Monday 28 September 2015

Independent Catalonia: the Spanish flag and Barça's greatness

Plebiscitary regional elections were held yesterday, 27th of September, in Catalonia. The coalition "Junts pel Sí" won (note: "Junts pel Si" comprises parties across the whole political spectrum solely united by their desire of Catalonian independence). And combined with the left-wing CUP party, also pro-independence (and anti-system), they have a majority of seats in the regional parliament. However, the combined votes of the pro-independence parties fell short of a majority of popular votes (48%). Where does this leave us? In a grey zone. What will happen next is not clear. Except that negotiations between the Spanish government and the new Catalan regional government will have to take place at some point to accommodate Catalonia's growing discontentment with the current status quo. Possibly something along the lines of a new-Spanish-constitution-creating-a-federal-state-followed-by-a-referendum-in-Catalonia-to-decide-on-be-part-of-a-federal-Spain-vs.-independence?

Whatever the next steps in the Catalan saga will be, it is time to ask the question: why do so many in Catalonia want to be part of an independent country? There are basically three reasons:

1. The "independence dividend". The pro-independence movement calculates that Catalonia pays EUR 16bn (c. 8% of Catalonian's GDP) more in taxes to the central government than it receives in benefits. We could discuss at length the appropriateness of the methodology used for the calculation (e.g. monetary flows vs. tax contribution-benefit method). However, we don't need to go that far to see what is at stake (for those who want to go into detail: CAT fiscal transfers).

The pro-independence movement assumes in its calculations that the Spanish government would have to continue to pay the pensions of Catalans, who paid their national insurance contributions into the Spanish social security system over the years, following independence. While 100% of the Catalan citizens' national insurance contributions post-independence would flow to the new Catalan government. The argument is that there is a "pension contract" between each individual taxpayer and the Spanish government that the latter has to honour. It is an apparently sound and compelling argument. And then it is not. It is disingenuous and wrong.

Spain's pension system (like basically all others in Europe) operates on a pay-as-you-go basis. Not on a funded basis. This means that pensions paid to current pensioners are financed from contributions paid by current workers. It is an inter-generational contract supervised by the state. The older generations pay healthcare and education for the younger ones while they are growing up, and once the latter enter the workforce they start paying the pensions of the former who retire.

In such a system, if the pensioners move to a new country after retirement (Germans, Swedes who decide to move to Spain after retirement or Spaniards who worked in Germany or Sweden and after retirement decide to move to Spain) the inter-generational contract remains intact. The pensioners will have reached an age where they will not make any additional (roughly speaking) contributions into the social security system anyway. No matter where they decide to spend their lives. And the younger generations remain in the country that pays the pensions. Working, paying their social contributions and keeping the pay-as-you-go system running.

Things change if a significant part of the entire population, young and old, working age citizens and pensioners, decide that the region where they live should become and independent country. In that case both the younger and older generations "move" to a new country. The younger generations of the "new" country will have to pay the pensions of the "new" country. Even because the shrunken number of young people in the "old" country, from which the "new" split off, will not be able to pay the pensions of both "old' and "new" country pensioners (the inter-generational contract would effectively be broken). So, the inter-generational contract remains in place but supervised by the newly created independent state and binding young and old generations of the "new" country.

Once you take this into account, the numbers change dramatically. Pensions paid in Catalonia amount to Eur 19bn per year. With the "new" independent Catalonia state having to pay for them the "independence dividend" turns into an annual "independence burden" of Eur 3bn.

The "independence dividend" is not the reason to become independent.


2. The construction of a new model state - the Sweden of Southern Europe

Spain has weak political end economic institutions. The judiciary is not fully independent. Neither is the press. Corruption abounds. Being part of Spain holds Catalonia, a more dynamic and entrepreneurial society, back. So the pro-independence argument goes.

Right.

Have there been notably less (proportionally to population size) corruption cases in Catalonia than in the rest of Spain in the last 10 years? 20 years? Is the Catalonian press less captured by corporate and political interests limiting its freedom of reporting and opinion? Are smaller countries, by design, less corrupt than larger ones? Is the former long-serving (23 years) president of the regional government (Jordi Puyol) not under investigation for money laundry and corruption? Has any president of the Spanish government (current or former) been under investigation for similar crimes? Do the political parties that comprise the coalition "Junts pel Sí" and the CUP party share a common political and economic agenda for the post-independence period?

The answers to all these questions are the opposite of what would be consistent with the "construction of Southern Europe's Sweden" pro-independence argument.

This leaves us with one last and powerful pro-independence argument:


3. Emotions, national identity

A large part of Catalans may feel that they are significantly different from the rest of Spaniards in the way they think, behave, approach life. That having their own language is a sign of a well defined and separate identity. These are all very respectable reasons to want to be independent. But then it should be made clear, and people be fully aware of it, that these are the reasons to want to be independent. Not something else.

This should also help to clarify what an independent Catalonia would likely to be politically, economically and socially in 20 years time (after a more or less long, more or less painful transition period). Looking at Spain's and Catalonia's history, at Spain's and Catalonia's path of development over the past 40 years of democracy and 30 years of EU membership, the conclusion seems reasonably straightforward: an independent Catalonia would tend to be more or less the same thing as a Catalonia part of Spain.

