European anti-crisis strategy: Sex, drugs, alcohol could boost economic growth

The euro sculpture is seen outside the headquarters of the European Central Bank (ECB) in Frankfurt, Germany. European governments are slowly turning to drugs, sex and contraband as a way to boost their respective economies. — Reuters pic

European governments are turning their attention to prostitution, drugs and contraband as possible ways of boosting their economic growth profiles, as they struggle away from their debt crises, AFP reports. 

Sex and drugs to add to Europe's murky GDP figures

Italy caused a stir when it announced last month that it would begin including revenues from drug trafficking and the sex trade, as well as contraband tobacco and alcohol, to calculate gross domestic product (GDP) from next year.

One effect would be to reduce the public deficit as a ratio of output, if EU authorities were to accept the idea. That would be a big help to countries trying to get their public deficits below the EU ceiling of 3.0 percent of output.

In 2012, Italy's central bank estimated the value of the criminal economy at 10.9 percent of GDP. Including these figures could therefore boost the country's growth to above the government's 1.3 percent estimate.

Last month, Britain said including illegal activities such as prostitution and drugs into national accounts would add about 10 billion pounds (12.3 billion euros, $16.8 billion) to GDP, equivalent to about one percent of national output.

Using the undeclared or so-called black economy to calculate national statistics is part of a range of changes recommended by the European Union's statistical institute, Eurostat, to be implemented in September.

Eurostat said including such data would allow a better comparison between countries with different laws.

"GDP is not an indicator of morality," said a spokesman, adding that only transactions carried out consensually would be included.

But others are less convinced.

Eric Vernier, researcher at the Institute of International Relations, said including "gross criminal product" in growth figures is a cynical attempt to combat the Eurozone's debt crisis.

"The problem is to put this new statistical method on the table at the moment when everyone has budget problems," he said.

"There has been a general acceptance of this accounting approach since the crisis: what matters most is what goes into the state coffers."

"Denial of basic morality"

Many of Europe's struggling governments will welcome any boost to growth figures that will reassure both disillusioned voters and markets.

But the decision has sparked outrage among politicians and rights groups.

The French minister for women's rights Najat Vallaud-Belkacem and Belgium's Interior Minister Joelle Milquet, have both written to the European Commission to express their "astonishment" over the proposals.

"Prostitution is not a voluntary commercial activity. To believe that it can have an ideological bias is a mirage and an insult to the millions of victims of sexual exploitation worldwide", they said.

"Prostitution cannot be assumed to be a transaction freely agreed between parties. The question also arises concerning drugs, especially hard drugs, considering the issue of addiction," added Ronan Mahieu, head of INSEE, which calculates France's GDP.

A spokeswoman for the Association for the Protection of Women's Rights in Britain said the group was "surprised and saddened" by the decision.

While in France, Marine Le Pen, the leader of the extreme-right National Front party which came top in recent European Parliament elections, described it as a "denial of basic morality."

'Shadow market'

Europe's black market is already huge, according to experts.

Friedrich Schneider, professor at the Johannes Kepler University of Linz in Austria, estimates that the European Union's "shadow market" is equal to 18.6 percent of the bloc's 2014 GDP.

But calculating the value of illegal activities is no easy task.

An EU document from 2012, littered with acronyms and complex mathematical formulas, gives guidelines on how to calculate the "inputs" of the prostitution industry, such as the cost of renting an apartment, or "transport and storage" for drug traffickers.

It even includes how to interpret the "ratio of purity" in narcotics.

Schneider argues that undeclared illegal activities and "value creating" services such as prostitution should be included in the calculations, but not totally criminal activities.

On this basis, Germany, Italy and France account for about half of Europe's black-market activities.

In recession-hit Greece, he estimates that black market transactions account for an estimated 23 percent of GDP, lower than the estimated 40 percent of the less-developed economies of Eastern Europe, but far higher than the roughly eight percent in Luxembourg. - AFP

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Will the lessons be learnt from the financial crisis in Cyprus?

This time, it is Cyprus’ turn to face a bitter financial crisis as bank depositors get hit and capital controls are imposed. 

Demonstrators in Athens. The roots of the eurozone crisis lie in its unwillingness to uphold fiscal discipline. Photograph: Louisa Gouliamaki/AFP/Getty Images

THE financial crisis in Cyprus has again shown that over-dependence on the financial sector and an unregulated and liberalised financial system can cause havoc to an economy.

The particular manner in which a financial crisis manifests itself may be different from country to country, depending on the ways the country became financially over-reliant or over-liberalised, and also on how ever-changing external conditions affect the country.

