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Game Theory Consider this: Could Western management techniques be successfully implemented in the countries of Central and Eastern Europe (CEE)? Granted, they have to be adapted, modified and cannot be imported in their entirety. But their crux, their inalienable nucleus can this be transported and transplanted in CEE? Theory provides us with a positive answer. Human agents are the same everywhere and are mostly rational. Practice begs to differ. Basic concepts such as the money value of time or the moral and legal meaning of property are non existent. The legal, political and economic environments are all unpredictable. As a result, economic players will prefer to maximize their utility immediately (steal from the workplace, for instance) than to wait for longer term (potentially, larger) benefits. Warrants (stock options) convertible to the company's shares constitute a strong workplace incentive in the West (because there is an horizon and they increase the employee's welfare in the long term). Where the future is speculation speculation withers. Stock options or a small stake in his firm, will only encourage the employee to blackmail the other shareholders by paralysing the firm, to abuse his new position and will be interpreted as immunity, conferred from above, from the consequences of illegal activities. The very allocation of options or shares will be interpreted as a sign of weakness, dependence and need, to be exploited. Hierarchy is equated with slavery and employees will rather harm their long term interests than follow instructions or be subjected to criticism never mind how constructive. The employees in CEE regard the corporate environment as a conflict zone, a zero sum game (in which the gains by some equal the losses to others). In the West, the employees participate in the increase in the firm's value. The difference between these attitudes is irreconcilable. Now, let us consider this: An entrepreneur is a person who is gifted at identifying the unsatisfied needs of a market, at mobilizing and organizing the resources required to satisfy those needs and at defining a long-term strategy of development and marketing. As the enterprise grows, two processes combine to denude the entrepreneur of some of his initial functions. The firm has ever growing needs for capital: financial, human, assets and so on. Additionally, the company begins (or should begin) to interface and interact with older, better established firms. Thus, the company is forced to create its first management team: a general manager with the right doses of respectability, connections and skills, a chief financial officer, a host of consultants and so on. In theory if all our properly motivated financially all these players (entrepreneurs and managers) will seek to maximize the value of the firm. What happens, in reality, is that both work to minimize it, each for its own reasons. The managers seek to maximize their short-term utility by securing enormous pay packages and other forms of company-dilapidating compensation. The entrepreneurs feel that they are "strangled", "shackled", "held back" by bureaucracy and they "rebel". They oust the management, or undermine it, turning it into an ineffective representative relic. They assume real, though informal, control of the firm. They do so by defining a new set of strategic goals for the firm, which call for the institution of an entrepreneurial rather than a bureaucratic type of management. These cycles of initiative-consolidation-new initiative-revolution-consolidation are the dynamos of company growth. Growth leads to maximization of value. However, the players don't know or do not fully believe that they are in the process of maximizing the company's worth. On the contrary, consciously, the managers say: "Let's maximize the benefits that we derive from this company, as long as we are still here." The entrepreneurs-owners say: "We cannot tolerate this stifling bureaucracy any longer. We prefer to have a smaller company but all ours." The growth cycles forces the entrepreneurs to dilute their holdings (in order to raise the capital necessary to finance their initiatives). This dilution (the fracturing of the ownership structure) is what brings the last cycle to its end. The holdings of the entrepreneurs are too small to materialize a coup against the management. The management then prevails and the entrepreneurs are neutralized and move on to establish another start-up. The only thing that they leave behind them is their names and their heirs. We can use Game Theory methods to analyse both these situations. Wherever we have economic players bargaining for the allocation of scarce resources in order to attain their utility functions, to secure the outcomes and consequences (the value, the preference, that the player attaches to his outcomes) which are right for them we can use Game Theory (GT). A short recap of the basic tenets of the theory might be in order. GT deals with interactions between agents, whether conscious and intelligent or Dennettic. A Dennettic Agent (DA) is an agent that acts so as to influence the future allocation of resources, but does not need to be either conscious or deliberative to do so. A Game is the set of acts committed by 1 to n rational DA and one a-rational (not irrational but devoid of rationality) DA (nature, a random mechanism). At least 1 DA in a Game must control the result of the set of acts and the DAs must be (at least potentially) at conflict, whole or partial. This is not to say that all the DAs aspire to the same things. They have different priorities and preferences. They rank the likely outcomes of their acts differently. They engage Strategies to obtain their highest ranked outcome. A Strategy is a vector, which details the acts, with which the DA will react in response to all the (possible) acts by the other DAs. An agent is said to be rational if his Strategy does guarantee the attainment of his most preferred goal. Nature is involved by assigning probabilities to the outcomes. An outcome, therefore, is an allocation of resources resulting from the acts of the agents. An agent is said to control the situation if its acts matter to others to the extent that at least one of them is forced to alter at least one vector (Strategy). The Consequence to the agent is the value of a function that assigns real numbers to each of the outcomes. The consequence represents a list of outcomes, prioritized, ranked. It is also known as an ordinal utility function. If the function includes relative numerical importance measures (not only real numbers) we call it a Cardinal Utility Function. Games, naturally, can consist of one player, two players and more than two players (n-players). They can be zero (or fixed) - sum (the sum of benefits is fixed and whatever gains made by one of the players are lost by the others). They can be nonzero-sum (the amount of benefits to all players can increase or decrease). Games can be cooperative (where some of the players or all of them form coalitions) or non-cooperative (competitive). For some of the games, the solutions are called Nash equilibria. They are sets of strategies constructed so that an agent which adopts them (and, as a result, secures a certain outcome) will have no incentive to switch over to other strategies (given the strategies of all other players). Nash equilibria (solutions) are the most stable (it is where the system "settles down", to borrow from Chaos Theory) but they are not guaranteed to be the most desirable. Consider the famous "Prisoners' Dilemma" in which both players play rationally and reach the Nash equilibrium only to