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Ways of the World

Carol Stone, business economist & active Episcopalian, brings you "Ways of the World". Exploring business & consumers & stewardship, we'll discuss everyday issues: kids & finances, gas prices, & some larger issues: what if foreigners start dumping our debt? And so on. We can provide answers & seek out sources for others. We'll talk about current events & perhaps get different perspectives from what the media says. Write to Carol. Let her know what's important to you:

Tuesday, April 20, 2010

Earth Day, Trinity Institute and the Greek Debt Crisis

At Trinity Institute back in January, the theme was "Building an Ethical Economy". As we wrote to you soon afterward, the presentations highlighted people's own behavior and people's own relationships as keys toward bringing about just economic outcomes that promote the well-being of everyone. Both Archbishop of Canterbury Rowan Williams and theologian Kathryn Tanner emphasized these person-centered factors beginning in the household and extending through markets. Also featured at the Trinity event, Professor Sir Partha Dasgupta of Cambridge University spoke about a more institutional issue, the definition and the role of "wealth".

Dasgupta wasn't talking about our financial wealth, although that can be a consideration, as we'll see later in this commentary. Dasgupta's concern is much broader. He's talking about our real wealth: the Earth and how we use it. The professor is a leader in the field we might call the macroeconomics of development: What does the shape of the economy today imply for our welfare tomorrow? Quite specifically, can we describe this for various countries, such as the U.S., China, India, Africa?

Dasgupta's presentation at Trinity[1] and some of his recent writings called my attention to the concept of "sustainability": what are the characteristics of the way an economy operates that enable it to keep moving up along a sustainable path? Is our work today good for the economy tomorrow or are we hurting it? Then, coincidentally, while reading about the implications of the current debt crisis in Greece, I ran into that term again, as in "debt sustainability". How can you assess the longer- run effects of budget deficits and government borrowing today? Might we have been able to expect the current distress in Greece?

"Capital": More than Finances, Also More than Bricks & Mortar
In the case of real wealth, economists usually talk about the nonfinancial wealth of a country as the capital goods it possesses, the buildings and equipment. In the U.S. for instance, the Federal Reserve publishes balance sheets for households and businesses that show their wealth as the sum of financial assets, plus, for households, the value of houses and perhaps vehicles, and for businesses, their office buildings, manufacturing plants and all the machinery. Incidental to these accountings is the value of the real estate they occupy. But clearly a nation has much more real wealth: croplands, pasturelands, sources of water, timber, protected areas and mineral and other "subsoil" resources, which most standard economic analysis ignores. There are other types of capital as well, more subtle forms, such as educational facilities, health facilities, reliable law enforcement and an even-handed court system, honest regulators and so on, which help the economy function smoothly – or hold it back. There's the "dis-capital" of environmental degradation and pollution that need to be accounted for.

The challenge for sustainable development is to achieve a balance in the growth of consumption in a country with the use of all this real and intangible wealth. The condition for development to be sustainable is that the total welfare of the nation should never decrease. That is, suppose factories belch smoke while making their widgets. The widgets might be great, but the accompanying harm to the people and the economy could be long-lasting.

Selling Off Natural Resources . . .
This can have unexpected ramifications. An extensive analysis conducted in 2004 by a group of economists and ecologists indicates that the countries in the world losing the most capital through time are the petroleum exporters in the Middle East.[2] That's because, until 2000, the latest year covered in the analysis, those countries were selling off that natural resource without investing enough of the proceeds in other capital to make up for the loss. Sub-Saharan Africa was the next biggest capital loser, but that had a more obvious cause in poor economic management generally, where both consumption and investment were declining. We've not found later data to know if the situations in either of these locations have subsequently turned around. The biggest capital gainer in the study was China, along with the U.K. The U.S. was in a kind of mid-range, while India and its neighbors all had small but positive capital growth, indicating that their current policies would support continuing growth into the future.

. . . Is OK Only If You Reinvest in More Capital
A good example of the difference capital investment can make comes in a comparison of Namibia with Botswana, which was conducted in 2003 by Glenn-Marie Lange, a natural resource economist.[3] She explains that Namibia, despite its great diamond wealth, has sold off much of that mineral wealth without commensurate reinvestment. There has been some growth in private capital and in other resources, such as fisheries. But this was not any greater than population growth, so wealth per capita was basically stagnant from 1990 through 2000. By contrast, Botswana put much of its diamond proceeds into infrastructure, public education and foreign financial assets. Per capita wealth expanded vigorously there, giving the potential for better performance in later years, which should help cushion the effect of the eventual flattening of diamond revenues.

