having its real estate crisis, China started one of its own.

There’s a difference though between China and America. The first is that in America the mortgage market is huge, and very closely connected with the banking system, and the banking system had the biggest effect on the economy. In China, the mortgage market is still small, the banks are still quite small, and there’s no much pressure put on the economy. I think although China can have a lot of problems with the real estate, it has not the kind of chain effect as America’s banks had on the global economy.

How would that crisis affect the price of the commodities?

A crisis in China would affect emerging economies, in the sense that it could affect the price of commodities.

I think that’s one reason you see commodities falling during the last months. Europe and America are huge for commodities, but China is the number one or number two receptor of commodities. And because of the slowdown in China, and India, and the other emerging markets, I think everyone thought the West would do good, but emerging markets would do better, and because of that you see a lot of that hot money flowing into commodities, and now you see that hot money to flow out because they see China’s slowdown as player. You still see growth in China, and a reasonable growth in India, but not as strong as it was before. And that’s why commodities’ prices fall and they may well fall further.

With commodity prices falling, how would that affect on Latin American countries which heavily rely on commodity exports, such as Brazil or Chile?

Of course, if the rest of the world slows down, it will have an impact on Latin America, but I think the good thing about Brazil or Chile is that while commodities prices were high, they were growing very fast, and they put some of that money aside, which I think it’s good. And then in past times, Latin America had borrowed a lot of money from the rest of the world, and when commodities prices fall that’s a big problem for them. But this time it’s different, because Latin America haven’t been really doing that much borrowing so the financial situation seems sounder.

I’m sure you’ll find, with commodity prices falling, some banks to face problems and experiencing tension but I think most people are expecting Latin America withstand quite well the slowdown. In fact most people think it will be one of the best parts of the world in economy.

Is there any chance, any possible scenario where this decline in the Chinese growth could make companies to leave China and take other destinations or returning to Europe and the US? Will China be less competitive in terms of outsourcing labor? And then, could commodities take a different destination other than China?

That’s already happening, we’ve been seeing Shanghai and Beijing getting very expensive.

You also see China trying to attract higher value added firms, like those performing in technology, and in that are doing very well, I think. At least a part of China is moving up the value chain. But as for the Western part of China became the home of a lot of outsourcing, but there has been two kinds of shifts outsourcing companies are taking. One is going to cheaper countries, like Vietnam or Bangladesh, while others go further West inside China.

The other thing you’re seeing is as they try to move up in the value chain, it gets more expenses. Then some manufacturing go back to the US and even Europe. China will get quality rights eventually, it’s up to the value chain. That’s how you see a small resurgence in manufactures in the US. It’s not reversing the change that has happened in the last 10 years, but it’s the first time you see something like a revival in the US manufacture.

How much influential are those professionals, like yourself, who perform a double role in academia and governmental institutions? How much can they weight over politics in terms of the decision making process?

You can look at it in terms of individuals, and in terms of the profession. There are very few individuals who can actually change things, who can influence on things. I think, as economists, the best we can do is tryingto stop politicians from doing bad things economically while doing good politically. If not, at least trying to minimize the cost economically. There are certain things that can do good economically and politically, and that’s doing good politics. But the politician at the end of the day has the big influence.

I think if you look at the profession, thinking over the premise that ideas drive action, all men of action are very much under the influence of some idea. That’s true, ideas do drive actions and I think as a profession, we can post ideas that capture the moods. The problem is that often the idea that captures people’s imaginations are the simple ones, and the politicians pick up on them, and they reward some economists for saying them, but not really leading to a vigorous debate.

The example of Inside Job shows how a lot of economists were writing works researching the financial sector, and were also getting paid by the financial sector. I think it’s the good call from that film. Within the academic community there have been strong and vigorous debate about whether the central banks are doing the right thing. But at the end of the day, the men and women of action, they don’t want to listen the academic debate, they just want to listen to simple views that confirm their politics or what they would like to do.

It’s an exaggeration to say that economists could safe the world. I think the politicians and policy makers tend to reward the economists they want to listen to. And then as a profession, economists are not very good at taking the debate into the mainstream and trying to make people understand that debate. We are very poor communicators, we tend to prefer to argue among ourselves. And to produce a fora on economics I think it is that way. We don’t do a good job by going out and telling people “this is what we know, this is what we don’t know, this is what we disagree”. And by not doing that, we give policy makers and the financial sector the opportunity to take certain people and say, “this is true because some say this is true”.

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