From Values to Economic Myths

Interview by Abel Hernández, published at Sintetia on September 24 (first part) and 26 (second part), 2012

Benito Arruñada is Professor of Business Organization at Pompeu Fabra University in Barcelona. His research is at the borders of Organization, Economics and Law. He has published a large number of books and scientific articles, and his most recent studies share a concern about the cognitive and institutional bases of impersonal exchange. This has led him to study a wide range of topics, such as the structure of moral systems and the standardization of property rights. He has just brought out a book on these subjects published by the University of Chicago Press.

These works throw some light on topics of great interest for Spain’s current situation. Spain is at a historical crossroads. It needs to reinvent itself, and this requires new, sound ideas. Spain has to listen to experts who are able to analyze the complexity of the situation without resorting to the false rigor of reductionism. Benito Arruñada is one such expert.

:: A few years ago you stated that Spain was not undergoing one crisis but three: an economic one, an institutional one and a crisis of values. Let’s begin with the last. What is a crisis of values?

You will remember that at the start not even the economic crisis was acknowledged. Fortunately, there is now incipient recognition of the institutional crisis which, until recently, was invisible for many economists. Acknowledging that there is a crisis is the essential first step for dealing with it. Moreover, understanding institutions and values is necessary if the right economic policies are to be chosen and adopted.

Of the three crises, the most debatable and difficult to analyze is the crisis of values. I believe that our starting-point here was bad because some of our traditional values (especially our preference for personal relations to the detriment of impersonal, institutional solutions) are out of place in a modern, developed society, but I feel we have been going backwards over recent decades, for two reasons. Firstly, we have enjoyed wellbeing and growth that we did not do much to achieve and, secondly, we have not managed education well, not only from a technical point of view but regarding values, which is perhaps worse.

:: What are the real reasons for this crisis?

First our wellbeing and growth were lying on weak foundations. They were based on credit and on a fortunate circumstance, the fact that Spain is attached to the European continent. This allowed us to enjoy two very beneficial shocks – our entry into the European Union and into the Eurozone. These shocks were not the result of our own efforts but were largely a matter of good fortune and the work of previous generations.

And, second, values have been damaged by badly-managed education.

:: To begin with the foundations of wellbeing and growth, what went wrong?

We didn’t use such shocks right. We took on debt in order to consume or to make largely useless investments. Private investment went well and made many of our firms much more competitive. But public investment, as well as those private investments that were most affected by public decisions, have been disastrous. Even today, several regions still enjoy tax privileges and subsidies, such as the Basque Country and Asturias. We have sunk a huge amount of resources into ruinous investments, such as most of the high-speed rail network which does not even pay for its maintenance and, above all, public administrations which are quite simply not viable, starting with the universities.

:: What about values and education…

We have not managed education well. Instead of modernizing our most dated values, we have reinforced them. The priority has been on leisure rather than on effort, rights rather than obligations, unlimited freedom rather than freedom with accountability. We have educated several generations in the useless belief (though sometimes true) that the individual is the last person to be responsible for his own failure. We hold other people responsible – employers, politicians or abstract concepts such as the “system” or the “market”.

:: Are you talking about morals, or religion?

I suspect that today we are more “catholic” than ever, especially considering the role played by personal responsibility and pardon. It sometimes seems that the only obligation for someone who has broken the rules is to ask for pardon, an act with almost sacramental effects. This, to say the least, is paradoxical because education policy has been designed by supposedly lay intellectuals.

It is not that we have built a less moralistic society. Quite the opposite. The moral code has been re-written, in such a way that it makes individuals less productive, less free and more unhappy. Just think of the reasoning behind many legal and legislative decisions, such as those relating to foreclosures. Such decisions are influenced by moral criteria, which is how it should be. But increasingly the morals applied are primitive morals, based on the most unthinking and superficial emotions of judges or voters.

:: What do we need to do to change in the medium term some of the characteristics of our culture, such as risk aversion or the fear of failure?