For the past two weeks, Cyprus hit the headlines because of the rapid twists and turns of its crisis, the terms of the bailout it negotiated with its European and IMF creditors, the hit that bank depositors are forced to take, and finally the “capital controls” that the government has imposed to prevent bank runs and capital flight out of the country.

Depositors with more than 100,000 (RM396,000) could lose more than half their savings.

Bank customers can only withdraw 300 (RM1,189) daily; cashing of cheques is prohibited; transfers of funds to accounts held abroad or in other credit institutions are prohibited; transfers due to trade transactions above 5,000 (RM19,832) a day require central bank permission; the use of credit cards overseas is restricted to 5,000 (RM19,832) per account a month; and travellers can only take out 1,000 (RM3,960) or equivalent in foreign currency per trip.

These capital controls, announced on March 28, were highlighted in the media as the first to be imposed by a country belonging to the European Union.

It was like the slaying of a “sacred cow”, because the freedom to move funds out of and into the European countries had been treated almost like a human right.

But it is this total freedom for the flow of funds that has contributed or even been ultimately responsible for so many financial crises in so many countries in the past few decades.

This liberalised system of capital flows enables residents to place their funds abroad or to purchase foreign assets like bonds and shares.

It also enables foreigners to bring in funds either for short-term speculation and investment or longer-term investment and savings.

After the Second World War, capital controls were the rule: flows of funds to and from abroad were mainly restricted to activities linked to the real economy of trade, direct investments and travel.

From the mid-1970s, the liberalisation of capital flows took place in the rich economies and gradually spread to many developing countries.

The finance ministers of Brazil and of other developing countries have been protesting against the easy-money policies in rich countries that have had adverse effects on emerging economies.

When the internal or external situation changes and investor perception changes with it, the inflow of funds turns into its opposite.

The sudden outflow of funds, and depreciation of the currency, can then cause an even more devastating effect on the economy.

In the 1997-99 crisis, East Asian countries that had over-liberalised their financial system found that local banks and companies had borrowed heavily in US dollars.

When their currencies depreciated, many of the borrowers could not service their loans.

The countries’ foreign reserves dropped to danger levels, forcing them to go to the IMF for bailout loans.

Malaysia fortunately had some control over the amount local companies could borrow from abroad, which prevented it from falling into an external debt crisis.

The imposition of capital controls over outflows in September 1998 enabled Malaysia to avoid a financial crisis requiring an IMF bailout.

The immediate response from the IMF and the Western establishment was that the capital controls would destroy the Malaysian economy.

Today, the economic orthodoxy has changed, and most analysts including at the IMF give credit to Malaysia for the capital controls.

The Malaysian controls included a temporary ban on foreigners transferring their ringgit denominated funds (for example in the stock market) abroad, a limit to the funds local travellers could take out of the country, and limits to overseas investments by local companies and individuals.

Today, the IMF itself has changed its position, saying that capital controls in certain situations are not only legitimate but may also be necessary.

It has partially recognised that unregulated capital flows can cause financial instability and economic damage.

In the case of Cyprus, analysts now conclude that its growth model was flawed because it was too reliant on a bloated financial sector, having become a haven for foreign savers, especially from Russia.

But a major factor in its recent crisis was that the country’s biggest banks invested in Greek government bonds.

In October 2011, a bailout package was arranged for Greece by the European Union and the IMF.

Part of the bailout terms was that holders of Greek government bonds would take a “haircut” or loss of about 50%.

This Greek debt restructuring meant a loss of 4bil (RM15.9bil) for banks in Cyprus, a huge amount in a country whose GNP is only 18bil (RM71.4bil).

Now, it is Cyprus’ turn to be reconfigured and re-created as part of a 10bil (RM39.7bil) bailout scheme. The two biggest banks, Bank of Cyprus and Laiki Bank are to be drastically restructured, with the latter to be closed.

The biggest innovation designed by the European Union and IMF creditors is that the bank depositors will have to take losses. Deposits less than 100,000 (RM396,000) are to be spared, after an original plan to also “tax” them by 6.75% was cancelled after a huge outcry and the fear of contagion, with bank runs in many European countries.

The final plan is for deposits over 100,000 (RM396,000) in the two banks to take losses not by the originally planned 9.9% but by much more.

The new European policy of getting bank depositors to take a big hit in bailouts of banks will have big ramifications for public confidence in banks.

The new perception is that money put as savings in banks is no longer safe.

The question remains: will the policymakers learn the real lessons from these crises?

GLOBALTRENDS BY MARTIN KHOR 

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Financial crises a result of governance failures

Financial crises a result of governance failures

ROMAN emperor Julius Caesar was famously warned by a seer about the Ides of March, traditionally March 15.