discover that they could have done much better by collaborating (that is, by playing irrationally). Instead, they adopt the "Paretto-dominated", or the "Paretto-optimal", sub-optimal solution. Any outside interference with the game (for instance, legislation) will be construed as creating a NEW game, not as pushing the players to adopt a "Paretto-superior" solution. The behaviour of the players reveals to us their order of preferences. This is called "Preference Ordering" or "Revealed Preference Theory". Agents are faced with sets of possible states of the world (=allocations of resources, to be more economically inclined). These are called "Bundles". In certain cases they can trade their bundles, swap them with others. The evidence of these swaps will inevitably reveal to us the order of priorities of the agent. All the bundles that enjoy the same ranking by a given agent are this agent's "Indifference Sets". The construction of an Ordinal Utility Function is, thus, made simple. The indifference sets are numbered from 1 to n. These ordinals do not reveal the INTENSITY or the RELATIVE INTENSITY of a preference merely its location in a list. However, techniques are available to transform the ordinal utility function into a cardinal one. A Stable Strategy is similar to a Nash solution though not identical mathematically. There is currently no comprehensive theory of Information Dynamics. Game Theory is limited to the aspects of competition and exchange of information (cooperation). Strategies that lead to better results (independently of other agents) are dominant and where all the agents have dominant strategies a solution is established. Thus, the Nash equilibrium is applicable to games that are repeated and wherein each agent reacts to the acts of other agents. The agent is influenced by others but does not influence them (he is negligible). The agent continues to adapt in this way until no longer able to improve his position. The Nash solution is less available in cases of cooperation and is not unique as a solution. In most cases, the players will adopt a minimax strategy (in zero-sum games) or maximin strategies (in nonzero-sum games). These strategies guarantee that the loser will not lose more than the value of the game and that the winner will gain at least this value. The solution is the "Saddle Point". The distinction between zero-sum games (ZSG) and nonzero-sum games (NZSG) is not trivial. A player playing a ZSG cannot gain if prohibited to use certain strategies. This is not the case in NZSGs. In ZSG, the player does not benefit from exposing his strategy to his rival and is never harmed by having foreknowledge of his rival's strategy. Not so in NZSGs: at times, a player stands to gain by revealing his plans to the "enemy". A player can actually be harmed by NOT declaring his strategy or by gaining acquaintance with the enemy's stratagems. The very ability to communicate, the level of communication and the order of communication are important in cooperative cases. A Nash solution:
The limitations of this approach are immediately evident. It is definitely not geared to cope well with more complex, multi-player, semi-cooperative (semi-competitive), imperfect information situations. Von Neumann proved that there is a solution for every ZSG with 2 players, though it might require the implementation of mixed strategies (strategies with probabilities attached to every move and outcome). Together with the economist Morgenstern, he developed an approach to coalitions (cooperative efforts of one or more players a coalition of one player is possible). Every coalition has a value a minimal amount that the coalition can secure using solely its own efforts and resources. The function describing this value is super-additive (the value of a coalition which is comprised of two sub-coalitions equals, at least, the sum of the values of the two sub-coalitions). Coalitions can be epiphenomenal: their value can be higher than the combined values of their constituents. The amounts paid to the players equal the value of the coalition and each player stands to get an amount no smaller than any amount that he would have made on his own. A set of payments to the players, describing the division of the coalition's value amongst them, is the "imputation", a single outcome of a strategy. A strategy is, therefore, dominant, if: (1) each player is getting more under the strategy than under any other strategy and (2) the players in the coalition receive a total payment that does not exceed the value of the coalition. Rational players are likely to prefer the dominant strategy and to enforce it. Thus, the solution to an n-players game is a set of imputations. No single imputation in the solution must be dominant (=better). They should all lead to equally desirable results. On the other hand, all the imputations outside the solution should be dominated. Some games are without solution (Lucas, 1967). Auman and Maschler tried to establish what is the right payoff to the members of a coalition. They went about it by enlarging upon the concept of bargaining (threats, bluffs, offers and counter-offers). Every imputation was examined, separately, whether it belongs in the solution (=yields the highest ranked outcome) or not, regardless of the other imputations in the solution. But in their theory, every member had the right to "object" to the inclusion of other members in the coalition by suggesting a different, exclusionary, coalition in which the members stand to gain a larger payoff. The player about to be excluded can "counter-argue" by demonstrating the existence of yet another coalition in which the members will get at least as much as in the first coalition and in the coalition proposed by his adversary, the "objector". Each coalition has, at least, one solution. The Game in GT is an idealized concept. Some of the assumptions can and should be argued against. The number of agents in any game is assumed to be finite and a finite number of steps is mostly incorporated into the assumptions. Omissions are not treated as acts (though negative ones). All agents are negligible in their relationship to others (have no discernible influence on them) yet are influenced by them (their strategies are not but the specific moves that they select are). The comparison of utilities is not the result of any ranking because no universal ranking is possible. Actually, no ranking common to two or n players is possible (rankings are bound to differ among players). Many of the problems are linked to the variant of rationality used in GT. It is comprised of a clarity of preferences on behalf of the rational agent and relies on the people's tendency to converge and cluster around the right answer / move. This, however, is only a tendency. Some of the time, players select the wrong moves. It would have been much wiser to assume that there are no pure strategies, that all of them are mixed. Game Theory would have done well to borrow mathematical techniques from quantum mechanics. For instance: strategies could have been described as wave functions with probability distributions. The same treatment could be accorded to the cardinal utility function. Obviously, the highest ranking (smallest ordinal) preference should have had the biggest probability attached to it or could be treated as the collapse event. But these are more or less known, even trivial, objections. Some of them cannot be overcome. We must idealize the world in order to be able to relate to it scientifically at all. The idealization process entails the incorporation of gross inaccuracies into the model and the ignorance of other elements. The surprise is that the approximation yields