On-line contribution about independent regulatory agencies

I just recorded a piece for an on-line course on regulation directed by my friend and colleague Antonio Estache from Université Libre de Bruxelles. I had to talk through Skype about independent regulatory agencies and the result will be in this course. I took as a starting point my 2010 working paper where I tried to summarize mine and others' (Montoya, Stern, Gual, Levine...) research on the topic. In that paper I argued that independent regulatory agencies were one of the possible means to alleviate the commitment problem in regulation: firms being reluctant to invest in sunk assets anticipating opportunistic regulatory behaviour. That is not the only rationale for independence, as the need to appoint experts in complex industries is another one. Through history, there have been other ways to try to alleviate the commitment problem, such as public ownership, popular capitalism or detailed legislation, but the preferred one in the recent decades has been regulatory independence. In between conversations trying to record a good cut, I learned from Antonio that the World Bank (where he worked for many years) tried to promote the UK version of the institution rather than the US version, because in the latter there were too many political appointees. The institution has a moderate but positive impact on investment according to the empirical literature, but it is not free from problems. One of them is isolation from the rest of government, which may prevent necessary coordination. Another one is the enhanced risk of capture, since the revolving doors phenomenon may show up precisely because independent agencies need to be staffed by experts who may have also a career in the private sector. Beyond my 2010 paper, I argued that currently there is promising research in trying to incorporate insights from behavioural economics to the field, in particular three departures from full rationality by regulators: failure to optimize (because of satisfying or adaptive behaviour); intrinsic preferences (for example, regulators may have not only career concerns but also a public sector ethos); and expert bias (for example, overconfidence in their own skills or tunnel vision). And another hot topic is the controversy between regulators accepting having a variety of objectives (as argued by Massimo Florio), or regulators being given only one single objective, as argued by Jorge Padilla and others in a recent paper published by the Brussels think-tank Bruegel.

"Network Industries and Social Welfare," by Massimo Florio

Prompted by a journal referee, I gave a quick read to the book by Massimo Florio on network industries in Europe. I should have read this book before, which does not mean that I agree with everything he says. This autor had already published a critical overall analysis of the privatization experience in the UK. Along the same lines of examining broad policy experiments, he analyzes what he calls the paradigm of network industries’ policies in Europe in the last 20 years. I like books like this, that take a look at the big picture. The author had discussed with the late social-democrat thinker and historian Tony Judt about the experience of privatizing railways and utilities, something that Judt had criticized in his last years. Having that connection is a badge of honour. I sympathize with the emphasis that Florio gives to the variety of corporate forms that still exists in utilities, including state-owned firms like those in Scandinavian energy. Florio argues that the dominant paradigm in Europe was born in Margaret Thatcher's Britain. However, the British paradigm did not include permanent regulation, as explained by Jon Stern in a paper discussing the origins of the UK reform. I am not even sure that the experiment started in the UK: USA (not only with Reagan), Chile, and other countries also experienced with various aspects of reform, not all of them good, or bad, or even finally reflected in the European experience. I also sympathize with the idea of public inetrvention in network industries encompassing a variety of objectives, which introduces caveats to the institution of independent regulation. Florio also correctly argues in my view that in the EU there is too much harmonization, but too little market integration. Still, I would not go back to state ownership monopolies, and I would have given more consideration of trade-offs, such as the one between investment commitment and short run objectives. I’ll give it a second slower read, and perhaps I'll try to write a proper book review for a journal, if I have time. The book deserves it, and it's supposed to be my topic.

“The Globalization of Inequality”, by François Bourguignon

This is an excellent companion to the books on inequality by Piketty, Milanovic, Deaton, Bowles and Stiglitz. It focuses on the impact of globalization on the relationship between inequality within countries and inequality between countries. It describes the process of increasing within country inequality in developed nations, and the process of decreasing inequality between developed and developing nations, especially thanks to the growth in very large developing countries such as India and China. Both processes are related to globalization: global market integration causing gradual convergence between countries and at the same time increased labour demand from unskilled workers in developing countries depressing the earnings of their competitors in developed countries, whilst at the same time skilled producers in developed countries facing increased demand for their services. Political forces à la Piketty also push in a similar direction. Although today between country inequality is still much higher than within country inequality, the danger is that the gains in international rebalancing are offset by increasing differences at the national level. If this happens, we will end up seeing next door the huge inequalities that today are largely invisible in the developed countries. Bourguignon thinks that it would not be ethical to stop global market integration (for example through protectionism), because this is the best hope for the populations in poor countries, but that within country inequality must be tempered with stronger redistributive policies. The book has also interesting parts on the coexistence of market imperfections and inequality, and the equity-efficiency trade-off. Specifically, many examples of market imperfections that reduce efficiency (for example, monopolies) also produce inequalities. By fighting this kind of problems, both efficiency and equity are improved, turning the trade-off upside-down.

