Academic Year 2013-2014 Lectures on: Economics of Sustainable Development

1. Academic Year 2013-2014Lectures on: Economics of Sustainable Development Prof. Alessandro Vercelli Objectives: Critical introduction to the theory of Sustainable Development and its application to the Global Economy in the light of the Great Recession Recommended prerequisites: basic notions of macroeconomics, microeconomics and statistics

2. Contents The lectures focus on the sustainability of global development connecting theory, methodology and the analysis of the empirical evidence In particular the lectures will analyse in some detail the following themes: -the “subprime” financial crisis as a consequence of unsustainable development -globalization and sustainable development -the Kuznets curve and social sustainability -the environmental Kuznets curve and environmental sustainability, -globalization and health, -happiness, health and sustainability -the sustainability gap of the energy system and climate change, -corporate social responsibility (CSR) and the sustainable firm, -the co-evolution of economic liberalism and the globalization of markets, -the policy strategies towards the sustainability of global development

3. Reading list: main references Main references: -Borghesi, S. and A. Vercelli, 2008, Sustainable Globalization. Social and Environmental Conditions, Basingstoke and New York, Palgrave Macmillan -Stiglitz, J.E, 2012, The Price of Inequality, Allen Lane. London, 2012 See also: -Stiglitz, J.E., 2006, Making globalization work, New York, Norton -Stiglitz, J.E., 2010 (2nd updated edition), Freefall. Free markets and the Sinking of the global Economy, London, Penguin Books -Krugman, P., 2012, End this Depression Now!, Norton, New York

4. Type of exams • No partial examination • Final examination: written

5. Audience • Magisterial degrees • (1° year) Economia dell’Ambiente e dello Sviluppo: 9 credits • (1° year) Management and Governance (curriculum Accounting and Management): 6 credits • (2° year) Finance: 6 credits

6. Venue and timetable Wednesday 10.00-12.00 lecture room 11 Thursday 10.00-12.00 lecture room 5 18.00-20.00 lecture room 3 added until Thursday 17 of April Friday 10.00-12.00 lecture room 9

7. Economics of sustainable development 2013Lecture 1Prologue:SUSTAINABLE DEVELOPMENT AND THE GREAT RECESSION

8. Main thesis The Great recession is the expression of the unsustainability of the development model prevailing in the last 30 years Occasion to modify this model radically enough to make it sustainable Otherwise the process of development will become even more unsustainable and we are condemned to further crises bound to be even more destructive and uncontrollable We can break this vicious circle only by modifying immediately this vicious circle without waiting for the end of the crisis

9. The Great recession (2007-?):an epoch-making crisis Deep crisis of the “neo-liberal” cycle (1979-2010?) This is recognized also by some of the protagonists: “… the Reagan-Thatcher model, which favored finance over domestic manufacturing, has collapsed…the mutually reinforcing rise of financialization and globalization broke the bond between American capitalism and America’s interests” (Greenspan in late 2008, Governor of Fed from 1987 to 2006) Awareness of the gravity of problems→ no safe return to BAU in the economy and in economic theory also in the language: the usual name “subprime crisis” betrays a clumsy attempt to minimize scope and responsibilities of the crisis: → I will call it Great Recession This terminology emphasizes that the crisis is not yet over (↑ U and global recession in 2009 and again since 2010 in Europe)

11. The costs of the crisis Huge costs: April 2008: 10% of US GDP IMF itself {} only the costs for IF April 2009: 30% of US GDP All the DMs should reflect on responsibilities: financiers, industrialists, policy authorities, economists … Many elude responsibilities shifting them on an extremely unlikely and unpredictable combination of exogenous shocks and policy errors: black swan sighted“once in a century” (Greenspan) In my opinion the causes are mainly endogenous: flawed and unsustainable model of development

12. Long cycles in finance, USA, 1900-2008 the neoliberal cycle: 1979-? US Stock market valuation Source: Martin Wolf FT, 26.11.08 from Robert Shiller et al. CAPE = cyclically adjusted price-earning ratio Q = cyclically adjusted Tobin Q (stock-exchange value/net worth)

13. Unsustainable lightness I focus on neo-liberalism as a macroeconomic policy strategy overconfidence in the self-regulating virtues of unfettered markets → aims to shift the boundaries market/state in favor of marketsby pursuing ♠ public expenditure:↑privatization and ↓welfare state ♣ regulation and supervision:↑deregulation light { ♥ concern for the social capital:↑inequality and ↑poverty ♦ concern for the natural capital: ↑scarcity and ↑pollution this lightness proved to be unbearable: → model of growth without development that is unsustainable from the economic, financial, social and environmental points of view 13