results, which tally closely with reality in view of its mutilation, affected by the model. There are more serious problems, philosophical in nature. It is generally agreed that "changing" the game can and very often does move the players from a non-cooperative mode (leading to Paretto-dominated results, which are never desirable) to a cooperative one. A government can force its citizens to cooperate and to obey the law. It can enforce this cooperation. This is often called a Hobbesian dilemma. It arises even in a population made up entirely of altruists. Different utility functions and the process of bargaining are likely to drive these good souls to threaten to become egoists unless other altruists adopt their utility function (their preferences, their bundles). Nash proved that there is an allocation of possible utility functions to these agents so that the equilibrium strategy for each one of them will be this kind of threat. This is a clear social Hobbesian dilemma: the equilibrium is absolute egoism despite the fact that all the players are altruists. This implies that we can learn very little about the outcomes of competitive situations from acquainting ourselves with the psychological facts pertaining to the players. The agents, in this example, are not selfish or irrational and, still, they deteriorate in their behaviour, to utter egotism. A complete set of utility functions including details regarding how much they know about one another's utility functions defines the available equilibrium strategies. The altruists in our example are prisoners of the logic of the game. Only an "outside" power can release them from their predicament and permit them to materialize their true nature. Gauthier said that morally-constrained agents are more likely to evade Paretto-dominated outcomes in competitive games than agents who are constrained only rationally. But this is unconvincing without the existence of an Hobesian enforcement mechanism (a state is the most common one). Players would do better to avoid Paretto dominated outcomes by imposing the constraints of such a mechanism upon their available strategies. Paretto optimality is defined as efficiency, when there is no state of things (a different distribution of resources) in which at least one player is better off with all the other no worse off. "Better off" read: "with his preference satisfied". This definitely could lead to cooperation (to avoid a bad outcome) but it cannot be shown to lead to the formation of morality, however basic. Criminals can achieve their goals in splendid cooperation and be content, but that does not make it more moral. Game theory is agent neutral, it is utilitarianism at its apex. It does not prescribe to the agent what is "good" only what is "right". It is the ultimate proof that effort at reconciling utilitarianism with more deontological, agent relative, approaches are dubious, in the best of cases. Teleology, in other words, in no guarantee of morality. Acts are either means to an end or ends in themselves. This is no infinite regression. There is bound to be an holy grail (happiness?) in the role of the ultimate end. A more commonsense view would be to regard acts as means and states of affairs as ends. This, in turn, leads to a teleological outlook: acts are right or wrong in accordance with their effectiveness at securing the achievement of the right goals. Deontology (and its stronger version, absolutism) constrain the means. It states that there is a permitted subset of means, all the other being immoral and, in effect, forbidden. Game Theory is out to shatter both the notion of a finite chain of means and ends culminating in an ultimate end and of the deontological view. It is consequentialist but devoid of any value judgement. Game Theory pretends that human actions are breakable into much smaller "molecules" called games. Human acts within these games are means to achieving ends but the ends are improbable in their finality. The means are segments of "strategies": prescient and omniscient renditions of the possible moves of all the players. Aside from the fact that it involves mnemic causation (direct and deterministic influence by past events) and a similar influence by the utility function (which really pertains to the future) it is highly implausible. Additionally, Game Theory is mired in an internal contradiction: on the one hand it solemnly teaches us that the psychology of the players is absolutely of no consequence. On the other, it hastens to explicitly and axiomatically postulate their rationality and implicitly (and no less axiomatically) their benefit-seeking behaviour (though this aspect is much more muted). This leads to absolutely outlandish results: irrational behaviour leads to total cooperation, bounded rationality leads to more realistic patterns of cooperation and competition (coopetition) and an unmitigated rational behaviour leads to disaster (also known as Paretto dominated outcomes). Moreover, Game Theory refuses to acknowledge that real games are dynamic, not static. The very concepts of strategy, utility function and extensive (tree like) representation are static. The dynamic is retrospective, not prospective. To be dynamic, the game must include all the information about all the actors, all their strategies, all their utility functions. Each game is a subset of a higher level game, a private case of an implicit game which is constantly played in the background, so to say. This is a hyper-game of which all games are but derivatives. It incorporates all the physically possible moves of all the players. An outside agency with enforcement powers (the state, the police, the courts, the law) are introduced by the players. In this sense, they are not really an outside event which has the effect of altering the game fundamentally. They are part and parcel of the strategies available to the players and cannot be arbitrarily ruled out. On the contrary, their introduction as part of a dominant strategy will simplify Game theory and make it much more applicable. In other words: players can choose to compete, to cooperate and to cooperate in the formation of an outside agency. There is no logical or mathematical reason to exclude the latter possibility. The ability to thus influence the game is a legitimate part of any real life strategy. Game Theory assumes that the game is a given and the players have to optimize their results within it. It should open itself to the inclusion of game altering or redefining moves by the players as an integral part of their strategies. After all, games entail the existence of some agreement to play and this means that the players accept some rules (this is the role of the prosecutor in the Prisoners' Dilemma). If some outside rules (of the game) are permissible why not allow the "risk" that all the players will agree to form an outside, lawfully binding, arbitration and enforcement agency as part of the game? Such an agency will be nothing if not the embodiment, the materialization of one of the rules, a move in the players' strategies, leading them to more optimal or superior outcomes as far as their utility functions are concerned. Bargaining inevitably leads to an agreement regarding a decision making procedure. An outside agency, which enforces cooperation and some moral code, is such a decision making procedure. It is not an "outside" agency in the true, physical, sense. It does not "alter" the game (not to mention its rules). It IS the game, it is a procedure, a way to resolve conflicts, an integral part of any solution and imputation, the herald of cooperation, a representative of some of the will of all the players and, therefore, a part both of