Minding Your Alphas and Betas

Martin Khor has an interesting post over at Triple Crisis that speculates on the secret negotiations over a draft Trans-Pacific Partnership Agreement.  He sees grounds for worry that a chapter on state-owned enterprises (SOE’s) will include a requirement that they pursue a commercial rate of return, based on existing Australian guidelines.

The trade lawyers would do well to absorb a bit of economic theory.  Private firms whose sole objective is profit maximization—firms that adhere to the “shareholder” model—will of course do just that, at least if they can avoid being commandeered by insiders.  But there is another model out there, the “stakeholder” model, in which firms are expected to serve a variety of interests, including not only investors but also workers, consumers, suppliers and affected communities.  SOE’s are nearly everywhere run on something like a stakeholder model.

To do its good deeds, a stakeholder firm has to stay in business.  Logically, its maximand should be the likelihood of being profitable over some time horizon.  That’s different from the shareholder maximand of profitability itself.  Given a risk-return tradeoff, SOE’s should generate lower average profit rates than firms run for the benefit of shareholders.  Lower beta, lower alpha.

Or it could be that the negotiators want to use the TPPA as a weapon against the stakeholder approach altogether in favor of a world of frictionless investment opportunities, in which case their ignorance is strategic.

PIESTEIN!

In his Essay Concerning Human Understanding, John Locke affirmed, "I do not question but that human knowledge, under the present circumstances of our beings and constitutions, may be carried much farther than it hitherto has been, if men would sincerely, and with freedom of mind, employ all that industry and labour of thought, in improving the means of discovering truth, which they do for the colouring or support of falsehood, to maintain a system, interest, or party, they are once engaged in."

In Takings: Private Property and the Power of Eminent Domain, Richard Epstein, henceforth Professor Piestein, gave the quintessential demonstration of how to employ "all that industry and labour of thought... for the colouring or support of falsehood." In his "philosophical preliminary" chapter, "A Tale of Two Pies" Professor Piestein purported to illustrate, with a drawing of two pies, a Lockean perspective on "how natural rights over labor and property can be preserved in form and enhanced in value by the exercise of political power."

Here is what Professor Piestein's pies looked like. Sandwichman coloured them in to make them prettier:

And here is what Professor Piestein wrote about his pies:

The larger pie indicates the gains that are possible from political organization. The outer ring represents the total social gains, while the dotted lines indicate the proportion of the gain received by each individual member. The implicit normative limit upon the use of political power is that it should preserve the relative entitlements among the members of the group, both in the formation of the social order and in its ongoing operation. All government action must he justified as moving a society from the smaller to the larger pie.

A couple of questions go unasked and, of course, unanswered by Professor Piestein. Why should we assume that the unequal endowments are the consequence of natural rights rather than a backward projection of the inequalities imposed in political society by its rulers? Second, even if the unequal endowments had been present in nature, why should that make the more fortunate individuals entitled to a proportionately larger share of the social gains, since they are, after all, social gains? In The Natural and Artificial Rights of Property Contrasted (1832), Thomas Hodgskin wrote:

Laws being made by others than the labourer, and being always intended to preserve the power of those who make them, their great and chief aim for many ages, was, and still is, to enable those who are not labourers to appropriate wealth to themselves. In other words, the great object of law and of government has been and is, to establish and protect a violation of that natural right of property they are described in theory as being intended to guarantee.

What would Locke say? I'll not waste your time with a pile of extraneous exegesis and superfluous hermeneutics. Number VIII of Locke's Essays on the Law of Nature was titled, "Is Every Man's Own Interest the Basis of the Law of Nature? No." Number VIII was the source for several of the arguments in Chapter Five, "Of Property," in Locke's Second Treatise on Civil Government.

What part of the word "no" did Professor Piestein not understand?

Review of Behavioral Economics (ROBE) Website Goes Live

Amazingly enough, today on my 65th birthday, the website of the new journal that I am Editor-in-Chief of, the Review of Behavioral Economics (ROBE), has gone live.  So, we are open for business at http://www.nowpublishers.com/journals/Review%20of%20Behavioral%Economics/Preprint .