Jean Tirole: "Europe's future is federal"

It seems that I am neither crazy nor alone. It is not me, it is Jean Tirole who says it, so perhaps federalism advocated by an Economics Nobel Prize will be paid more attention:
"The federalist vision requires two pre-conditions. First, any insurance contract must be signed behind a veil of ignorance: you wouldn’t include solidarity in a buildings insurance plan if my house were already on fire. It would eventually be possible to resolve the current asymmetry between northern and southern countries by identifying and isolating problems inherited from the past in order to confront them; this is complex but can be done.
Then, and in the main, countries sharing the same roof must have common laws in order to limit moral hazard. It goes without saying that legal uniformity must apply to laws which may create collateral damage for other European countries and not, shall we say, the “pasteurisation” of supplies consumed in the member state: subsidiarity must apply in areas where it creates no costs for the rest of Europe.
The ECB’s centralised supervision within a banking union raises a sliver of hope and might pave the way for common deposits insurance since centralised supervision reduces the chances that countries supervising their banks prudentially end up paying for lax ones.
A Necessary Loss Of Sovereignty
But mutualisation cannot be achieved regarding unemployment insurance. Effectively, the unemployment rate in Eurozone countries is only partly determined by the economic cycle and is very much linked to choices regarding employment protection, active labour market policies, contributions to social security, professional training bodies, the type of redistribution (minimum wage or fiscal allowances), etc.
Clearly, countries electing institutions that enable them to obtain a 5% unemployment rate won’t want to “co-insure” countries that, de facto, opt for 20% joblessness. The same holds for pensions and the mutual sharing of debts. Against all this evidence, Europeans still cannot bring themselves to think of giving up their sovereignty.
We Europeans must accept the loss of sovereignty that’s necessary to live under one roof. And, to do so, we should rehabilitate the European ideal and unite to defend it against populist nationalism – and this is not easy these days…"

Democracy and soccer

Yesterday the members of FC Barcelona, the soccer (and multisport) club, elected their president in a one member-one vote election. Almost 50.000 people approached the club’s facilities to vote for one of the four candidates who had made the final cut. In most other clubs in the world, the top official is elected by the owners with the largest stake in the ownership, or by some other board. There is one important restriction to the operation of democracy in FC Barcelona and a few other Spanish clubs: only those members who can show enough financial collateral can run for the presidency, because in case of accute financial difficulties they are held legally responsible. This means that only members of the Catalan bourgeoisie can afford to run for the position. Nevertheless, after a few weeks of campaigning and debates, in the style of a political campaign, Mr. Josep M. Bartomeu was re-elected as president. His main rival Mr. Joan Laporta, a former president, had pledged to sign a French star, Pogba, and to cut the deals of the institution with Qatar, whose government-linked entities have been sponsoring the club in the recent past. Mr Laporta had finished his previous period in office (2003-2010) with two political positions (in the City Council of Barcelona and in the Catalan regional Parliament, which he no longer holds), and also with accusations of obscure deals with the ruling family in Uzbekistan. Bartomeu has also his fair share of legal problems, as he is being investigated for the irregularities of the signing of Neymar. Bartomeu had to pledge allegiance to the pro-independence drive in Catalonia during the campaign, fearing the mobilization of radical separatist members in favor of Mr. Laporta: this move has pushed some non-member fans who do not support Catalan independence to express their despair. A previous president of the club (the first to be elected democratically in 1978), Mr. Josep Ll. Núñez, is in jail for fiscal fraud and blackmail in matters unrelated to soccer. Meanwhile, the club remains very successful on the pitch (the last winner of the most important club  soccer competition, the European Chapions League) and the members are very proud of the democratic nature of the club. Paradoxes of democracy.

Regulators: three sources of bounded rationality

Trying to organize my thoughts and my readings on the application of behavioural economics to regulatory agencies, it seems to me that there are three sources of bounded rationality in the behaviour of regulators, and all of them have shown up in different papers, although no paper has addressed all of them together:
-Intrinsic preferences: real life regulators are neither benevolent social planners nor bureaucrats à la Niskanen, that is, self-interested and budget maximizers. Rather, most of them care about what they do, perhaps because they have career concerns, but also because they have a public sector ethos. Particular details of these intrinsic preferences depend on experience, professional background, nationality or other aspects of personality.
-Non-optmizing behaviour: in his PhD thesis papers, the regulatory economist Paul Joskow tested a conceptual framework, based on the ideas of Herbert Simon, where regulators were not maximizing any objective function, but they made their decisions consistently with a satisficing behaviour. Years later, some papers have assumed that regulators are adaptive agents, or that they behave with "minimal squawk."
-Expert biases: along the lines of a recent paper by Kovacic and Cooper in the Journal of Regulatory Economics, regulators suffer from expert biases such as over-confidence, confirmation or availability. These biases also affect ordinary people, but they have been shown to be particularly acute in regulators and high profile experts.
As a result of these departures from traditional assumptions, positive models of regulatory behaviour, as well as policy or institutional recommendations based on these models, should carefully fill in the details of the consequences of these real-life regulators.