their utility functions and of their strategies to obtain their preferred outcomes. Really, these outside agencies ARE the desired outcomes. Once Game Theory digests this observation, it could tackle reality rather than its own idealized contraptions. Germany, Economy of On Monday, the unthinkable happened. The European Commission has initiated "excessive budget deficit" procedures against the two biggest members of the European Union, France and Germany, for having breached the budget deficit targets prescribed by the much-reviled Stability Pact. This seems to have vindicated the voices in both countries who blame their economic woes on the stringent requirements of the compact intended to stabilize the euro. Yet, the Stability Pact is merely a convenient scapegoat. It is because Germany brazenly -and wisely - ignored it that it is being cited by the Commission. Still, despite an alarming budget deficit of close to 4 percent of gross domestic product (GDP) this year and a transfer from Brussels of 0.25 percent of GDP as flood aid, the German economy is stagnant. It is set to grow by 0.5 percent this year and by 1.5 percent in 2003, says the government. Not so, counter its own council of independent economic advisors, the "five wise men". Growth this year will be a paltry 0.2 percent and next year, fingers crossed, 1 percent. The IMF is more optimistic. Growth in 2003 will be 1.75 percent, it predicted last week. Even so, German GDP is growing at 3 GDP points below trend. The excess capacity translates to deflationary pressures on prices and to rising unemployment, currently at over 4 million people, or almost 10 percent. One of every six adults in the eastern Lander is out of work. The much-observed monthly index of business expectations, published by the ZEW Institute, predicts a nosedive in economic activity in the first half of 2003. Moody's have just downgraded the rating of yet another German household name, the Allianz insurance group. German banks are caught in a worrisome spiral of loans gone sour, interest rates set stiflingly high by the European Central Bank (ECB), the removal of state subsidies and yet another looming recession. Business confidence is extinct, unemployment and bankruptcies soaring. More than 1000 firms go belly up every week - three times the rate in 1992. The two pillars of the German economy - the small, family-owned, businesses (Mittelstand) and the export industries - are in dire shape. Eurostat, the European Union's statistics bureau, has just announced that industrial output in the eurozone during the third quarter actually contracted by 0.1 percent. In the USA, Germany's other big export destination, if one takes intermediate goods into account, the anodyne "recovery" relies entirely on the ominous profligacy of ever less solvent consumers. Germany's problems - like Japan's - are structural. It is ageing fast. It is inordinately expensive. It is bureaucratic. Its banks are tottering, unable to create new credits. The state is overweening and interventionary. Many of the country's industries are already uncompetitive. Germany's labor markets are rigid, its capital markets either dissolute or ossified. The scandal-ridden small caps Neuer Markt was closed down this year, having lost more than 90 percent of its value since March 2000. Both the average German and decision-makers are loth to reform a virulent system of prodigal social welfare coupled with all-pervasive rent-seeking by various industries, especially in construction, banking, the media and agriculture. Germany is living off a past of miraculous wealth creation. But the signs are that it may have exhausted the principal. Germany faces a series of painful choices between unpalatable alternatives. The Minister of Finance, Hans Eichel, must either hike taxes - including on wages, in contravention of campaign promises only two months ago - or lose control over the public finances. According to new proposals, pension contributions will go from 19.1 to 19.5 percent. Another idea is to set a minimum corporate profit tax, thus preventing businesses from using accumulated tax credits. A host of business-friendly tax loopholes and deductibles will be abolished. These measures will surely discourage hiring and investments and may cause long-suffering multinationals - both German and foreign - to relocate. German household debt is higher than in America. But taxes on capital gains and interest - about to be raised - discourage savings. This will be further compounded by the ballooning deficits of both central and state budgets. Even if all the right ideas are implemented, including massive spending cuts, the government, according to Business Week, will have to borrow $32 billion this year - crowding out the private sector. Fiscal largesse is considered to be an automatic stabilizer in a recessionary economy. But whether it is depends on how much new money is included in government spending and how productively it is targeted. Japan's river of squandered supplementary budget packages, for instance, did little to revive the moribund economy. In an apocalyptic analysis published last week, The Economist warned that Germany is under a serious threat of deflation. It endured an asset bubble, it has large private sector debts, a weak banking system, structural rigidities, it suffers from political and social paralysis and a shrinking and ageing population. "Our analysis suggests that Germany has more symptoms of the Japanese disease than America." - concluded the paper somberly. Germany is luckier and more resilient than Japan, though. It is subject, willy-nilly, to intense competition within the single market and thus is being forced to shape up. Its banks, though in crisis, are far more robust than Japan's. Business inventories may be already declining. Furthermore, most of Germany's excess spending goes on welfare benefits. Poor people consume more of their disposable income than does the middle class. Thus, welfare checks almost immediately translate into consumption. Even the IMF warned Germany last week not to cut its budget deficit too fast lest it damages a hesitant economic recovery. Moreover, interest rates in the eurozone - and the euro's exchange rate - are bound to come down as fiscal rectitude is restored and industrial production plummets. German business confidence largely hinges on the ECB's inflation-obsessed policies. A relaxation in monetary policy will result in an export-led investment mini-boom and a reversal of the rising trend of unemployment. Declining oil prices as the Iraqi conflict unwinds one way or the other will help a nascent recovery. Should the government implement its own recommendations for labor-market and pensions reforms, it will have removed growth-stifling rigidities. Yet, averting recession and the much-feared risk of deflation would do nothing to tackle the fundamental problems faced by the German economy. According to the Financial Times Deutschland, the Bundesbank warned on Monday that the government's budget plans will actually harm prospects for long term growth. Hobbled by a partisan, opposition-controlled, upper house and an election victory barely snatched from the jaws of defeat, there is little Gerhard Schroeder, the embattled Chancellor, would be able to do to counter the increasingly militant and strike-happy unions. The two axes of Germany's multiple problems are its monstrous welfare system and no less overwhelming red tape and bureaucracy. Employees and workers pay one seventh of their wages to finance only the increasingly troubled healthcare system. Another fifth goes into retirement funds. According to The Economist. labor costs are set to grow to an unsustainable 