14. The emergence of the NL paradigm Typically,the ruling policy strategy is blamed for a severe and persistent crisis remove the causes of the crisis →new policy strategyto {emerges avoid new crises This is what happened in the period from the late 1960s-early 1970s (workers and students struggles) and during the following stagflation in the rest of the1970s Economic NL in the version of NCEcs emerged as winner of a long and hot struggle against the Keynesian policy strategy 14

15. The fight against Keynesianism The Keynesian policy strategy considered asinconsistent with equilibrium and thus efficiency: Real equilibrium suboptimal:excessive interference of the state excessive public expenditure countercyclical policies discretionary monetary policies Monetary equilibrium:inflationary bias in the real economy full employment policies countercyclical policies deficit spending → Phillips curve as a menu of policy choices 15

16. Phillips curve in the late 1960s and 1970s ∆w/w U U* 16

17. Recipes to sustain the optimum equilibrium Accepta vertical Phillips curve at the natural rate of unemployment full employment policies Forsake{ countercyclical policies rigid monetary policy rule Adopt fixed policy rules { budget equilibrium Focus on structural policiesto shift economic decision power from the state to the market: privatization and deregulation 17

18. 4 Phases 1979 Mrs Thatcher The neoliberal policy strategy adopted since { 1980 Reagan administration 4 phases: A) The Great Disinflation: 1979-1987 B) The Roaring 1990s: 1990-2000 (Krueger and Solow, 2002; Stiglitz, 2003) C) The Zero Years: 2000-2007 (Krugman, 2009: the big zero decade) D) The Great recession: 2007-2014? 18

19. A) The Great Disinflation: 1979-1987 The Great Disinflation:monetarist phase(inspired by the monetary equilibrium business cycle of Lucas) Initiated and pursued by Paul Volker (chairman of FED 1979-1987) trade unions strict monetary policy → weakening { producers of raw materials labor market and industrial relations → deregulation{ international markets (in particular financial markets) inflationary tensions in real markets overcome→ “Great Moderation”: better monetary policy stability of w and p even during the booms { ↑ flexibility of labor market →downward shift and flattening of the Phillips curve 19

20. Phillips curve in the late 1980s ∆w/w “Great Moderation” U U* 20

21. Collateral effects: increasing inequality Praised as great success of NL policies (not by the workers); however the same structural reforms immediately producedcollateral effects: 1° collateral effect: ↑ inequality of income distribution within countries → inversion of a downward trend persisting since WW1 this occurred in all the OECD countries while in many developing countries that deviated from NL precepts this did not occur (e.g. Brazil) 21

22. Inequality in the U.K., 1939-1996 (%) 56 52 48 44 40 36 Gini index 32 28 24 20 16 1985 1975 1945 1955 1965 1935 1995 1970 1990 1940 1950 1960 1980 2000 Fig. 5 Source: Brandolini (2002) 22

23. Inequality in the USA, 1929-1996 56 52 48 44 40 Gini index 36 32 28 24 20 16 1985 1975 1915 1945 1955 1965 1925 1935 1995 1970 1990 1940 1950 1960 1980 1930 1920 2000 Fig. 6 Source: Brandolini (2002) 23

24. Collateral effects: increasing poverty 2° collateral effect: acceleration in the number of poor people Contrary to the “Pareto law” and “Bhagwati hypothesis” the increase in inequality since the beginning of modernization played a crucial role in the increase of poverty “had the world distribution of income remained unchanged since 1820, the number of poor people would be less than 1/4th than it is today and the number of extremely poor people would be less than 1/8th of what is today” (Bourguignon and Morisson, 2002, p.733) Further increase of the poor and malnutrition in consequence of the Great Recession 24

25. Poverty trends (< $2 per diem) 25 Source: Bourguignon and Morisson (2002)

26. Collateral effects: slowdown of growth 3d collateral effect: slowdown of the trend of GDP growth ↑ inequality and poverty →↓ of growth trend of aggregate demandand thus also ofGDP ↓ growth trend Consequences{ ↓growth in OECD countries more than in developing countries less intoxicated by the NLPS therefore both the change in trend and the worse trend of OECD countries may be explained as a consequence of NL policies (applied more systematically in OECD countries) 26

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28. B) The roaring 1990s (1): 1987-2000 Since 1987 change in monetary policy(Greenspan, 1987-2006) preceded by a change in theory: from the monetary equilibrium business cycle of Lucas to the real business cycle of Kydland and Prescott (1982) “Greenspan put”: floor to the price of financial assets without a ceiling → the real inflationary bias replaced by a financial inflationary bias → Greenspan put: alters the relative price, risk and expectations of financial/real investment :↓ real investment→↓ growth →↑ U Consequence 1)doping of growth: ↑ indebtment of households to sustain aggregate demand ↑ deficit spending by the Reagan, Bush1 and 2 Administration -investment bubbles fed by excess liquidity and the implicit insurance of financial assets value (e.g. the “new economy” bubble) 28