Welfare, democracy and federalism in Europe

When the US founding fathers discussed the US independence and the constitution they discussed democracy and economic policies and institutions in the same package. They were aware that economic arrangements for efficiency and distribution had to do with democracy: "no taxation without representation". In The Federalist Papers, written my Hamilton and Madison, the discussion was not only about the division of powers between the federal government and the states, but was also about the separation of powers at each level of government and about the economic role of the states and the federal government. Economic policy, democracy and federalism were part of the same discussion. These days in Europe, we are in a similar position. The controversy surrounding the recent referendum in Greece shows that the quality of democracy belongs to the same discussion as the solution of the economic and financial problems of the euro zone. These problems cannot be solved without trying to fix at the same time the governance and democratic deficits of the euro zone and the European Union. A federal Europe with a significant transfer of sovereignty from the member states to the Union would contribute to solving many of the current economic problems, but this step requires increasing the democratic nature of the decision-making process. A common fiscal policy requires a treasury and a significant budget, but then... "no taxation without representation", and the powers of the European Parliament should be significantly increased. One day, a European president should be chosen by universal sufrage. A political career would necessitate voters in most countries of Europe, and not only from a single electorate. A democratic federalism would then be able to decide on legitimate policies and the Europeans would be able to pool their resources to become a more secure welfare powerhouse.

"Circus Maximus," by Andrew Zimbalist, on Barcelona

The economist Andrew Zimbalist has recently published an excellent book about "the economic gamble behind hosting the Olympics and the World Cup" entitled "Circus Maximus." The book summarizes for a broad audience the academic literature about hosting big sports events, such as Olympic Games and soccer World Cups. The conclusion of this literature is clear and almost unanimous: there are higher social costs than social benefits involved in hosting these events for cities or countries. The financial gains are captured by the international governing bodies of the Olympic family (the IOC) and global soccer (FIFA), two organizations that are well known for their past or present corrupt practices. The economic legacy is always exagerated and unclear. The book devotes some space to one supposed exception to this trend: the Olympic Games of Barcelona in 1992. These games would be an exception because the organization was preceded by a previous urban plan, and the games were put at the service of this plan. There were other factors that surely made Barcelona 1992 an exception, such as Barcelona having some clearly untapped assets due to marginalization in the Franco centralist dictatorship that had just ended some years before, and the partnership between private and public investors (although the figures are somehow fuzzy on this). I was there, because I was a (very young) city councillor between 1991 and 1995, and I was member of the city government who promoted and organized the games. Of course my role was minimal, as I was the youngest councilor, in charge of youth policy and related issues. But I was a witness to the popularity of the games and the (I believe) good organization. But with the benefit of hindsight, and knowing now well the literature (subsequent to the Barcelona games, and almost unknown in Barcelona and Spain) reviewed by Zimbalist, I believe that the picture that he paints is even too optimistic about Barcelona. Although of course the games in Barcelona were better than others, there are two issues he doesn't mention about our city, somehow inconsistently with things he says in the rest of the book. One is that Barcelona has also left a legacy of white elephants. In particular, the two most important sports facilities of the games, the Olympic stadium and the Palau Sant Jordi, do not have a regular use and are a costly burden for the city. Additionally, although he argues convincingly that after the games Barcelona has become a big tourist power, he doesn't answer a question he asks previously in the book: could that have been achieved by other cheaper means? For example, an additional Woody Allen movie or something similar. After all, the millions of tourists that visit Barcelona every year visit places that were here long before the games (the Ramblas, the Gaudi buildings). Other aspects that emerged from the games were positive, in addition to aspects mentioned by Zimbalist, for example the fact that the political leader of the games, mayor Pasqual Maragall, some years later made possible the end of the monopoly of the regional government by the nationalist right. I agree however with the general message of Zimbalist: the circumstances that surrounded Barcelona 1992 were exceptional, and one should not expect them to happen somewhere else. Very recently, the new mayor of Barcelona has decided to withdraw the candidacy of Barcelona-Pyrinees to host a winter Olympic Games. I just regret that she didn't put the decision to a referendum (as the mayor of Boston has done), because then people would have been aware of the urgency to read the book by Zimbalist and question the myth of big sports events.