42 percent of gross wages next year. The welfare state is sacrosanct. Schroeder himself admitted as much last month. In a speech to the nation, he taunted the opposition. Voters re-elected him, he boasted, because he "expressly did not decide to scrap the welfare state, cut benefits indiscriminately and roll back employees' rights" - though "some entitlements, rules and allowances of the German welfare state" must be reconsidered, he added, incongruously. The opposition promptly - and somewhat justly - accused him of "electoral fraud" for hiding the true state of the economy and making false campaign promises. German workers indeed want more of the same, as the re-elected Chancellor has astutely observed. IG Metall, Germany's largest trade union, called for both the provisions of the Stability Pact and the ECB's monetary policy to be relaxed to allow for "offensive impulses (read: more government spending) against the stagnant economy." German workers, concerned with job security and bent on escalating wages, actually prevent the creation of new jobs for the unemployed by opposing the formation of part time and contract "mini-jobs". Germans are wealthy. Average annual income, according to the BBC, is $25,500. The unemployed in Germany are better off than many workers in Britain. But, as work ethic, good corporate and state governance and plant modernization increased throughout Europe, they declined in Germany, David Marsh, of the Droege Group in Dόsseldorf told the BBC. Since unification, 12 years ago, Germany has avoided facing reality by embarking on a borrowing binge, partly to finance a net annual transfer of 4 percent of GDP to the former East Germany. In all fairness, west Germany's performance is still impressive. It is being dragged down by the eastern parts whose productivity, compared to the west's, is one third lower and unit labor costs one tenth higher. Unemployment in the east is double the west's, the infrastructure is decrepit and brain drain is ubiquitous. Germany will survive. But the gradual decline of the third largest economy in the world and the most prominent in Europe might have serious geopolitical implications. The first to pay a heavy price would be the economies of central and eastern Europe. Germany is by far their largest export market and Germans the biggest foreign investors. It absorbs close to 40 percent of the exports of Poland, the Czech Republic and Austria. Germany also holds a majority of the sovereign and private sector debts of these countries - more than half of Russia's $140 billion in external debt, for instance. During the devastating floods, according to Stratfor, the strategic forecasting consultancy, Germany was able to call on $172 million in Russian obligations. These links within an emerging common economic sphere are mutually-beneficial. Hence Germany's avid sponsorship of EU enlargement. Central and eastern European polities will not be the only casualties of a German meltdown. The European Union itself will suffer greatly. Germany and France form the economic core of the alliance. Germany, once the economic powerhouse of the continent with one quarter of the EU's GDP, could well have become a drag. Until recently, according to the Economist Intelligence Unit and the IMF, Germany was the target of one third of Dutch and Swiss exports and one quarter of Danish, Belgian and French goods. Will Germany recover? Most likely so. Will the recovery lead to a new era of prosperity? Unlikely. It is hard to contemplate painful reforms on a full stomach, regardless of how imminent the dangers. What Germans need is another crisis, a shock to wake them up from the stupor of affluence. It may well be on its way. Alas, the cost of German reawakening is likely to be paid by every single European country - except Germany. Golden Shares In a rare accord, both the IMF and independent analysts, have cautioned Bulgaria that its insistence on keeping golden shares in both its tobacco and telecom monopolies even after they are privatized - will hinder its ability to attract foreign investors to these already unappealing assets. Bulgaria's $300 million arrangement with the IMF - struck late last year by the new and youthful Minister of Finance in the Saxe-Coburg government - is not at risk. Golden shares are usually retained by the state in infrastructure projects, utilities, natural monopolies, mining operations, defense contractors, and the space industry. They allow their holders to block business moves and counter management decisions which may be detrimental to national security, to the economy, or to the provision of public services (especially where markets fail to do so). Golden shares also enable the government to regulate the prices of certain basic goods and services - such as energy, food staples, sewage, and water. But, in practice, golden shares serve less noble ends. Early privatizations in Central and Eastern Europe were criticized for being crony-ridden, corrupt, and opaque. Governments were accused of giving away the family silver. Maintaining golden shares in privatized enterprises was their way of eating the privatization cake while leaving it whole, thus silencing domestic opposition effectively. The practice was started in Thatcherite Britain and Bulgaria is only the latest to adopt it. The Bulgarian golden share in Bulgatabak is intended to shield domestic tobacco growers (most of them impoverished minority Turks) from fierce foreign competition in a glutted market. Golden shares are often used to further the interests of interest groups and isolate them from the potentially devastating effects of the global market. The phenomenon of golden shares is not confined to economically-challenged states selling their obscure monopolies. On December 1989, the Hungarian Post was succeeded by three firms (postal, broadcasting, and a telecom). One of the successors, MATAV, was sold to MagyarCom (currently owned by Deutsche Telekom) in stages. This has been the largest privatization in Hungary and in Central and Eastern Europe. The company's shares subsequently traded in Budapest and on NYSE simultaneously. MATAV embarked on an aggressive regional acquisitions plan, the latest of which was the Macedonian Telecom. Yet, throughout this distinctly capitalistic and shareholders-friendly record, the Hungarian government owned a golden share in MATAV. Poland's Treasury maintains a golden share in LOT, its national carrier, and is known to have occasionally exercised it. Lithuania kept a golden share in its telecom. Even municipalities and regional authorities are emulating the centre. The city of Tallinn, for instance, owns a golden share in its water utility. Hungary's largest firm, Hungarian Oil and Gas (MOL), was floated on the Budapest Stock Exchange (1994-1998). The state retains a "golden share" in the company which allows it to regulate retail gas prices. MOL controls c. 35% of the fuel retail market and owns virtually all the energy-related infrastructure in Hungary. It is an aggressive regional player, having recently bought Slovnaft, the Slovak oil and gas company. Theoretically, Hungary's golden share in MOL may conflict with Slovakia's golden share in Slovnaft, owned by MOL. Contrary to popular economic thinking, golden shares do not seem to deter foreign investors. They may even create a moral hazard, causing investors to believe that they are partners with the government in an enterprise of vital importance and, thus, likely to be bailed out (i.e., an implicit state guarantee). Moreover, golden shares are often perceived by investors and financial institutions as endowing the company with preference in government procurement and investment, privileged