"Of Property" and the Mercantilist Fallacy

"Though the earth, and all inferior creatures, be common to all men, yet every man has a property in his own person: this no body has any right to but himself. The labour of his body, and the work of his hands, we may say, are properly his. Whatsoever then he removes out of the state that nature hath provided, and left it in, he hath mixed his labour with, and joined to it something that is his own, and thereby makes it his property."

The above is the core of what is commonly referred to as John Locke's "labour theory of property." It is a extraordinarily compelling narrative, resplendent with "self-evident truth" ("We hold these truths to be self evident...) and nearly indiscernible ambiguity (what does "labour" mean? what's "mixing" got to do with it?).

It is widely acknowledged by Locke scholars that his economic views were essentially mercantilist. Keynes suggested that Locke stood with "one foot in the mercantilist world and one foot in the classical world." However that may be, chapter five of Locke's Second Treatise on Civil Government, "Of Property", is relentlessly, incorrigibly, two-footedly mercantilist. And nobody seems to have noticed (except possibly John R. Commons [correction: C.B. MacPherson stressed Locke's mercantilism in chapter 5]).

Why would this even matter?

Greg Mankiw Blasts Another Obama Tax Proposal

I guess we should be used to this:

President Obama's budget is going to include some kind of penalty for people who have accumulated more than $3 million in retirement accounts. The details are not yet known, but I think we know enough to say that this is a terrible idea. A sizable body of work in public finance suggests that consumption taxes are preferable to income taxes. Completely replacing our tax system with a better one is, however, hard. Retirement accounts, such as IRAs and 401k plans, are one way our tax code has gradually evolved from an income tax toward a consumption tax. The use of these accounts should be encouraged, not discouraged. By the way, exceeding $3 million in such accounts is not very difficult for an individual who is financially successful and frugal.

Greg explains by noting some folks can readily put away $50,000 a year. The median worker, however, cannot. But there may be something else afoot here as Brian Beutler explains:

One way experts believe financial managers avoid the current annual contribution limit to IRAs is by using IRAs to participate in investments and assigning those investment interests a nominal value vastly below fair market.

Brian cites as an example some clever tax planning done by a chap named Mitt Romney.

Factor Price Equalization – Outsourcing to China or Mexico?

Twenty years ago, one of the arguments for NAFTA was that free trade would boost the demand for Mexican workers hopefully increasing their real wages. Ten years we opened our markets to Chinese produced goods. Over the last decade, a lot of the demand for Mexican workers shifted towards Chinese workers. Pan Kwan Yuk reports on an interesting analysis by Carlos Capistran, an economist at Bank of America Merrill Lynch:

Not only are average hourly manufacturing wages in Mexico now lower than those in China in constant dollar terms, they are 20 per cent less.

Capistran produced a chart of Chinese and Mexican hourly wages in US$. Back in 2003, Mexican wages were around $2 an hour and are now around $2.50 an hour. Chinese wages ten years ago were around $0.60 an hour and are now almost $3 an hour. The story continues:

But is this necessarily a good thing for Mexico? True, stagnant salaries over the past decade have been credited with reviving Mexico’s manufacturing sector, which was hard hit by China’s entry on to the world stage following membership into the World Trade Organisation in 2001. A study by Barclays last year reckoned that the rise of China as the “world’s factory floor” chipped about 60 basis points off Mexico’s gross-domestic-product growth every year between 2002 and 2006. Some of the biggest casualties in Mexico’s manufacturing sector were textiles, clothing and shoes. And now thanks to soaring wages in China, high transportation costs and the steady recovery seen in the US economy, the tide is turning back in Mexico’s favour ... Optimism over Mexico’s growth prospects has made the country a darling among international investors … By contrast, in Mexico, wage stagnation, under-employment and inflation have eroded the income level of some 31m Mexicans ... as many as 60m people are living below the poverty line. This in a nation of 113m.