29. B) The roaring 1990s (2) → ↓ risk perception Consequence 2){→↑ financial instability → ↑ financial fragility → environment liable to financial bubbles: increase in financial instability of the 18 main financial crises identified by Kaminsky and Reinhart (1999) in the second half of the past century (all post-deregulation): 3 occurred in the 2° half of the 1970s, 7 in the 1980s, 8 in the 1990s not global:circumscribed to a particular institution (LTCM, 1998), sector (US saving and loan associations, 1984), or country (Italy 1990, UK 1991, Japan 1992 …) All these episodes happened after specific acts of deregulation (Kaminsky-Reinhart) the prompt and generous bail-out of big FIs under financial stress paved the way for the global crises of the years ’00 1997 Asian crisis may be considered as the first global financial crisis (as it hit also the USA and Japan) but its center was not in the core of the system 29

30. C) The Zero Years: 2000-2007 The process of increasing financial stability culminates in the zero decade: two major global crises originated within the core of the system new economy crisis 2001: serious warning of a major disaster approaching but its structural causes were neglected → BAU also in this case monetary policy succeeded in thwarting the crisis sooner than expected, strengthening the confidence in the omnipotence of the invisible hand (helped bytheGreenspan’s visible hand) Speculation shifted from immaterial ICT goods to brick-and-mortar goods: first wave of the 2° global crisis: → bubble of the housing sector(US, UK, Spain, etc.) detonator → crisis of subprime and ARM mortgages { propagation of implosion 30

31. The Great Recession: 2007-?the detonator of the first wave -housing crisis: decline of prices in the 2nd half of 2006 → soft landing expected Detonator { -price of oil: from $63 in December 2006 to $147 in July 2008→ cost inflation → notwithstanding the emerging crisis, central banks reacted as usual from 2% in May 2004 by increasing the discount rate: Fed { to 6.25% in August 2008 31

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34. Oil production world summary(source: Energy Watch Group, 2007) 34

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36. The end of the “great moderation” Perverse interaction between financial, economic and environmental problems (in particular those related to the energy system based on fossil fuels) that makes clear the unsustainability of the NL growth regime → this brought to an end the era of “great moderation”: in the financial sector dual inflationary bias { in the real sector not ↑ wages (as in the Bretton Woods Era) but ↑ p resources This has been partly masked by the ongoing recession and the North-Africa and Middle-East turmoil, but cost-inflation will accelerate immediately with recovery jeopardizing its viability: the price of food and resources started to increase again in the second semester of 2009 36

37. The propagation mechanism The structural causes underlying the propagation mechanism have increased further its destructive potential In the Bretton Woods period the propagation mechanism was strong mainly within the real side of the economy: conflict on income distribution→ leapfrogging: steep Phillips curve shifting upwards → stop-and-go fluctuations, accelerating inflation, stagflation… Since the late 1970s deep transformation of the propagation process: → propagation effects mainly through the financial side of the economy in consequence of the structural transformations started in the early 1980s 37

38. Structural Changes in the neoliberal era (1) a) Globalization:growing global interconnection among DMs financial (immediate):→ sale to ↓D/Y → ↓p → ↓ Y (wealth effect) → ↑ D/Y: panic accelerating the process contagion{ real (rapid):↓ demand→↓ production → ↓ employment →↓ demand → interaction with financial contagion 38

39. Structural Changes in the neoliberal era (2) b) Securitization:propagation of systemic risk through the market assets → generalized moral hazard:no one responsible for evaluation { risk alibiprovided by NL economists:“market knows better” Derivatives: OTC from 10% (1980) to > 90% e.g. Mortgage-backed securities: spread risk in an unknowable way, Credit Default Swaps: the financial system cannot insure itself c) Shadow banking:propagation of systemic risk and financial fragility in an opaque way as they depend on off-balance sheets operations FIs too big to fail →transmission of financial fragility to the state →powerful and dangerous propagation process 39

40. Second wave -shock:speculation on sovereign debt in the Eurozone 2nd wave { -policy response:severe austerity measure the shock triggering the 2nd wave has been produced by the policy response to the first wave: 2nd stage of the same Great Crisis: “…finance was rescued, only to turn and bite its rescuer” (RMF 1, p.2) Blame on Keynesian policies of deficit spending but the historical record suggests the opposite 40