access to decision makers, concessionary terms of operation, and a favorable pricing structure. Golden shares are often coupled with guaranteed periods of monopoly or duopoly (i.e., periods of excess profits and rents). The West, alas, is in no position to preach free marketry in this case. European firms are notorious for the ingenious stratagems with which they disenfranchise their shareholders. Privileged minorities often secure the majority vote by owning golden shares (this is especially egregious in the Netherlands and France). The European Commission is investigating cases of abuse of golden shares in the UK, Spain, Portugal, Germany, France, and Belgium. The Spanish government possesses golden shares in companies it no longer has a stake in. As American portfolio investors pile in, corporate governance is changing for the better. But some countries of the former Soviet Bloc (such as Estonia) are even more advanced than the EU. Greek Investments (in the Balkans) On December 10, 2001 the Brussels-based think tank, International Crisis Group, proposed a solution to the Greek-Macedonian name dispute. It was soon commended by the State Department. The Greeks and Macedonians were more lukewarm but positive all the same. The truth, though, is that Macedonia is in no position to effectively negotiate with Greece. The latter - through a series of controversial investments - came to virtually own the former's economy. So many Greek businessmen travel to Macedonia that Olympic Airways, the Greek national carrier began regular flights to its neighbor's capital. The visa regime was eased. Greeks need not apply for Macedonian visas, Macedonians obtain one year Schengen visas from the applicants-besieged Greek liaison office in Skopje. A new customs post was inaugurated last year. Greek private businesses gobbled up everything Macedonian - tobacco companies, catering cum hotel groups, mining complexes, travel agencies - at bargain basement prices, injecting much needed capital and providing access to the EU. The sale of Macedonia's oil refinery, "Okta", to the partly privatized Greek "Hellenic Petroleum" in May 1999, was opaque and contentious. The Prime Minister of Macedonia, Ljubco Georgievski, and the then Minister of Finance, Boris Stojmenov, were accused by the opposition of corrupt dealings. Rumors abound about three "secret annexes" to the sale agreement which cater to the alleged venality of top politicians and the parties of the ruling coalition. The deal included a pledge to construct a 230 km. $90 million oil pipeline between the port of Thessalonica and Skopje (with a possible extension to Belgrade). The Greeks would invest $80 million in the pipeline and this constitutes a part of a $182 million package deal. This was not "Hellenic Petroleum"'s only Balkan venture. It acquired distribution networks of oil products in Albania as well. After the Austrian "Erste Bank" pulled out of the deal, "National Bank of Greece" (NBG) drove a hard bargain when it bought a controlling stake in "Stopanska Banka", Macedonia's leading banking establishment for less than $50 million in cash and in kind. With well over 60% of all banking assets and liabilities in Macedonia and with holdings in virtually all significant firms in the country, "Stopanska Banka" is synonymous with the Macedonian economy, or what's left of it. NBG bought a "clean" bank, its bad loans portfolio hived off to the state. NBG - like other Greek banks, such as Eurobank, has branches and owns brokerages in Albania, Bulgaria, and Romania. But nowhere is it as influential as in Macedonia. It was able to poach Gligor Bisev, the Deputy Governor of Macedonia's central Bank (NBM) to serve as its CEO. Another Greek bank, Alpha Bank, has bought a controlling stake in Kreditna Banka, a Macedonian bank with extensive operations in Kosovo and among NGO's. Recently, the Greek telecom, OTE, has acquired the second mobile phone operator licence in Macedonia. The winner in the public tender, Link Telekom, a Macedonian paging firm, has been disqualified, unable to produce a bank guarantee (never part of the original tender terms). The matter is in the courts. Local businessmen predicted this outcome. They say that when "Makedonski Telekom" was sold, surprisingly, and under visible American "lobbying", to MATAV (rather than to OTE) - Macedonian politicians promised to compensate the latter by awarding it the second operator licence, come what may. Whatever the truth, this acquisition enhances OTE's portfolio which includes mobile operators in Albania (CosmOTE) and Bulgaria (GloBUL). Official Greece clearly regards Greek investments as a pillar of a Greek northern sphere of influence in the Balkan. Turkey has Central Asia, Austria and Germany have Central Europe - Greece has the Balkan. Greece officially represents the likes of Bulgaria in both NATO and the EU. Greek is spoken in many a Balkan country and Greek businessmen are less bewildered by the transition economies in the region, having gone through a similar phase themselves in the 1950's and 1960's. Greece is a natural bridge and beachhead for Western multinationals interested in the Balkan. About 20% of Greece's trade is with the Balkan despite an enormous disparity of income per capita - Greece's being 8 times the average Balkan country's. Exports to Balkan countries have tripled since 1992 and Greece's trade surplus rose 10 times in the same period. Greek exports constitute 35% of all EU exports to Macedonia and 55% of all EU exports to Albania. About the only places with muted Greek presence are Bosnia and Kosovo - populated by Moslems and not by Orthodox coreligionists. The region's instability, lawlessness, and backwardness have inflicted losses on Greek firms (for instance in 1997 in disintegrating Albania, or in 1998-9 in Kosovo and Serbia). But they kept coming back. In the early 1990's Greece imposed an economic embargo on Macedonia and almost did the same to Albania. It disputed Macedonia's flag and constitutional name and Albania's policy towards the Greek minority within its borders. But by 1998, Greeks have committed to invest $300 million in Macedonia - equal to 10% of its dilapidated GDP. Employing 22,000 workers, 450 Greek firms have invested $120 million in 1280 different ventures in Bulgaria. And 200 Greek businesses invested more than $50 million in the Albanian and economy, the beneficiary of a bilateral "drachma zone" since 1993. In 1998, Greece controlled 10% of the market in oil derivatives in Albania and the bulk of the market in Macedonia. Another $60 million were invested in Romania. Nowhere was Greek presence more felt than in Yugoslavia. The two countries signed a bilateral investment accord in 1995. It opened the floodgates. Yugoslavia's law prevented Greek banks from operating in its territory. But this seems to have been the sole constraint. Mytilineos, a Greek metals group, signed two deals worth $1.5 billion with the Kosovo-based Trepca mines and other Yugoslav metal firms. The list reads like the Greek Who's Who in Business. Gener, Atemke, Attikat (construction), 3E, Delta Dairy (foodstuffs), Intracom (telecommunications), Elvo and Hyundai Hellas (motor vehicles), Evroil, BP Oil and Mamidakis (oil products). The Milosevic regime used Greek and Cypriot banks and firms to launder money and bust the international sanctions regime. Greek firms shipped goods, oil included, up the Vardar river, through Macedonia, to Serbia. Members of the Yugoslav political elite bought properties in Greece. But this cornucopia mostly ended in 1998 with the deepening involvement of the international community in Kosovo. Only now are Greek companies venturing back hesitantly. European