On March 15 this year, banks in Cyprus were closed to allow politicians time to decide how to raise 5.8 billion euros so that the country could qualify for 10 billion euros in bailout funds from the rest of eurozone and the International Monetary Fund (IMF). The solution suggested was to levy a tax on depositors, sparking a realisation that finally, the Europeans had decided to “bail-in” investors and depositors, rather than using public funds to “bail-out” everyone else.

The Cyprus crisis caused a stir in global financial markets, because it punctured expectations that the worst was over. Instead, it demonstrated another episode of muddling through.

Banks in Cyprus re-opened on Thursday with new capital controls on the amount depositors can take out. Larger depositors with over 100,000 euros would stand to lose up to 40% of their deposits. Of course, a significant portion of the deposits in Cyprus banks belong to Russians, who may suffer losses of 4 billion to 6 billion euros. For certain investors, this is the price of putting money in higher risk offshore financial centres. The price to Cyprus of operating as an offshore financial centre is likely to be a drop of GDP of more than 20% in the next couple of years.

The Cyprus outcome is not unexpected. If European governments are to be loaded with heavy debt burdens as a result of the crisis, they will be bound to start “taxing” offshore financial centres, where rich Europeans had been avoiding tax for years. If the eurozone banking union is to have any credibility, they will have to start controlling banking centres which operate largely on tax and regulatory arbitrage. Moreover, having banking assets seven to eight times GDP is no longer considered viable, whether for Cyprus or Iceland.

At the heart of such troubles lies the issue of governance. Financial crises are more governance failures than anything else.

Last week, The End of History philosopher and political scientist Francis Fukuyama published an important blog commentary on “What is governance?” This is the much-awaited part of his promised series on political governance, beginning with his 2011 book The Origins of Political Order. In that book, he looked at the three components of a modern political order a strong and capable state, the rule of law and accountability of the state to its citizens. Since the 2011 book stopped at the French Revolution, most readers would be curious to see how he handled the rise of China, which has a different political system from the West.

Fukuyama's new definition of governance is “a government's ability to make and enforce rules, and to deliver services, regardless of whether that government is democratic or not.” Notice that he has decided to remove any suggestion that democracy is automatically associated with good governance, appreciating that “an authoritarian regime can be well governed, just as a democracy can be mal-administered.”

Accordingly, he uses four approaches to evaluating the quality of governance: procedural measures, input measures, output measures and measures of bureaucratic autonomy. To put it into simple language governance should be measured according to how you govern (the processes); the efficiency of governance (how much tax or resources you need); the effectiveness (outcomes rather than objectives) and whether the bureaucracy is independent of politics or not (the autonomy question).

In dissecting governance into its different dimensions, Fukuyama has helped to clarify the methodology in thinking about the tradeoffs between the ability to have high discretion versus being bogged down by excessive rules, and high capacity to execute, versus low capacity to execute. Critics of that approach would argue that strong states with excessive discretion may not be sustainable. On the other hand, weak states with too many rules and no discretion may not be sustainable either.

Fukuyama is right to point out that the bureaucracy's interests may not be identical to those of the people. The bureaucracy is supposed to be agent of the people (the principal), but many bureaucracies serve their own interests, rather than the public to the extent that civil servants may be neither civil nor servants.

Indeed, the simplistic view that the state is deterministic versus the view of free market self-order misses the fundamental point that large bureaucracies also have self-order. Anyone familiar with working in large complex bureaucracies in China, India or the United States, with many layers of government, would recognise that it is not easy to implement policies from the centre. State or provincial governments have a mind of their own, with very different priorities from that of the centre.

Indeed, in the 21st century, many cities have become more effective instruments of state, and it is not surprising that effective mayors have become national leaders because they show a capacity to deliver close to the people.

The more interesting question about governance is: why are collective action traps so pervasive? In other words, it is understandable why ineffective and weak bureaucracies or political systems are unable to overcome gridlock in their systems, but it is common to see highly effective and capable bureaucracies also caught in gridlock.

These gridlocks are apparent in the resolution of the euro crisis, the stalemate in the Doha World Trade Organisation negotiations and the Durban climate change debates. In the first week of April, the Institute for New Economic Thinking, the Centre for International Governance Innovation and the Fung Global Institute will be hosting a major conference in Hong Kong on how creative and innovative thinking can open up new avenues of thinking on the solutions to global governance. As a respected member of the global economic community, Hong Kong should make its voice heard.

You can watch most of the podcasts on www.ineteconomics.org or www.fginstitute.org.

THINK ASIAN By ANDREW SHENG

Tan Sri Andrew Sheng is president of the Fung Global Institute. 

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