We should forgive the Mexican workers for not being overjoyed at this news. Maybe they have gained their competitive advantage but only because wages in Mexico remain very low. Then again – one should have expected the benefits from free trade over the past decade to accrue to two parties – the multinationals hiring low cost foreign workers and Chinese workers with Mexican workers not faring so well from freer trade.

President Obama Breaks His Promise On Social Security

Which was that he would not cut any of its benefits, a promise made during the 2008 campaign and now broken with his proposed budget that will replace using CPI-W for the COLA with the chained CPI-W, the former estimated by many to rise about 0.3% more per year than the latter.  However, nobody should be surprised that he has done so as he has been signaling a willingness to do so for some time now at least since the 2011 budget negotiations with Congressional Reptards over the debt ceiling increase (and, yes, he should declare the debt ceiling unconstitutional and dispense with that bloody thing).  I am not going to comment on the politics of this move, although plenty of people argue that it is not a winner in any way shape or form.

As it is, I weirdly take this sort of personally.  Back during the 2008 campaign, Bruce Webb and I wrote a memo to the Obama campaign at a time when he was supporting some sort of "Social Security Reform," arguing that such was not needed, and he made his promise not to do anything at all to or about SS shortly after our memo was sent, although I suspect that it was broader political forces that were responsible for his change of mind then rather than our memo.  However, I took the promise to heart and am now sad to see it definitely broken (although see more below).  There are many economic arguments for why this new proposal is a bad idea.

The obvious one that has been discussed by many is that it is highly likely to reduce the growth of SS benefits for seniors in an era when arguably they should be increased more due to the collapse of defined benefit private pension plans.  See http://krugman.blogs.nytimes.com/2013/05/desperately-seeking-serious-approval and http://www.theatlantic.com/politics/archive/2013/04/memo-to-president-obama-expand-social-security-dont-cut-it/274728 .  This latter by Steven Hill goes on to propose a major increase in benefits in a two-tier system, funded by raising the income cap and closing certain high income tax loopholes, not a bad proposal.

The other is the point that over a long period of time it appears that the cost of living for seniors has been rising more rapidly than the overall cost of living, so that the experimental CPI-E for elderly should be used after getting it into proper shape.  This higher rate of elderly cost of living increase has been largely due to the greater use of medical care by the elderly, which has risen more rapidly than the general rate of inflation for a long time, and has been 0.2% greater per year between 1982 and 2011 than the CPI-W.  Among those making this point previously have been Dean Baker http://www.cepr.net/index.php/blogs/cepr-blog/thoughts-on-the-chained-cpi-social-security-and-the-budget , Bruce Webb at his own blog http://socialsecuritydefender.blogspot.com , and me http://econospeak.globspot.com/2012/12/retiring-on-price-index-chain-gang , a matter that is getting more personal as I officially become a senior citizen this coming Friday.

I note that Will Wilkinson argues that between 2006 and 2012, the CPI-E actually rose by 0.1% less than the COI-W or CPI-U, although I think his argument that this reflects a deceleration of medical care cost increases does not explain it.  He supports going to a chained CPI-E index, http://www.economist.com/blogs/democracyinamerica/2013/04/barack-obama-budget .  In any case, if the main source of difference between the measures is medical care costs, this is all the more reason to get the rate of medical care cost increases under control and in line with the other sectors of the economy.

Having mentioned my old friend Bruce Webb's blog, I cannot avoid noting his discussion of "Rosser's Equation."  This is simply the empirical observation that after a supposed "bankruptcy" of the system, as much of the media likes to call it, that is projected to happen in the 2030s if nothing is done, recipients would actually be better off in real terms than are current ones although they would experience a cut from what they had been receiving at that point, with me estimating this in 2005 at 120% better, although more recently Dean Baker has it at 125%.  In any case, I must credit Dean with noting this before I did, although it has always been in the Social Security Trust Fund reports for anybody to see who looked closely enough, Anyway, I think I made more noise about it than did Dean then, although I would be fine with it being called the "Baker-Rosser Equation," :-).