Tobacco has invested $47 million in a 400 workers strong tobacco factory in Serbia to be opened early next year. Still, the 3500 investments in the Balkan between 1992-8 were only the beginning. Despite a worsening geopolitical climate, by 2001, Greek businesses - acting through Cypriot, Luxemburg, Lichtenstein, Swiss, and even Russian subsidiaries - have invested in excess of $5 billion in the Balkan, according to the Economic Research Division of the Greek Alpha Bank. Thus, Chipita, the Greek snacks company bought Romania's Best Foods Productions through its Cyprus subsidiary, Chipita East Europe Cyprus. The state controlled OTE alone has invested $1.5 billion in acquiring stakes in the Serb, Bulgarian, and Romanian state telecoms. This cannot be considered mere bargain hunting. OTE claims to have turned a profit on its investments in war torn Serbia, corruption riddled Romania and bureaucratic Bulgaria. Others doubt this exuberance. Greek banks have invested $400 million in the Balkan. NBG has branches or subsidiaries in Macedonia, Bulgaria, Romania, and Albania. EFG Ergasias and Commercial Bank are active in Bulgaria, and Alpha Bank in Romania. The creation of Europe's 23rd largest bank as a result of the merger between NBG and Alpha is likely to consolidate their grip on Balkan banking. Greek manufacturing interests have purchased stakes in breweries in Macedonia. Hellenic Bottling - formerly 3E - started off as a Coca-Cola bottler but has invested $250m on facilities in the south Balkans and in Croatia, Slovenia and Moldova. Another big investor is Delta dairy products and ice cream. Moreover, Greece has absorbed - albeit chaotically and reluctantly - hundreds of thousands of Albanian, Macedonian, Serb, Romanian, and Bulgarian economic immigrants. Albanian expatriates remit home well over 500 million drachmas annually. Thousands of small time cross border traders and small to medium size trading firms control distribution and retailing of Greek, European, Asian, and American origin brands (not to mention the smuggling of cigarettes, counterfeit brands, immigrants, stolen vehicles, pirated intellectual property, prostitutes, and, marginally, drugs). As a member of the EU and an instigator of the ineffectual and bureaucratic Stability Pact, Greece has unveiled a few megabuck regional reconstruction plans. In November 1999, it proposed a $500 million five year private-public partnership to invest in infrastructure throughout the region. Next were a $1 billion oil pipeline through Bulgaria and northern Greece and an extension of a Russian gas pipeline to Albania and Macedonia. The Egnatia Highway is supposed to connect Turkey, Greece, Bulgaria, Macedonia, and Albania. Greece is a major driving force behind REM - a southeast Europe Regional Electricity trading Market declared in September 1999 in Thessalonica. The Hellenic Observatory in the London School of Economics notes the importance of the Greek capitalist Diaspora (Antonis Kamaras, "Capitalist Diaspora: The Greeks in the Balkans"). Small, Greek, traders in well located Thessalonica provided know-how, contacts and distribution networks to established Greek businesses outside the Balkan. The latter took advantage of the vacuum created by the indifference of multinationals in the West and penetrated Balkan markets vigorously. The Greek stratagem is evident. Greece, as a state, gets involved in transportation and energy related projects. Greek state-inspired public sector investments have been strategically placed in the telecommunications and banking sectors - the circulatory systems of any modern economy. Investments in these four sectors can be easily and immediately leveraged to gain control of domestic manufacturing and services to the benefit of the Greek private sector. Moreover, politics is a cash guzzling business. He who controls the cash flow - controls the votes. Greece buys itself not only refineries and banks, telecoms and highways. It buys itself influence and politicians. The latter come cheap in this part of the world. Greece can easily afford them. Growth (and Government) It is a maxim of current economic orthodoxy that governments compete with the private sector on a limited pool of savings. It is considered equally self-evident that the private sector is better, more competent, and more efficient at allocating scarce economic resources and thus at preventing waste. It is therefore thought economically sound to reduce the size of government - i.e., minimize its tax intake and its public borrowing - in order to free resources for the private sector to allocate productively and efficiently. Yet, both dogmas are far from being universally applicable. The assumption underlying the first conjecture is that government obligations and corporate lending are perfect substitutes. In other words, once deprived of treasury notes, bills, and bonds - a rational investor is expected to divert her savings to buying stocks or corporate bonds. It is further anticipated that financial intermediaries - pension funds, banks, mutual funds - will tread similarly. If unable to invest the savings of their depositors in scarce risk-free - i.e., government - securities - they will likely alter their investment preferences and buy equity and debt issued by firms. Yet, this is expressly untrue. Bond buyers and stock investors are two distinct crowds. Their risk aversion is different. Their investment preferences are disparate. Some of them - e.g., pension funds - are constrained by law as to the composition of their investment portfolios. Once government debt has turned scarce or expensive, bond investors tend to resort to cash. That cash - not equity or corporate debt - is the veritable substitute for risk-free securities is a basic tenet of modern investment portfolio theory. Moreover, the "perfect substitute" hypothesis assumes the existence of efficient markets and frictionless transmission mechanisms. But this is a conveniently idealized picture which has little to do with grubby reality. Switching from one kind of investment to another incurs - often prohibitive - transaction costs. In many countries, financial intermediaries are dysfunctional or corrupt or both. They are unable to efficiently convert savings to investments - or are wary of doing so. Furthermore, very few capital and financial markets are closed, self-contained, or self-sufficient units. Governments can and do borrow from foreigners. Most rich world countries - with the exception of Japan - tap "foreign people's money" for their public borrowing needs. When the US government borrows more, it crowds out the private sector in Japan - not in the USA. It is universally agreed that governments have at least two critical economic roles. The first is to provide a "level playing field" for all economic players. It is supposed to foster competition, enforce the rule of law and, in particular, property rights, encourage free trade, avoid distorting fiscal incentives and disincentives, and so on. Its second role is to cope with market failures and the provision of public goods. It is expected to step in when markets fail to deliver goods and services, when asset bubbles inflate, or when economic resources are blatantly misallocated. Yet, there is a third role. In our post-Keynesian world, it is a heresy. It flies in the face of the "Washington Consensus" propagated by the Bretton-Woods institutions and by development banks the world over. It is the government's obligation to foster growth. In most countries of the world - definitely in Africa, the Middle East, the bulk of Latin America, central and eastern Europe, and central and east Asia - savings do not translate to investments, either