I doubt that there is much of a problem regarding our risk preferences. What is needed is to modify the remuneration of risk, and this requires fair, stable rules of the game. We are not remunerating risk correctly when we tax success as we do with our income tax, which rises very fast at relatively modest levels of income, or when we condone failure, helping out all sorts of economic agents who have made wrong decisions, from mortgage debtors to the purchasers of preferential shares and highway licensees. The same can be said about treating employers as exploiters. Bearing in mind that in Spain no-one wants to be an entrepreneur and, even less, an employer, there’s not likely to be much scope for rents to be extracted by employers from their employees.

:: Samuelson said he didn’t mind who wrote the laws providing he was allowed to write economics textbooks …

Economics textbooks will perhaps be important in the long term, but their usefulness depends on their content and on who reads them and how. I am afraid that economics has lost out in two ways. The Wealth of Nations was a textbook in Spanish Law Schools throughout most of the 19th century, when economics was only studied by law students. The founders of the liberal state had studied it, as can be seen in the preambles of the laws that still today make a market economy possible in Spain. I suppose the founders of the welfare state must have read Samuelson. But I am not sure to what extent they were affected (influenced?) by what they read. Perhaps they only took what they liked from Samuelson and company, although, irrespective of his academic caution, maybe that was what Samuelson himself actually wanted.

:: Is it only possible to change institutions if citizens have been well educated and are sensitive to such changes?

Education is essential for the proper functioning of democracy, but not formal or academic education, and certainly not anything like “Education for good citizenship”. The education that is most valuable is that based on personal experience of how public services are financed. It is especially important for citizens to know what taxes they pay. In this field, our country is a model for concealing costs. Prices are inclusive of VAT, most payroll tax is disguised as “Social Security contributions made by the employer” and income tax withholdings are calculated so that most voters receive a refund. What’s more, these refunds are perhaps the area in which the Administration actually moves relatively fast.

If we want to raise the political capability of citizens, we have to imagine that they are as aware of public finance as they are of the finances of their respective homeowner associations. Would they have tolerated, for example, that the homeowner association rescue the penthouse neighbor because he wrongly invested in a failed bank or a ruinous tollway?

:: There now seems to be a consensus on the institutional crisis you mention. Most institutions seems to have been captured by the main parties and there are practically no checks and balances. Do we have any tools to deal with this problem?

I don’t think there is a feeling of institutional crisis outside Spain. At least, not to the same degree. Nor do I altogether agree with the diagnosis. It is true that our system of checks and balances is not perfect, but none are. But the main difference, and the main shortcoming, lies in the behavior of citizens in that they are uncritical, they just follow the flock. Any system of checks and balances, however well-designed, ultimately is the responsibility of citizens. If they are not able to punish their political representatives when necessary, then the counterweights won’t work, however well-designed they are. Nor is it sufficient to make corrections to politicians’ incentives, by changing, for example, from proportional to first-past-the-post representation when electing members of parliament.

:: Are you pessimistic or optimistic about dealing with this challenge?

If I were pessimistic, I would have to think the cause of the problem is values, which are very difficult to alter in the short term. Since I am optimistic, I think that, whatever the values are, the political conduct of citizens is affected above all by their information asymmetry, which is the main determinant of competition in the political market.

I consider it essential to reduce this information asymmetry in order to increase competition, so that the checks and balances can start working. In other words, given our more privately-oriented values, our tax system has to be much more transparent.

:: Transparency, that great challenge and not only fiscal transparency…

To make taxes more transparent would be a good first step but there are many others. For instance, institutional advertising should be made illegal. It now allows those governing us to advertise their achievements while concealing their mistakes, and gives them control over the press. Competition in the “market for ideas” that the media belong to is another ingredient that is needed in an open society. To remove the cultural propaganda apparatus of governments would be a minimum exercise in democratic hygiene. It would also put an end to the current dependence between intellectuals and State budgets.

:: Today the most important institutions of our democracy are being questioned for reasons of corruption, bureaucracy, a lack of connection with citizens. What do you think about this?

The institutional crisis is clear in that the Constitution of 1978 has been unable to establish a real separation of powers. Politicians and governors lie, town councils and regions are going bankrupt, and they are all gaily spending money they don’t have. And not only is no-one pursuing those responsible but hardly any measures are being taken to prevent the same problems from being repeated in the future.

:: What can be done?