All of this reminds me that in 2005 the three of us through the old MaxSpeak that preceded this blog fought long and loud and hard against Bush's campaign to partially privatize Social Security.  Although I cannot say for sure, I think that we were partly responsible for bringing the lack of a need to do anything to or about Social Security to the attention of more widely read bloggers such as Paul Krugman and Mark Thoma, who brought this argument to a wider public, with Bush's campaign failing pathetically. However, this time the threat looks more serious, coming as it does from a Dem president.  The public does not want this, and it is not needed for budgetary reasons in a world of rapidly falling deficits and still stagnating employment growth, but we need to move again to make our voices heard on what a bad idea this is all around.  Obama should go back to keeping the promise he made in his 2008 campaign.

Barkley Rosser

David Stockman and Dark Matter

Paul Krugman has more on the rant by David Stockman:

Well, the $8 trillion number is right. But while it may be EIGHT TRILLION DOLLARS, that’s a cumulative deficit (which began in the 80s, by the way, not the 70s) of only half of this year’s GDP. And if you know anything about the subject, you know that America’s debtor position isn’t actually that deep, because of capital gains (which aren’t counted in the current account) ... But OK, market valuations are one thing, what about income flows? Aren’t we now paying a lot in interest to foreigners? Ahem. Here’s US net international investment income — income from US assets abroad minus income payments on foreign assets in the US — as a percentage of GDP

Yes – massive current account deficit started with that ill advised fiscal irresponsibility when David Stockman served as OMB director. But give Stockman a break as Robert Samuelson thought it started in 1964. As far as our net international investment income, it has been positive despite the fact that we have more foreign liabilities than foreign assets. Which got me thinking – what’s the latest on Dark Matter:

That is, the US is still borrowing from the rest of the world, but at a reduced pace. The value of the US' net foreign assets has been volatile as markets and currencies have gyrated over the past several years, but the official data says the US is even more in debt to the rest of the world now ... Repeating Hausmann and Sturzenegger's calculation today says that (as of the end of 2011) the US was a net creditor by $4540 billion. Relative to the official net international investment position of $4030 billion, that implies a stock of "dark matter" of $8570 billion! … The worry, circa 2005, was that buyers of US debt would run for the exit, leading to a spike in US interest rates and a collapse in the dollar. The crisis we actually got had the opposite effect, as everyone rushed into US debt, which has helped drive yields down. The US' net income is boosted by the fact that its paying very low returns on all those Treasuries being held abroad these days. In Hausmann and Sturzenegger's framework, the financial crisis has been a huge boon to US exports of (unmeasured) liquidity and insurance services.

But something tells me that David Stockman has no clue what this Dark Matter discussion was about.

The Clown Says, "Italy Should Not Be In A Rush To Have A Government"

And Beppe Grillo, the (former) clown, may be right.  Indeed, as of yesterday, Luigi Bersani of the Democratic Party who has been trying to form a government in Italy, gave up.  He has refused to make a grand coalition with Silvio Berlusconi's party, and his efforts to attract support from Grillo's 5 Star Movement have failed.  As a result, while there is a parliament, there is no government.  President Napolitano has appointed a group of 10 Wise Men to work for 10 days to come up with proposals to change how elections are run, five politicians and five bureaucrats.  None are from Grillo's 5 Star Movement, which came in second in the Senate election, which has led to Grillo's statement contained in the subject head of this post.  For more details see http://www.euronews.com/2013/04/02/10-wise-men-try-to-get-italy-s-politics-moving .

While the rise of Grillo and his "Grillismo" and even "Grillonomics" has led many to essentially freak out that this is the end of Western Civilization As We Know It, or at least of any hope for reasonable or sensible government in Italy, with these fears exacerbated in light of the financial crisis in Cyprus and the potential threat to the European and world economies, these fears may well be overblown.  While there has been much reporting of increasing spreads between Italian and German bonds, in fact the movement has been minor, with these well below crisis levels.  In Autumn 2011, 10-year Italian bonds hit 7%, viewed by many as the crisis point, but the latest report has them only at 4.63%, compared with 5.02% in Spain, 6.58% in Portugal, and 12.25% in Greece.  Grillo has made many provocative statements, including in 2007 instituting Veffanculo (Fuck you) Days, or "V-days," but it is far from clear that his actual economic ideas are all that outrageous, even if he refuses to back Bersani or a new government at this time.

