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Thursday, August 19, 2010

General Motors "Profit"

We are being told that the turnaround in General Motors profit is a remarkable success for its management and for its majority shareholders (the US and Canadian governments), who now hold about seventy percent of its stock. Over the last six months, GM has earned $2.1 billion in profits versus the thirteen billion it lost over the same period last year.

The "secret" to GM's success is evident from its income statements. From January 2009 to its takeover on July 7, GM paid $16 billion in interest payments. From July 8 to year end, it paid $5 billion. For this period, its expenses were thus reduced by $11 billion as its debt was converted into shares owned by the U.S. and Canadian governments. Without this equity bailout, GM would still be losing almost $9 billion, instead of its reported profit. Notably, there has been no reduction in GM's pension liabilities to its workers.

It seems to me that just about any company could achieve such a turnaround if the government were willing to take its debt and convert it into shares.

Tuesday, August 17, 2010

The Low Cost of Korean Unification

The Korean President has proposed a reunification tax to prepare for the presumed high cost of Korean reunification. The North has predictably responded with anger and saber rattling. Many of the Korean scholars I have met in Germany believe, on the basis of German experience, that the costs of their reunification would be high, perhaps prohibitively so. The German experience, however, is not an appropriate benchmark for Korea for a number of reasons.

First, the German constitution’s federalism laws call for equal treatment in transfers among the states and also German labor unions demanded wage equality between East and West despite huge productivity differentials at the time of reunification. These two features meant that East Germans had immediate access to Germany’s generous welfare state and that East Germans were required to be paid wages well in excess of their productivity. The result has been persistent and exceptionally high unemployment in the East. In the Korean case, there are no constitutional requirements for equal transfers that I know of. Also the South Koreans can learn from the German experience and avoid the mistake of requiring wage equality between North and South. Another factor is that social welfare transfers in the South are a small percentage of total government, unlike the German case where they are the dominant state expenditure.

Second, East Germany had a large industrial sector, in fact, the most advanced in the communist bloc. After an initial period of optimism, Germany learned that, rather than bringing money into the state budget, former Eastern state enterprises required large subsidies to keep in business and then close down. North Korea has largely an agricultural economy that has been ruined by state and collective farms. We now have the experience of China, Russia and Ukraine that shows that agriculture recovers quickly once freed of collective and state farms. North Korean agriculture will quickly become an asset as opposed to a liability. As its productivity increases, living standards in both the North and South will increase.

Third, German reunification was accompanied by an immediate opening of borders. Although population transfers occurred, they were limited by the equalization of wages and benefits. In the case of Korean reunification, it would seem that borders would have to be opened gradually in light of the huge living standard differentials. Although such a policy might be regarded as harsh, the desperate welfare situation of the North could be immediately remedied, again at relatively low cost. Under any circumstances, the welfare of the population of the North would be improved by a huge factor.

Fourth and finally, there is an implicit and substantial cost to the South of having an unstable nuclear power next door. Although the probability of a nuclear holocaust is low, the cost to the South of such an event would be astronomical. Weighed against the expected-value cost of such a disaster, any economic cost of reunification would be small.

Thursday, August 12, 2010

Russian Agriculture: The Story No One is Telling

Drought will cut Russia’s grain harvest by one quarter. Vladimir Putin, in a burst of populism, bans the export of grain. Grain futures rise in world markets. These headlines obscure a much larger story that no one is telling: Russia, twenty years after the collapse of the Soviet Union, is feeding itself with grain left over to export. Prerevolutionary Russia’s black-earth zone was the breadbasket of Europe. Contemporary Russia is on the path to reclaiming this title.

After Stalin defeated his last opponent in 1929 – Nikolai Bukharin, the proponent of private agriculture -- Russian agriculture collapsed. Russian and Ukrainian peasants were forced into collective and state farms, where they had no incentive to produce. The Soviet Union was forced to admit its agriculture was broken in July of 1972, when it began massive purchases of U.S. wheat, driving up agricultural prices worldwide. Russia had to purchase grain abroad despite the fact that it was spending more than four percent of its GDP on agricultural subsidies.

What has caused this spectacular turnaround that no one has noticed? Is it shining new tractors and combines? Is it new agricultural technologies? No. The answer is that market forces are again directing Russian agriculture. Farmers have turned their backs on collective and state farms. There are again incentives to produce. Food is again being distributed by markets and not the state. Instead of standing in line for food products that are priced ridiculously low, Russian consumers pay market prices and weigh carefully what they buy. Food is no longer a “free good” that no one can get.

Consider the effect of the return to market agriculture on the Russian people. The great Soviet famine of 1932-33 saw a loss of grain output of around twenty percent – a similar figure to the predicted decline of this year. The immediate result was the loss of six million or more lives. Russian-Ukrainian relations still suffer from the aftermath of the great holodomor. In 2010, the worst that the Russian people face is higher food prices. Russia is part of the world economic community. In the worst case, it can import grain this year and resume exports when weather conditions return to normal.