Without separation of powers, accountability is impossible. But our separation of powers is limited. The executive is in the hands of endogamous parties prone to antisocial consensus. Legislative power serves as a mere employment agency for parties. And, with a few honorable exceptions, the regulatory bodies and, to a lesser extent at least so far, the judiciary, are just an extension of the parties.

Moreover, the parties are governed internally like dictatorships, with no room for debate or discrepancy. Instead of productive competition, which can be the source of ideas and new proposals, there is unproductive competition for power and for the privileges that stem from it.

It would also be essential to separate the judiciary from the executive, re-professionalizing judges, starting with the General Council of the Judiciary and the Constitutional Tribunal.

:: What about re-professionalizing the Administration?

That, too, is necessary, because it has grown excessively and the management levels have become politicized. We should turn both processes round. One the one hand, we need to strengthen the central core of the State that  produces true public goods —the judiciary, the police, the army—and, on the other, we need to trim the Administration of all the bodies and services that should either not exist (such as business promotion bodies) or should be provided privately with varying degrees of public funding (health care, primary and secondary education). And it is not just a problem that these areas are in the hands of the regions, which some people seem to think. We need to reinvent the whole of the public administration, making it smaller and more focused on its “core competencies”.

:: It seems to be becoming fashionable to claim dation in payement as a mechanism for settling a mortgage debt. You have done research into this. Can you summarize it for us?

For existing mortgage loans, compulsory dation in payment (i.e., approximately equivalent to treating loans contracted as recourse loans as non-recourse mortgage loans) would be unfair. Why should creditors and, in the case of the bankrupt savings banks, taxpayers and sensible debtors subsidize reckless debtors? Why should citizens who did not play the lottery of the real estate bubble subsidize those who did? This would also be reckless because it would go against the rule of law at a time when there are already doubts about the solvency of our public treasury and the soundness of our institutions.

:: Would it affect future loans?

Changing the rule for future loans would also be a serious mistake. In Spain, as in most of the developed world, creditors and debtors prefer recourse mortgage loans with unlimited personal liability. So, we must interpret that this is optimal for those contracting, especially when there is substantial competition amongst lenders, and especially because this exercise in contractual freedom does not cause negative externalities for third parties. In fact, it is limited liability wtat causes systemic externalities, as has been seen in the United States in those states in which the law forces the parties to limit the debtor’s liability.

In general, solutions to these and to many other contractual problems that have arisen with the crisis need to respect the rule of law. This means contracts must be enforced unless the judge finds that there have been contract failures such as, e.g., misrepresentation.

For mortgage contracts, I argue in a recent paper that it is necessary to facilitate private, voluntary negotiation of dation in payment. This can be done simply by eliminating the large fiscal disadvantage involved in comparison with foreclosure.

:: What are the three main myths about economics held by citizens?

It’s a good question. Firstly, I don’t really believe that it is only citizens that hold economic myths. Most intellectuals and even many economists also believe in them, at least in practice.

Myth number one. The essential myth is that of “solutionability”, that is, thinking that the economic problem is easier to resolve than problems that can be solved by physical science or medicine. This myth is what lies behind the socializing idealism of both revolutionaries and social democrats. For economists, it is a blessing because it means that people believe the market can be supplanted. For example, it might seem easy to give jobs to the unemployed, easier than placing a man on the moon. But economics is a much more complex system than a space rocket or a living being. The information a country needs to coordinate its economy is huge and is not given; it has to be produced and put together. The former Soviet Union employed as many as 18 million civil servants in planning-related tasks, and we know how little they achieved not only with regard to poverty but also inequality.

The market is the master planner. It may not be perfect but it has fewer weaknesses than intentional, and inevitably political, intervention in the economy. As an imperfect tool it needs to be helped by good institutions, such as independent judges and sensible laws. But the myth or the desire for solutionability make us prevent it from working well. For example, in order to avoid the damage caused by closing down a bank or a company, we provide a bailout, thus seriously distorting competition and, worse still, often just postponing the inevitable collapse. A case in point, one that lasted for over a century, was the coal-mining sector in Asturias, and as a result that region is now in a dead end.