Indeed, the 5 stars of the movement's name (it is not a "party"), represents the five planks from its economic platform: public water, sustainable transport, development, connectivity, and environmentalism.  Clearly these are somewhat vague, but they have taken more concrete form in writings and documents coming from Grillo's top economic adviser, Mauro Gallegati of the Polytechnic University in Ancona.  Gallegati is the co-founder with Alan Kirman of the Workshop on Heterogeneous Interacting Agents (WEHIA) and a coauthor of several papers with Joseph Stiglitz and Bruce Greenwald, which has led to reports that Stiglitz would be advising Grillo, although this does not appear to be the case.  Nevertheless, Gallegati has led a group to advise the newly elected Grillini to the Italian parliament on economic policy, and has more specifically advocated taxing the rich, emphasizing happiness over standard economic growth, with a focus on developing culture and tourism as keys to non-corrupt and sustainable Italian economic growth, along with a focus on encouraging green technologies.

What is somewhat unclear is the group's view on the most pressing macroeconomic issues facing Italy.  Grillo like Berlusconi ran at least partly opposing externally imposed austerity coming from Germany in particular.  More than Berlusconi, Grillo also seems to support a departure by Italy from the euro, although this does not seem to have been the central issue in his refusal to support a government led by Bersani.  Of course many observers think that indeed the euro is bad for the periphery and doomed in some longer run, although I have forecast that the euro will probably muddle through.  Nevertheless, the most likely locus of a move to really end the euro is Italy, and the Grillini may be the key to this, even if none of their number are among Napolitano's Wise Men.

(I should note that I have coauthored with Gallegati and consider him a friend, although I have not discussed in any depth his views on all this other than to make jokes about his role in the movement.  He is a big wise cracker who has been known to preface professional presentations with anti-Berlusconi jokes.)

I note trhat critics of Grillo argue that he is overly nationalistic and that there is a lack of internal democracy within his movement, although its candidates for office have been selected by online voting and must have certain educational and "cleanliness" credentials.  Nevertheless, some Grilli critics have been expelled from the movement by him.

In any case, Italy is leading us into interesting times, one of those old Chinese curses, and the Grillini may end up playing a decisive role in how these events transpire.

Barkley Rosser

Doesn’t Liz Cheney Know That Reagan Supported the Brady Bill?

Liz Cheney wrote another rant, which has been ably critiqued by Jonathan Chait, Aaron Carroll, and Paul Krugman. Much of their takedowns relate to Cheney’s batshit insane comments about ObamaCare but let’s also look at this:

The president has launched a war on Americans' Second Amendment rights.

Really? Because he wants to restore what Sarah Brady pushed for – effective background checks? That makes Barack Obama “the most radical man ever to occupy the Oval Office”? Did Ms. Cheney forget about how even Ronald Reagan supported the Brady Bill? Who knew the patron saint of conservatives was such a radical!

Mankiw’s Mistakes on the Long-Run Debt Issue

Greg Mankiw wants to lecture the President on fiscal sustainability. Alas, his op-ed is full of errors starting with:

Representative Paul D. Ryan, chairman of the House Budget Committee, has a plan to balance the federal budget in 10 years.

Should we just fall out of our chairs laughing at such an incredibly absurd statement? Ryan wants to cut tax rates but assume a level of tax revenues that is over $500 billion a year above what many analysts suggest. And I have a plan to replace Tim Duncan as the center for the Spurs even though I’m only 5 feet 6 inches. And then we get these canards:

With the exception of a few years starting in the late 1990s, when the Internet bubble fueled an economic boom, goosed tax revenue and made President Clinton look like a miracle worker, the federal government has run a budget deficit consistently for the last 40 years.