41. Source: IMF, GFSR, Apr. 2010 41

42. The hegemony of finance After the first major wave huge unprecedented bail-out of distressed big FIs composition and retribution of top management without conditions { support of the real economy Rescue plan of the EU in May 2010 ostensibly meant to rescue the sovereign debt of PIIGS but the main concern was in fact the protection of the balance sheets of heavily exposed banks of core countries (Germany and France) shifting the burden on taxpayers, public sector workers, and citizens at large (increase of unemployment, deterioration of pensions, services and so on) In the meantime bankers are set for record pay and bonuses for second year US: ↑4% in 2009 (J.P. Morgan); e.g.: Goldman Sachs projections 2010: revenue ↓ 13.5% while compensation ↑ 3.7 % 42

43. the revival of NLPS by the “deficit hawks” “Ricardian equivalence” → the multiplier of fiscal stimulus m = zero: Barro: ↓ current private E anticipating ↑ tax burden = ↑ public E RE and efficient financial markets: counter-factual Criticisms { 1<m≤2 in the US and is higher when U is higher large fiscal D/Y → ↑ r and inflation:this is false in current conditions while in the longer period it depends crucially on the dynamics of Y Blanchard-Perotti (2002):1% ↑ Y growth →↓ D/Y = 2.1% in the U.S. “Treasury view”:crowding out of private E, but lack of effective demand Jayadev-Konczal (2010) vs Alesina-Ardagna (2010) in growing economies Deterioration of expectations :worsened not because of state intervention but because of the austerity measures (BoE surveys) 43

44. The errors of economic policy 1:deregulation neoliberals:errors of economic policy authorities + shocks Hot debate { critics: market failures responsibilities deriving from a common cause: market fundamentalism → errors of policy as permissive factors repeal (1999) of the Glass-Steagall Act (1933) Deregulation { OTC (Over The Counter) derivatives all the postwar financial crises after deregulation of financial markets (Kaminsky and Reinhart)

45. The errors of economic policy 2: monetary policy “Greenspan put” (1987-2006) Monetary policy { “Bernanke put” (2006- ?): illusion that a financial crisis may be thwarted cheaply ↓ perception of risk by flooding the system of liquidity { ↑ moral hazard in the short period → Stabilization { but de-stabilizes in the long period (Minsky)

46. The errors of economic policy 3:structural policies ↑ inequality - Dismantlement of the welfare state{ → ↓ aggregate demand ↑ poverty -housing: Fanny Mae, Freddy Mac - Debt of households encouraged { -credit cards, consumption credit - firms (mainly FI) Effects: growing financial fragility { - households - state → vulnerability to shocks (oil, raw materials, food, climate...) N.B.: all these behaviors encouraged by market fundamentalism

47. The causes of the crisis: market failures exogenous factors We cannot attribute all the blame { policy errors Fundamental factor: endogenous propagation mechanism -housing: endogenous Also the detonator { -oil price: unsustainable model of development Macroscopic market failures: it does not exist (Stiglitz) -the invisible hand is invisible because { -coerced by visible hands In any case the real market is quite different from the perfect-competition one

48. The unsustainability of the existing development model Nexus betweensocial-environmental-financial-economic conditions: ↓welfare state and ↑ flexibility/precariousness of labor →↑inequality and poverty→ ↓growth of per capita income→ ↓aggregatedemand→ ↓PIL industrialists banks and governments supported thegrowth of GDPencouraging theindebtedness of households and firms→ ↑ → ↑ D/Y → ↑ financial fragility ofbanks, firms and households exogenous: ↑ oil price ← scarcity → ↓ vulnerability to shocks { endogenous: ↑ discount rate

49. The unsustainability of the existing development model ↑ production of biofuels andclimate change→↑price of food → further ↑ inequality and poverty →↑ financial fragility →↑ →↑ financial crisis →↑ real crisis →↑ recession →↑ unemployment → ↓ reduction of the oil p → ↓ investment in renewable energy sources →↑ climate change → economic recovery→↑ oil price →↑ stagflation → also the future growth will be unsustainable unless we radically modify the model of development → sustainable development

50. The ultimate cause of the crisis The ultimate cause of the crisis is the unsustainability of the model of development supported and promoted by toxic ideologies: • Fetishism of the market: securitization, indebtedness, laxity of supervisors, weakening of regulation, dismantling of the welfare state, flexibility and precariousness of labor, and so on → escape the pendulum between state and market through apt reforms meant to revive the participation of citizens and stakeholders • Fetishism of market-led growth:shared by classical and Keynesian(Ben Friedman) economists, entrepreneurs and unions, right-wing and left-wing parties → transition towards sustainable development that may go on even with a low rate of growth • Fetishism of market-led innovation: not always beneficial to citizens; in particular in finance often to elude controls and increase short-term profits → transition towards a model of sustainable innovation