Power matters, Cyprus edition

It's widely agreed that the EU's plan to penalize smaller depositors in Cyprus's banks is a terrible idea, because as Paul Krugman says:

It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

But if it's such a bad idea, why do it? The answer lies in something known by Marxists and heterodox economists, but which orthdox economics still has trouble acknowledging. Quite simply, the allocation of wealth, or costs, depends upon power.

Let's put it this way. Who could pay for Cyprus's insolvent banks? The answer isn't their bond-holders, because these are almost non-existent, and nor is it shareholders, as even a 100% loss for them doesn't cover the banks' liabilities.

In principle, Cyprus's government could have bailed out the banks. But this would have left it insolvent, requiring a bail-out itself. That would have imposed losses on holders of Cypriot government debt, such as European banks and hedge funds. But such holders had the power to resist this - in part because of the credibleish threat that such losses would have weakened confidence in the general European financial system, and as Kalecki said, "confidence" is one of the tools whereby capitalists retain power over the economy and governments.Pawelmorski says:

The hedge funds win again. A favourite trade for speculators has been Cypriot government debt. And it’s done very nicely. Mayfair sends its thanks.

This leaves only two possible payers. One is German tax-payers. But these have the obvious bargaining power of having little to lose if no agreement is reached.

The other possibility is that larger depositors in Cyprus's banks pay more - these being Russian gangsters legitimate businessmen and Greek tax-dodgers. But naturally, the rich have the power; the joke that Cypriot president Nicos Anastasiades "has only rich friends" gains power from its plausibility.

As a matter of elimination, therefore, smaller depositors - those who supposedly had a "guarantee" must pay. They do so not because of any principle of fairness or efficiency, but because they lack the power to protect their interests. What we're seeing here, says Pawelmorski, is "a cruel piece of realpolitik."

One quirk here is that its possible that these haircuts are a backdoor way of channeling Cyprus's large gas reserves into Russian hands. This, of course, in no way undermines my point, which is that economic allocations are determined by power.

My point here is not just about Cyprus. It's about economics generally. If we cannot understand Cyprus's situation without thinking about power relationships, why should we assume that we can ignore power in other aspects of economics, such as the everyday transactions that have led to rising inequality?

The answer, of course, is that we can't. Power matters more than fairness or efficiency. It's about time conventional economics cottoned onto this. 

Comments

[LordSidcup]

"One quirk here is that its possible that these haircuts are a backdoor way of channeling Cyprus's large gas reserves into Russian hands. This, of course, in no way undermines my point, which is that economic allocations are determined by power."

Theoretically true, maybe, but why would the ECB/Germany channel Cyprus's large gas reserves into Russian hands? Seems totally implausible.

[Cityunslicker]

For someone who I rarely agree with Chris (not being a marxist myself) - this article is superb and entirely correct. I doubt the bit about hedge funds winning, but that is purely from my own insight which has been this is far more aboue not defaulting on sovereign debt - the hedgies guessed right, they did not make it happen; they lose alot too when they go on macro-political bets (e.g. large positions shorting the FTSE when we lost AAA, all for nowt). Power is the driver here. Putin is alleged to have told the Cypriot Prime Minister to hang a german flag outside of his office if this went ahead - shortly before ordering gazprom to try one last bribe.

[Alex]

There is another and only payer - ECB. What is happening in Cyprus is an ultimate example of lemon socialism. The insolvent banks should be nationalized by ECB, the deposits reimbursed according to the Deposit Guarantee Scheme.

[Stephen]

Two comments, from different angles of scepticism.

One: if this is being driven by the Germans, is it not possible they have calculated possible results? Bank runs, departure of southern Euro members, end of their financing by Germany?

Two: accepting Chris's statement that "Power matters more than fairness or efficiency", what reason have we to suppose that anything will be different after socialism/ come the revolution/ all shall be well and all manner of things shall be well whatever?
Power will prevail, fairness and efficiency be damned. See rather a large volume of post-revolutionary history.

Or pre-revolutionary: query, where can we best look for actually existing fairness and efficiency?

[Igor Belanov]

Alex has outlined the only sensible solution to the problem. Unfortunately no-one seems to think that European-level institutions adopting European-level measures is a possibility. On one side there exists a supra-national body issuing diktats, on the other people who believe that it should be every country for itself in a race to the bottom.

[Keith]

To answer Stephen this is exactly why people like Atlee became socialists. If Capitalism is the Law of the Jungle then Civilised people need to replace it with something more moral.