"On the Move, A Life" by Oliver Sacks

In his autobiography, Dr. Sacks ends his story by explaining that to him story telling and writing are a natural human disposition. He describes in all the book the learning life that in his case is the foundation of this natural disposition. The book is the story of his youth in England, his professional life in the USA, and finally his many journeys and connections with academics, professionals and ordinary people. He writes openly about his sexual life and his experiences with drugs, and how everything was part of an immense learning material. The reader that is familiar with his previous work can revisit stories like those of Awakenings, or the stories of blind people who can suddenly see, just to be overwhelmed and needing to go back to blindness. But those who have not read the stories before can enjoy a wonderful book about an extraordinary life. Sacks is empathic with his patients and is empathic with the readers. He is also open about the difficult relationship he had with some of his colleagues, like those who did not approve of his popularity, or others for the envy that sometimes plagues the work of academic or professional institutions. It is the story of the life of someone who has reasons to be proud of what he has done, but it is also explained with modesty and humour. Dr. Sacks will perhaps leave us soon, but his readers, current or future, will always be able to go back to his words.

A tale of two trilemmas

I am honoured that Branko Milanovic spent some time thinking about a question I asked in his recent talk at IESE in Barcelona. This is the result of his thoughts. After explaining the two trilemmas (his and Rodrik’s), he reflects on the fact that the point they have in common is globalization, and that in practice more than clear corners of the trilemma we have some intermediate or fuzzy realities, such as not very democratic international institutions. 

What the trilemmas show is that while they are useful constructs to try to understand things, reality is more complicated to be shoe-horned into the schemata. In effect, in both cases, the three cartouches that we drew above continue to exist (none has been “deleted” as we would expect in a real “solution”) but are being redefined. 

Here we have perhaps the foundations of an interesting debate with the more optimistic although perhaps unjustified view of Josep M. Colomer about global institutions. Still, I believe that both trilemmas are useful to describe the tensions we live in. It seems difficult to me to understand some of the pressing issues in Europe (Greece and immigration) without thinking of the trilemmas. Rodrik has a recent piece on the federal deficit in Europe. In it, he seems for the most part to be willing to abandon national sovereignties (the opposite of what he does in his book "The Globalization Paradox") although at the end of the article he goes back to federal pessimism, which I guess has intensified with the drama in Greece. The current situation there reflects precisely the social costs of the “federal deficit.” But given the ghosts of Europe, and given Milanovic’s trilemma (which I interpret as walls to globalization being incompatible with technology and inequalities), I dare to simplify even more than using trilemmas: it’s misery or democratic federalism... But OK, accepting that reality is more complex.

The missing "Yes" in the Greek referendum

In the hurried and chaotic referendum called by the Greek government on Sunday there are two "No" votes and so far only one "Yes" vote. There are two different positions asking people to vote no. Alexis Tsipras and Syriza ask people to vote no (to a question that is impossible to understand) to the Troika conditions, but with the willingness to keep Greece in the eurozone. But others, such as economist Paul Krugman, ask people to vote no and be ready to abandon the euro. These are two very different positions. Krugman is consistent with his position in the Scottish referendum: a currency union is incompatible with national sovereignty (which is why he criticized the position of the Scottish nationalists in that referendum, implicitly supporting the "No to independence" campaign). And he is consistent with Rodrik's trilemma: globalization, democracy and the nation-state are not simultaneoulsy compatible. We can choose only two of them, and in this case Krugman advocates in practice disconnecting Greece at least in part from globalization. Only in part, because his claim is that with a new currency Greece would boost its exports, although of course losing any influence on common policies to solve international and global market failures, including the one of its oligarchy sending their money to other countries (Branko Milanovic commented recently on the implications of the absence of a global federalism for the Russian oligarchy). The position of Tsipras, however, creates the fiction of an absence of trade-offs: he wants his country to stay in the euro, and at the same time proclaims its national sovereignty in terms of fiscal and other policies. In front of these "noes", there is so far only one yes: the yes of Angela Merkel and the troika, asking Greek citizens to vote yes to austerity policies and the tough conditions of creditors and the current governance of the euro zone. It would be very useful to have another "yes" campaign. A campaign that solves Rodrik's trilemma in a different way from the one envisaged by Krugman: let's ditch the fiction of national sovereignty. Let's keep democracy and globalization and build a transnational federalism where the eurozone has a significant budget and where creditors and debtors reach transparent agreements that are validated by democratic institutions, to share the costs of the crisis so that the most vulnerable sectors of society cease to pay for the bulk of them. This is a "Yes" vote that should be defended by the European social democracy. I remember that at one point in the Scottish campaign Krugman said that he had a preference for large democratic aggregates. Perhaps he has lost hope on turning Europe into one such large democratic aggregate, but many people in Europe, me included, have not lost this hope, perhaps because we are more aware of the ghosts of European history.