Myth number two is that of false justice. It emerges in redistributive decisions, when their systemic effects in terms of inefficiency and even of injustice are forgotten. Such effects can often be seen in judicial or legislative decisions that repeal the terms of contracts that were freely established by the parties.

Such decisions are often the result of compassion. They aim to protect a weak or unfortunate party, but the consequence is damage to all future parties with the same characteristics. For example, a recent law has raised the minimum, non-seizable income to help today’s low-income mortgage debtors, but in fact it damages all future low-income workers because it will inevitably make things much more difficult for them to obtain a mortgage in the future.

Similar effects have arisen in the home rental market. Over-protection of tenants has meant that fewer properties are available for rent, that rental prices are higher, that more guarantees are required, and that the sector has become artisan, homespun, and, though it  may sound incredible, less developed than it was a hundred years ago.

Also in the labor market. Franco’s laws, which were hardly altered by later laws such as the Workers’ Statute apart from the matter of trade union freedom, gave many additional rights to workers. That probably benefited those who were in permanent employment at the time, but was damaging for those who under these new conditions could not find anyone ready to employ them, the same situation that we see today.

The reasoning behind these cases is always the same. The decision-maker’s conscience is clear because wealth is being re-distributed among the parties to current contracts but, in the future, weak parties will find it increasingly difficult to enter into contracts. But such gain is hidden and does not affect the conscience and compassionate reputation of the reformer.

In order to benefit insiders who have a contract, outsiders who do not are damaged because they are unlikely to ever be party to such a contract or, if they are, it will be at a much higher price.

Myth number three is a very fashionable one, the “conspiracy” myth, that is, the belief that the cause behind a loss are the evil workings of other individuals who benefit from the situation at the cost of the losers. This was the case of Jews in the past, and today is the case of “speculators” and English-speaking financiers regarding the public debt or the debt risk premium or even, according to some people, our German neighbors in relation to the euro.

This third myth also has undesirable consequences. For example, it affects the activity of those who go against other people’s optimistic criterion so they invest their money in the opposite direction and obtain a profit when their fears prove to have been founded, but only if this actually happens. This benefit leads observers —especially if they have lost money— to believe that such contrary investors were the cause of the crisis. They are mixing up the cause and the consequence and sometimes end up shooting the messenger.

We disparagingly describe pessimists as “speculators”, unlike the optimists, even though both types of investor are equally speculative and nobody can buy without someone selling. And, in fact, such investors who go against the grain actually play a useful social function because the earlier they act the sooner the bubbles will burst. But such investors tend to appear late because it is very risky to go against the flow and we often shoot, or at least, expropriate the messenger.

:: You have already mentioned labor regulation in Spain but can you expand on your opinion?

Labor law is a good example of how over-protection destroys what it sets out to protect. It helps those who are employed when enacted, but it prevents those who are not from finding jobs in the future. It forgets that two people do not contract if one is not interested. Even the trade unions are perfectly well aware of this, as shown by the discrepancy between their opinions and their acts. They say they are against liberalization of labor relations but, when they have to pay, they are the first to act like any other employer. They employ temporary rather than permanent staff, and they resort to redundancy schemes just like any other employer.

Do you think we need a completely new labor law paradigm, as in Austria for example?

I don’t know the details of the Austrian model, but in general I don’t have much faith in institutional transplants. The solution is to truly liberalize the labor laws which, as I’ve already said, are still essentially those of Franco. Our problem is a very simple one, and everyone knows what the solution is, as is clear from the behavior, though not the declarations, of the trade unions.

But let me add something on the matter of transplants. Recently, one of our best economists spoke in favor of “legislative changes to standardize the economic structure of the Eurozone”. But it’s not that easy. Our problems cannot be solved by copying Austrian labor relations, German vocational training or Finnish schooling. We have to find solutions that suit our characteristics, especially our resources, our values and, in the specific case of legislation, our poor capacity for law enforcement.

My intuition tells me that our capacity for following models that work in Northern Europe is limited. We are more individualistic and we need institutions that take this into account. We need more individualized incentives. The solutions probably need to be more liberal (in the classic sense of the word) than those for Northern Europe, but today they are much less liberal.

:: What is the ideal agenda for returning to a growth path? Are there any short-term solutions?