As to how to do this the old clause four maintained that the

"popular control of each industry or service"

was the way. Capitalism turns out to be based not on Libertarian free contract but secret deals by corrupt Kleptocrats and their servants. And as for the Law what happened to deposit protection? Laws are for little people not the well connected. Confiscating savings was a policy used a number of times in the USSR; nice to see "European values" at work, they seem more like soviet values every day.

[Adam]

First, excellent strategic analysis of the situation.

However, I would quibble with your statement that orthodox economics does not consider "power" relationships. It surely does via game theory. However, perhaps your point was more nuanced. I think it is correct to state that orthodox economics has failed to incorporate strategic game playing into macro-economic models. The reason, of course, is because it is mathematically intractable. This is not an excuse but instead a criticism of orthodox economics placing mathematical models above good models.

[Oakchair]

@Stephen
The reason "socialism"/"Communism" would be different is that instead of power being concentrated in the hands of the few it would be shared amongst all. Decisions would be based on what the majority thinks is best instead of what a few people want.

There are multiple ways you can distribute power equally. You can make it so a democratically elected government controls everything, that every business is controlled equally via voting by its workers/investors, or somewhere in-between.

[Luis Enrique]

so now looks like poorer depositors are going to be exempt, which tells us what about who has power? Maybe it tells us that fairness sometimes dominates power?

[some people seem to think taxing depositors it's not such a terrible idea in this context. Beats me, but there's another alternative explanation: it's the right thing to do]

[chris]

@ Luis - I don't think the rethink (if it happens) undermines my point. It shows that fairness norms can sometimes be a source of power - albeit only weakly so, given that the austerity that accompanies bail-outs hits the innocent poor hard. Also, people with guaranteed deposits do have a form of power, in the sense that hits to them could undermine the euro area by increasing the likelihood of future bank runs elsewhere in the region.

[Luis Enrique]

sure, fairness only *sometimes* dominates power.

But I think your response here does undermine your point about conventional economics not having cottoned on to power. When you write "people with guaranteed deposits do have a form of power ..." that is exactly the sort of power that conventional economics does incorporate. I'm sure in a standard economic model, if you wish to eliminate bank runs, you insure deposits. If you renege on your promise, you risk bank runs, so you don't want to renege. Because of the power depositors have to create runs on banks.

[Andrew]

Chris, it seems to me you don't really know what you mean by "power".

If fairness norms can be a source of power, then how is power opposed to fairness? If economic power is a form of power then how is it not considered by classical economics?

If political power is not considered in economics, then how come there is a market price for political access and PR?

What do you mean by it? How would you quantify it?

[chris]

@ Andrew - fairness norms aren't the same as fairness. Eg, in the 1960s, UK trades unions fought for norms of fairness which acknowledged (modest) differentials between skilled and unskilled workers, but permitted large inequalities between male and female pay. The norm of fairness, then, was not what we would today consider the "reality" of fairness.
The neoclassical economics I had in mind was the claim that incomes equal marginal product. This surely clashes with the notion that people can be paid above their MP - eg bankers getting a TBTF subsidy.
Herein, tho, lies a problem with quantifying power. One way to do so is to check whether people are paid their MP. If they are, we might say that political power isn't different from the economic power that results from eg skills.
However, because MP isn't always observable, we can't do this. But the problem, here, surely lies with neoclassical economics rather than heterodox theories.

[Luis Enrique]

the idea that people might not be paid their marginal product cannot really be called a heterodox theory - it is mainstream labour economics.

Here are Rogerson and Shimer in most recent mainstream-defining Handbook of Labor Economics describing the macro implications of search models

"Match-specific rents: Search models naturally give rise to match-specific rents. This
in turn implies that, even if workers and firms exploit all the bilateral gains from trade, wages are not uniquely determined by competitive forces... rents [from search frictions] exist at the initial meeting
of the worker and the firm, and so cannot be contracted away. Other mechanisms that generate match-specific rents, such as match-specific human capital and private information, only produce rents after the match has been formed"

and here's a handbook chapter on imperfect competition in labour markets:

http://www.sciencedirect.com/science/article/pii/S0169721811024099

[Andrew]

@Chris - thanks. I still don't understand what your idea of power entails though.

It seems to me that when you contrast "fairness" with "fairness norms" you are just asserting your own personal norm or fairness against those of others/in the past. Or some kind of notion of absolute morality.

No one really (still?) believes people would tend to be paid their marginal product, surely?

[information]

i don't understand it