Internet bubble? Mankiw really seems to hate that the Clinton years, which started with the 1993 tax rates increases, had better economic performance that either the Reagan-Bush41 years or the Bush43 years. As far as the deficit being positive for all these other years, he should read what both Milton Friedman and Robert Barro were writing on the deficit back in 1979 and 1980 – that being that the debt in inflation adjusted terms was falling. Hey – I don’t mind a conservative economists lecturing the President on fiscal policy if he gets the facts right. This op-ed, however, fails to get a few key facts right.

Trade Prospects for Cyprus

The question of what would happen if Cyprus were to leave the euro with a sharply devalued national currency has been much debated in recent days.  Krugman and others arguing for it note that nations outside the euro such as Iceland recovered better from banking crises after a year or two lag than those tied to broader currencies.  Argentina may have had a GDP decline of 10% the year it unhooked from the dollar with a massive devaluation, but grew well after that.  For Cyprus to gain from a devaluation, although it looks likely Cyrpus will stick with the euro, its exports would need to surge.

As it is, Cyprus is a very open economy.  Of its 24 billion euro GDP, nearly 40% is exports.  Important sectors in this are refined petroleum products, agriculture, particularly citrus fruits and potatoes, semin-conductors, pharmaceuticals, and some textile products.  However, Cyprus has traditionally run a trade deficit in most years.  Greece has been by far the leading destination of exports as well as supplier of imports.  Egypt and Germany are second and third as export destinations, with China and Israel second and third for import suppliers.

While it is not part of the trade account, important to the current account is tourism, which is about 10% of GDP and is the largest single sector of the Cypriot economy.  Certainly a surge of tourism would be necessary to prop up the economy in the case of a devaluation.  Russians, British, Germans, and Swedes are the top tourists, although Russians might be less inclined to come after being hit for uninsured deposits in Cyrpriot banks.

Further down the road is the prospect of natural gas production and exports.  There are mixed accounts of how much natural gas there is, but it may be as much as $400 billion worth.  However, there are several caveats.  One is that this is not likely to get into production prior to about 2020.  Another is that there are disputes over who owns portions of the large gas field of the Eastern Mediterranean, with this getting tangled up in international politics.

In particular, the matter of relations with Turkey are very important.  Part of the problem is the ongoing split of Cyprus, with Turkish-dominated northern Cyprus claiming a portion of the fields.  But there is also the matter of markets for the gas, particularly with rising production in the US.  The obvious market is Turkey itself.  That Turkey and Israel have recently made up does not help Cyprus in this either.

Indeed, there is a not-so subtle view that part of why the Eurozone leaders are being so hard on Cyprus has been in fact that Greek-dominated Cyprus is viewed as the holdout on resolving the long-running division of Cyprus that many in Europe would like to see resolved.  It may well be, that whatever Cyprus does about the euro, it will need to make peace with Turkey and the northern part of itself if it wishes to fully develop and sell its natural gas down the road.  Maybe peace in a part of the Eastern Mediterranean may well yet be one outcome of this financial crisis that has hit Cyprus so hard.

Barkley Rosser

The Washington Post Does Not Understand Effective Tax Rates

Darla Cameron and Jia Lynn Yang want to report on how US multinationals are shifting profits to foreign tax havens but their key statistic is the ratio of US tax expenses to worldwide profits:

A Washington Post analysis of data compiled by Capital IQ found that in the late 1960s and early 1970s, companies in the current Dow 30 routinely cited U.S. federal tax expenses that were up to half of their worldwide profits. Now, most are reporting less than half that amount. The reason? The slow but steady transformation of the American multinational after years of globalization. Companies now enjoy an unprecedented ability to move their capital around the world, and the corporate tax code has not kept up with the changes. Across industries, virtually every major U.S. firm has seen the rate of its tax contributions plummet, at least according to publicly available financial statements.