Government Debt: How To Know If It's Sustainable
How does all of this connect to the presently difficult financial situation in Greece? There's another kind of sustainability, debt sustainability. As we explain, the material by Dasgupta that we've seen doesn't examine financial issues specifically. But it would seem to us that such financial debacles as the U.S. has just been through and continues to struggle with the aftermath of, would have a significant effect on the U.S.'s ability to provide the capital needed to sustain growth in years to come. Dasgupta's work includes a capital productivity factor measuring the degree by which the economy's total output responds to capital, and this factor may encompass the effects of financial market functioning. But that force cannot be glossed over in dealing with these long-run national issues, any more than we can ignore the valuation of water and timber resources, for instance.

Economists at the Inter-American Development Bank, among numerous others, describe conditions for debt sustainability. If a government carries debt and additionally runs an annual budget deficit, the country's economy must be able to generate revenue to satisfy the debt service requirements, that is, to pay the interest on current debt and pay off maturing bonds and loans and also cover the new debt from the added deficit. If it instead has to roll over the old debt and borrow still more even to meet interest expense, the country faces the prospect that its debt will spiral out of control forever. A standard formula for gauging this prospect requires the long-run growth rate of the country's economy to exceed the "real" or inflation-adjusted interest rate on the debt.[4]

Greece's Problems are Multi-Faceted
We conducted some of our own calculations according to this standard formula, which we applied to Germany and to Greece. We found Germany out of bounds during 2009, but it had performed well over the preceding three years or so, and we'd surmise that a continuing economic recovery will lift it back into positive territory. Greece, on the other hand, over the course of the 10-year range of our data, never came close. Its long-term debt service coverage was well below required amounts even if its budget were currently in balance, much less in further deficit. This is an unsustainable debt situation, and we're seeing the ramifications of it play out now in the turmoil in European markets.

Notably, correcting the debt sustainability condition needs some of the same changes to the economy that promote sustainable development. Here are some examples for Greece, cataloged for us by the Organization for Economic Cooperation and Development.[OECD, 5] (a) Greece had juggled its reported budget numbers until last autumn, understating its actual financing needs. So not only did they need more money, they had misled lenders. Along the same lines, press reports last week highlighted graft among officials. This misuse of funds raises risk and also hurts the efficiency of the economy. Another inefficiency comes from the large portion that civil servants make of the Greek work force, with a salary scale generally higher than private sector employees. So an early priority is getting the basic operation of government under better control. This reduces the current budget deficit, a good place to begin. It can also lower the real interest rate by reducing the risk premium the country's debt is subjected to. (b) The Greek labor force is in general much less productive than that in other countries. That could be improved through some deregulation and more flexible work arrangements, the OECD recommends. The social security system is the most generous among the countries of the Euro currency Area, encouraging workers to retire early, just when their years of experience might mean they are the most efficient. Reforms in that arrangement would raise the long-term growth rate. (c)Enhancement of the system of child care and public education is needed. This too would raise productivity growth over the long-run by increasing "human capital".

So on Earth Day this year, Ways of the World looks at efforts that can lead to better use of resources and better environmental outcomes among the world's economies. We find – with a new awareness – that that those same actions also promote long-run financial stability. That's not necessarily what you might think, going in. But it's quite a bonus for carrying on Earth-healthy growth strategies.

[1] Partha Dasgupta. "Natural Wealth (What Is Wealth?)" 40th Trinity Institute National Theological Conference. New York. January 28, 2010. Also see "Measuring Sustainable Development: Theory and Application" Asian Development Review, Vol. 24, No. 1, 2007, pp 1-10.

[2] Kenneth Arrow, Partha Dasgupta, et. al. "Are We Consuming Too Much?" Journal of Economic Perspectives. Vol. 18, No. 3, Summer 2004. Pp. 147-172.

[3] Glenn-Marie Lange, "National Wealth, Natural Capital and Sustainable Development in Namibia". DEA Research and Discussion Paper Number 56. Windhoek, Namibia: Directorate of Environmental Affairs, Ministry of Environment and Tourism, Government of Namibia. February 2003.

[4] Carolos Diaz Alvarado, Alejandro Izquierdo and Ugo Panizza. "Fiscal Sustainability in Emerging Market Countries with an Application to Ecuador". Inter-American Development Bank Research Department Working Paper #511. August 2004.

[5] Organization for Economic Cooperation and Development. "Greece at a Glance: Policies for a Sustainable Recovery" Brochure. March 15, 2010. Accessed April 14, 2010, from .

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