A prosperous country, just as the rest of Spain. More prosperous than today, just as the rest of Spain. With a 25%-30% higher GDP per capita than that of the rest of Spain, just as today. With stronger political and economic institutions, just as the rest of Spain. With a more independent judicial system, just as the rest of Spain. With a more independent press, just as the rest of Spain. Part of the Eurozone, just as the rest of Spain. With an ageing "native" population, higher retirement age and more immigrants, just as the rest of Spain. With a more innovative economy, just as the rest of Spain. A place with a high quality of live, just as the rest of Spain.

And with two important differences: there would be no Spanish flags hanging on official buildings. And FC Barcelona would have become an irrelevant club in European and world football.

Catalans should ask themselves the question which of the two differences does the more good to their emotions and sense of national identity. By answering it, they will know if they want to have an independent Catalonia. Or not.

Thursday 10 September 2015

Greece's 3rd bail-out: make or break?

Greece's third bail-out programme was given green light in August. All went according to plan. So far.

The relevant question now is: after the failures of the previous two, what are the risks of failure facing this one? There are four main risks:

1. The banking sector's comprehensive restructuring and recapitalisation doesn't take place

Greek banks need to write-off bad debts and be recapitalised to provide financing to the private sector. Without it no sustainable private sector driven economic recovery can start.

The third bail-out package includes Eur 25bn to recap the Greek banking sector. This accounts for around 6.5% of the Greek's banking system total assets. It should be more than enough to recapitalise the Greek banks properly.

Existing shareholders in some banks (all but National Bank of Greece?) will most likely be wiped out - sorry guys, the EU's Bank Recovery and Resolution Directive (BRRD) will only enter fully into force in January 2016 but given Banco Espirito Santo's bail-in precedent in August 2014, January 2016 is too close for the EU authorities to let shareholders off the hook. Bondholders (both junior and senior) will be (partially) bailed-in. But all will be ok.

The Greek banking sector not being comprehensively dealt with and recapitalised is not a risk.

2. Primary surpluses demanded by the Quartet (European Commission, ECB, ESM and IMF) are detrimental for growth

Too aggressive fiscal targets imposed on Greece by the Quartet could be too restrictive for public spending. Social unrest would pick up new momentum. Implementing the structural reforms agreed as part of the third bail-out package become an impossible task. The programme would fail. Again.

These are the final primary surplus targets agreed between Greece and the Quartet: -0.25% of GDP for 2015 (a primary deficit) vs. 1% (surplus) that was agreed earlier in the summer; 0.5% in 2016 vs. 2% agreed earlier in the summer; 1.75% in 2017 vs. 3% earlier; 3.5% in 2018 vs.....3.5% earlier.

And there will be surely some willingness to accommodate a deviation from the agreed 2015 primary surplus target to take into account any unexpected adverse effects on GDP growth following the bank closures and imposition of capital controls in July. As long as the Greek government implements the agreed structural reforms for 2015.

There is hardly anything too aggressive and demanding here. So, no significant risks on this topic either.

3. Public debt restructuring will not take place

A silent and significant debt restructuring has been taken place since 2011 as I showed in detail some time ago (http://cubismeconomics.blogspot.co.uk/2014/12/greece-what-now.html). And more is to come via maturity extensions and lowering of interest rates as long as the new Greek government implements the agreed reforms. And as soon as the first review of the third bail-out programme is favourably concluded.

With an average maturity of 31 years the loans of the new bail-out programme are a clear signal of where the debt restructuring journey is going.

Absence of further debt restructuring is clearly not a risk.

4. Lack of political will to implement agreed reforms

Mr. Tsipras went as close to the edge of the Euro cliff as one could possibly go. Seeing the Grexit abyss he stepped back and agreed to a new comprehensive third bail-out package. If we wins the upcoming general elections (20 September), and forms a majority government, not implementing something that he agreed to is surely not a realistic scenario to contemplate. Even if of one argued that he only agreed reluctantly to some of the measures in the MoU, the electoral victory would give him the mandate to implement them.

What if the opposition (ND led government) wins the election? Not much changes. With the pro-Grexit parties likely to end up with only 15% to 20% of the votes, any Greek government will have a clear mandate to do whatever it takes to stay in the Euro. And after the dramatic quasi-Grexit events in July, that plain and simply means implementing the agreed reforms.

Greece being Greece, not all agreed reforms will be implemented. However, even if the implementation ratio is 50% (instead of the rather 10% in the past) that would be good enough.

Arguably Syriza winning now would be a superior outcome for mid to long-term policy continuity purposes. If after 3-4 years in government Syriza lost the general election in 2018-2019, a new ND-led government (potentially in coalition with Potami) would tend to continue along the roughly same economic path as defined by the third bail-out programme. No dramatic reversal of economic policies would take place allowing Greece to reap the full benefits of the difficult reforms implemented in the meantime. The same cannot be said with the same degree of confidence if Syriza loses this election and wins the next one. There is always the possibility that at that point in time even a more moderate Syriza tries to reinvent the wheel, once more, and reverses some of the reforms implemented in the meantime.

Then again, will it make any substantial difference for reform implementation over the next 18-24 months who wins the 20 of September election? Not really. The Quartet's first review on the progress of reform implementation will take place in November. Greece will pass. Further debt relief will then be conceded by the EU. And the ECB will be able to extend its QE programme to the purchase of Greek government bonds. With bond spreads narrowing, capital controls slowly being lifting, foreign investors returning to the country and the economy starting to recover, Greece could well be 2016's economic suprise of the year. And with a cyclical-adjusted PE of under 5x, Greece's equity market could do much better than most expect over the next 18 months.

No one ever said that Greece is a boring country. And rightly so: over the coming 18 months it is likely to continue to be a box full of surprises. This time good ones.