Let’s consider two very different situations. Company A has mostly US activities but has shifted its intangible assets to a Cayman affiliate. If half of its profits are attributable to intangible assets, then not only has its US tax expenses dropped below 20%, its effective tax rate is also below 20%. Company B does not create much in the way of intangible profits but has half of its activity in high tax Europe. Its effective tax rate – calculated as worldwide tax obligations relative to worldwide income – is still high even though its US taxes are likely less than 20% of worldwide profits. Company A is involved with the kind of transfer pricing manipulation that the press should be complaining about. Company B is not. But this statistic cannot distinguish between the two very different situations.

Why Won't Cyprus Obey Krugman?

Longtime euro-critic, Paul Krugman tells Cyprus, "Leave the euro.  Now." http://krugman.blogs.nytimes.com/2013/03/26/cyprus-seriously .  He recognizes that it will probably not do so, but reasonably invoking the deep recession of neighboring Greece, he argues that they should leave before they end up like Greece.  The question then arises, why are they not likely to do so, and for that matter, why has not Greece done so?

A lot of it of course is some sort of desire to "belong to Europe" and all that, which strongly influences both Greece and Cyprus, and continues to attract such possible joiners as Poland, which Krugman accurately notes did better than any other nation in Europe while not being in the euro during the Great Recession.  Sweden also did well staying out, atlhough the UK is not such a great example.  But, I think that there may be an economic fear that while probably overblown is not totally irrational.  It is the fear of a possible major collapse in living standards from the likely massive devaluation that would arise if they were to get out (which as Krugman also notes, would not be all that easy to do).

The fact is that Cyprus is a very open economy, with imports running about 1/3 of GDP.  A very major drop in the value of a new Cypriot currency would sharply increase the cost of living for Cypriots, and while the unemployment rate would certainly rise a lot, the entire citizenry would experience the potentially sharp decline in the standard of living.  While this devaluation might make it easier for Cyprus to recover several years down the road, that recovery would indeed be several years down the road, and in the meantime there would be a lot of pain for the entire citizenry that will not happen if they stay with the euro.

The poster boy for this fear might be Argentina in 2001.  The inflation rate went from actually negative just before the unpegging from the dollar to as high as 44% in 2002.  The value of the peso fell to about 1/4 of what it was before, and while imports were only 22% of GDP, there was a massive short-term decline in living standards, with many middle class people at least temporarily thrown into poverty.  That Cyprus would be moving off a long-in-place peg in a crisis environment suggests that it could experience a devaluation as bad as Argentina's or even worse.

OTOH, there is Iceland, a fave of Krugman's.  Now they were floating, so not delinking from a longstanding peg.  But in some ways they were arguably more vulnerable than Argentina or Cyprus, with imports running at 40-50% of GDP.  After the 2008-09 financial collapse and banking crisis there, with many similarities to the Cyprus situation, their currency fell by more than half against both the dollar and the euro, but not by nearly as much as the Argentine peso fell.  Inflation spiked from only around 2% to over 12% for two years in a row.  They also had a recession, with the unemployment rate doubling, although that does not look all that much worse than what has happened in quite a few other European countries, and certainly not as bad as in Greece.  But then, just as Argentina recovered after several years, so has Iceland's situation improved noticeably, although not all the way back to where it was before the crash.

Curiously, the more likely countries to see voters support an exit from the euro might well be some of the larger ones whose exit would be far more damaging to the euro itself (although some might disagree with that and say "good riddance").  The obvious case is Italy, where a majority of voters just supported candidates who at least criticized austerity policies imposed from outside, even if not necessarily supporting an exit from the euro (Grillo does, but Berlusconi has not so far).  But such countries would probably not be hit as hard as Cyprus or Iceland or even Argentina for the simple reason that imports are smaller compared to GDP than in those smaller economies.  A large devaluation, and it might not be as large anyway, would not impact the immediate cost of living as severely as happened in either Argentina or Iceland, or probably what would happen in either Greece or Cyprus.

Barkley Rosser

The Reason for Higher Education

Let me turn the microphone over to Adam Smith:


"A knowledge of science and philosophy is the great antidote to the poison of enthusiasm and superstition."