Lobbying through economic fallacies

David THESMAR (HEC Paris & CEPR)

motivation

• In several countries in Europe, economic literacy is low – Cynical view of economists not shared (incentives)

– General equilibrium effect hard to grasp

– Financial literacy / accounting are limited

• Fallacies in the general public can be exploited – By interest groups

– Political endorsement is key • Sincere deceivers (politicians believe in fallacies)

• Strategic PR (politicians cater to common beliefs)

This talk

• Two fallacies of public opinions used by interest groups

– We should reindustrialize our economies

– Competition policy hurts the economy

• Conclusion: leveraging policy makers’ misconception of finance

We should reindustrialize our economies

We should reindustrialize our economies

We should reindustrialize our economies

• Who does it benefit?

– Industrialists looking from subsidies

• R&D subsidies, employment subsidies

• Favorable regulation (shale gas etc.))

– Trade unions linked to manufacturing

– Larger firms who carry bigger political weight

– Politicians who can claim

• To restore “national pride” on global markets

• In the post-crisis world: back to “real stuff”

Sub-fallacies

• It is possible to increase share of manufacturing output

• Without manufacturing, there is nothing to export

• Without strong manufacturing base, it is impossible to create unskilled jobs

• Without manufacturing, there is no growth

It is possible to increase share of manufacturing output

(the myth of the US manufacturing renaissance)

Without manufacturing, there is nothing to export

-80

-60

-40

-20

0

20

40

60

80

1995.0 1996.0 1997.0 1998.0 1999.0 2000.0 2001.0 2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2008.0 2009.0 2010.0 2011.0 2012.0

French trade deficit

Without manufacturing, there is nothing to export

Trade deficit

-80

-60

-40

-20

0

20

40

60

80

1995.0 1996.0 1997.0 1998.0 1999.0 2000.0 2001.0 2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2008.0 2009.0 2010.0 2011.0 2012.0

French trade deficit

Service surplus + net profit from FDI

Without strong manufacturing base, it is impossible to create unskilled jobs

Polarisation in the post industrial society (US data)

Routinizable tasks (manufacturing)

Household services

Managers, doctors, Lawyers, engineers

Jobs ranked by their 1980 wage

Cumulative employment growth since 1980

Nurses, School teachers

Without manufacturing, there is no growth

Competition policy hurts the economy

Competition is

Harmful

Competition is harmful

France 5.03 South Korea 4.01

Chile 4.94 Germany 3.91

Poland 4.94 South Africa 3.91

Argentina 4.67 Canada 3.82

Netherlands 4.66 Australia 3.75

Italy 4.42 Switzerland 3.62

Japan 4.3 Norway 3.49

Hungary 4.29 United States 3.48

Turkey 4.21 Indonesia 3.44

Spain 4.2 China 3.41

Great Britain 4.18 Peru 3.41

Brazil 4.16 Sweden 3.39

Malaysia 4.15 New Zealand 3.27

Russia 4.12 Mexico 3.22

Finland 4.03 Romania 3.09

Morocco 4.03 India 2.78

Source: World Value survey

Competition hurts the economy

• Firms want to raise barriers to entry – Would be unprofessional not to try

• Empirically, competition is good at: – Reducing prices (consumers notice this)

– Increasing quantities and therefore employment (retail industry, cab drivers for instance)

– Improving quality (telecom, air travel)

– Effect on innovation: ambiguous, often >0

• Case study: the French mobile phone sector

French market concentrated

Average revenue / user

Time line

• In January 2010, French authorities opened the door to a 4th mobile operator

– Already big in fixed broadband

– No political tie (firm < 10 years old)

– Huge dissent among politicians

• Sarkozy publicly against (1 is too much)

• Independent regulator + competition authority in favor

• Entry effective in 2012.

A fourth mobile operator enters

harder competition

Mo

re in

no

vati

on

French mobile Phone industry

Mo

re in

no

vati

on

harder competition

Bottom line

• Subscription prices fell by 50%

– Consumption of mn & data increased

• Employment did not fall (but it will, eventually)

– Not competition, technical change!

• Investment in 4G accelerated

Conclusion

• An alternative: leveraging economic fallacies believed by politicians (not by people)

• A strategy of choice for the financial sector

– If banks are forced to recapitalise, it will jack up the cost of capital, and hurt lending

– A sovereign cannot default on its debt, even partially

If banks are forced to recapitalise, it will jack up the

cost of capital, and hurt lending

Bank recaps do not affect the cost of capital

• bank balance sheet (loans) have given level of risk – Depositors are made whole, whatever comes.

– Shareholders pick up the rest they bear all the risks

shareholders are sensitive to % of deposits – If lots of deposits to finance loans, they demand higher

returns because their claims are risky

– Conversely, when a bank recapitalize, shareholders demand LOWER returns

• When the bank uses more capital, capital is less expensive cost of capital = constant.

Bank recaps do not affect the cost of capital

• This is the Modigliani-Miller theorem

– It holds in the medium run

• Policy-makers do not know it.

– Bank lobby exploits this ignorance to fight recapitalization

– WHY?

– Because recap primarily benefits depositors and taxpayers, but hurt existing shareholders

• Since the crisis, armies of economists have taught this to central bankers. Now they know.

A sovereign cannot default

• When a state is too indebted, it increases taxes: – discourages investment (a long-term effect)

– Discourages consumption (a short-term effect)

– This hurts growth over very long periods (reinhardt&rogoff)

• Solution out of debt overhang = debt restructuring – Write-off (hard core)

– Lengthening of maturity

– After such an episode, growth resumes.

A sovereign cannot default

• Common subfallacy: need for riskless asset in the economy

– Govt debt is risky (interest rate risk, inflation risk)

– When investor believe it is riskless, they invest recklessly, bring interest rates to the ground