We have to learn to be patient. Setting up the reforms will take many years, and the results will take even longer to appear. In the short term, internal devaluation is needed together with drastic reductions in public expenditure and Social Security contributions in order to reduce our costs, to encourage us to consume and import less, and to allow us to export more. Unfortunately, so far only the easy bit has been done, that is, income tax and VAT have been raised, but there has been no substantial reduction in Social Security contributions.

:: What does Spain need to create an attractive ecosystem for business?

All firms need are freedom and equality. Freedom involves returning power to individuals so that they can transact as they wish: converting compulsory rules into default rules, that is, rules that save on transaction costs but do not hold back organizational innovation.

Equality requires a reasonable fiscal framework, with lower rates but better enforcement, making it possible for the most efficient to receive the reward they deserve. This requires reasonable tax regulations, serious punishment for idlers and tax evaders and the disappearance of less efficient firms, whatever their size or alleged strategic nature.

Unfortunately, those in charge insist on complicating the playing field for businesses. Not only do they constantly bring out new regulations that prevent the search for optimum organizational methods, but they promote inequality.

:: What lies behind that inequality?

First they tax, then they subsidize selectively, in line with fashion and the political weight of the various sectors. In this way, they only generate public employment and end up spending twice as much. Apart from increasing their own power, which is their real objective, they distort comparative advantage. It is important to realize that this advantage is something that only entrepreneurs are able to identify. Only they have the right incentives to find it. Politicians and bureaucrats have no idea and lack the incentives to learn about it. They would never have dreamed of searching for the advantage of Zara in Galicia, even though Zara is by far the best company that this country has produced.

:: Does Zara have the recognition it deserves?

Recently they gave its founder the Cross of Civil Merit which, to me, seems like a very miserly decoration for the person who has possibly contributed most to the country’s wellbeing. Especially if we remember that the Collar of Civil Merit, a higher-ranking decoration, has been awarded to people like Fraga, Roca or Solbes, the sign of whose public contribution is, to say the least, debatable. I am afraid our society continues to not appreciate the merit of model entrepreneurs while it praises mediocre politicians. The signal we are giving young Spaniards could not be worse. And politicians will eventually claim to correct things with new laws and added bureaucracy to promote entrepreneurship. We must learn the importance of recognizing success, and of being grateful to those who achieve it.

:: Is it absurd that people who could work here have to emigrate to Germany to work?

It is not absurd for our young people to emigrate because they are worth more outside Spain than here. And this is a situation that has been a long time in the pipeline. Emigration was, and is, the logical consequence of ludicrous labor laws. It happened back in the 1950s and 60s, and continues to happen today. The years after entering both the European Union and the euro were just anomalous parentheses. And it is even more reasonable for well-trained young people to emigrate. For the same cost, the most valuable resources travel furthest. Moreover, we have spent too much on university education and not enough on primary schooling. They are worth more abroad.

 

:: Now, to close, please complete the following sentences:

            1.- My greatest failure … A certain predilection for analyzing unsolvable problems.

            2.- What I learnt from this failure … The value of routine.

            3.- Success for me … Managing that routine.

            4.- A leading writer who’s always been with me … It’s difficult to choose between Coase and Hayek.

            5.- What I do to be organized and productive … I’m not at all well-organized.

            6.- My purpose in life … is to satisfy my curiosity.

            7.- I’m worried … that Spain might follow the path of Argentina. This is likely to happen if we end up leaving the Eurozone.

            8.- A blog … I think “Nada es gratis” has done a great service to the country.

            9.- An initiative that has surprised me in Spain … Above all, Zara. Also Mercadona, and the young champions such as Rafa Nadal and the like. They have all shown that, with freedom and organized competition, like in sport, Spaniards can stand alongside the best.

            10.- A place for restoring my personal peace of mind … La Vega de Liordes. Since it’s difficult to get there, I don’t think my mentioning it is likely to cause too much congestion.

 

[We at Sintetia are hugely grateful to Benito Arruñada, for his excellent disposition, for his great capacity as a communicator and for being prepared to discuss anything. We would love to talk with him for hours and hours because he is pure intellectual combustion. We publicly express our thanks.]

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