in the form of corporate debt or in the form of corporate equity. In most countries of the world, institutions do not function, the rule of law and properly rights are not upheld, the banking system is dysfunctional and clogged by bad debts. Rusty monetary transmission mechanisms render monetary policy impotent. In most countries of the world, there is no entrepreneurial and thriving private sector and the economy is at the mercy of external shocks and fickle business cycles. Only the state can counter these economically detrimental vicissitudes. Often, the sole engine of growth and the exclusive automatic stabilizer is public spending. Not all types of public expenditures have the desired effect. Witness Japan's pork barrel spending on "infrastructure projects". But development-related and consumption-enhancing spending is usually beneficial. To say, in most countries of the world, that "public borrowing is crowding out the private sector" is wrong. It assumes the existence of a formal private sector which can tap the credit and capital markets through functioning financial intermediaries, notably banks and stock exchanges. Yet, this mental picture is a figment of economic imagination. The bulk of the private sector in these countries is informal. In many of them, there are no credit or capital markets to speak of. The government doesn't borrow from savers through the marketplace - but internationally, often from multilaterals. Outlandish default rates result in vertiginously high real interest rates. Inter-corporate lending, barter, and cash transactions substitute for bank credit, corporate bonds, or equity flotations. As a result, the private sector's financial leverage is minuscule. In the rich West $1 in equity generates $3-5 in debt for a total investment of $4-6. In the developing world, $1 of tax-evaded equity generates nothing. The state has to pick up the slack. Growth and employment are public goods and developing countries are in a perpetual state of systemic and multiple market failures. Rather than lend to businesses or households - banks thrive on arbitrage. Investment horizons are limited. Should the state refrain from stepping in to fill up the gap - these countries are doomed to inexorable decline. Grundig Dutch electronics giant Philips reported yesterday a first quarter loss of $76 million with sales plunging by one seventh. It promptly blamed tottering consumer confidence, escalating pension costs, vanishing sales of television sets and a generally grim economic outlook. The demise this week of a German competitor, Grundig, did not help. Yet, the two succumbed to different malaises. Grundig - a 1997 Philips spin-off with plants in Germany, the United Kingdom, Portugal and Austria - was circled to its dying breath by corporate suitors, among them Taiwan's Sampo and Turkey's Beko Elektronik, one of its sub-contractors. But both pulled out in haste when acquainted with the full picture - and especially with Grundig's $220 million in unfunded pension obligations. The biting irony of a Turkish company taking over a German one was thus avoided. Grundig's products - increasingly regarded as commodities - were exorbitantly expensive. DVDs, TVs, video cameras, audio equipments and VCRs compete on price rather than technology. The precipitous drop in prices yielded a contraction of 3.4 percent in the global sales of consumer electronics, to $22 billion in 2001. Belated attempts to cut costs - for instance, by outsourcing to the likes of Turkey and Hungary - were half hearted. The shedding of thousands of experienced and dedicated workers did not help. Nor was Grundig the epitome of good governance. Its last audited financial statements are two years old and show a loss of about $160 million using the current exchange rate. This amounted to one tenth of its fast imploding sales. The company is thought to have bled another $80 million in red ink this year on $1.3 billion in turnover. Grundig is only the last in a long list of German corporate failures: the Kirch media empire, construction company Phillip Holzmann, aircraft manufacturer Fairchild Dornier, electronics plant Schneider Technologies, engineering office Babcock Borsig, stationery maker Herlitz and airship developer Cargolifter. The Federal Statistics Office pegs the number of insolvency filings last year at 84,428. Yet, Grundig reified the German postwar economic miracle. It was an icon of self-satisfied consumerism and the unsustainable social safety net it had spawned. Renowned for its audacious innovations and perky marketing, it flourished well into the 1970s. In 1979, it employed 38,000 laborers in 30 plants worldwide. It opened offices in France, Italy, Portugal, Spain, Sweden and Taiwan. But low-cost competitors, notably the Japanese, were already making inroads into its traditional markets. It now employs less than 4,000 people. Grundig, like many other German companies, denied, at its peril, the painful emergence of cheaper production locales in Asia and Latin America. In the 1990s, it resisted pressures to cut costs by Philips, its holding company. Like a faded beauty, it refused to transform itself into a lean research and development or design company. Grundig abhorred the thought of becoming the mere coordination center of overseas manufacturing and assembly facilities. It would not admit that nothing much is left of Grundig except its brand and its sales network, estimated by radio aerial and satellite dish maker Anton Kathrein, the majority shareholder since 2000, to be worth $550 million. Ironically, even in its death throes, Grundig's products kept garnering coveted industry accolades. Last month, the Grundig Tharus 51 LCD screen has received the 2003 red dot award, bestowed annually by the Design Zentrum Nordrhein-Westfalen. It competed with 1494 products from 28 countries and was singled out for its outstanding "innovation, functionality, formal quality, ergonomic efficiency and environmental compatibility." Still, Grundig's demise is a sign of healing. As incestuous old boy networks are crumbling under the onslaught of globalization and the financial system its strained to its limits, bank lending is being rationalized. Political meddling, though still ubiquitous, is abating. The cozy confluence of state and economic interests is waning. Grundig is a perfect example of just how pernicious these can be. Last year, The European Commission allowed Bavaria to extend $50 million in new, 6-month, credits to the ailing manufacturer. Instead of ploughing the money into Grundig's profitable but labor-poor car radio, hotel satellite communications and office communications units - the money was misspent on its hemorrhaging TV production facilities. But last week, according to Financial Times Deutschland, four creditor banks, including Deutsche Bank, Dresdner Bank, Bayerische Landesbank (Bavarian State Bank) and the Bavarian State Foundation for Structural Financing - refused to extend expiring credit lines and thus doomed Grundig to a timely death. The Grundig debacle also brought into sharp relief the German postbellum invention of corporate supervisory board, composed of erstwhile chairmen of the board, deposed chief executive officers and hapless representatives of banks held hostage by previous sprees of reckless lending. These are joined by trade union or employee representatives, there to oppose job cuts and disinvestment. Germany in inexorably pushed, kicking and screaming, to adopt the Anglo-Saxon, "heartless", model of capitalism. Its reliance on exports for growth makes it particularly vulnerable to global winds. It can no longer survive in splendid economic isolation. Gradually, it is being reduced to a mid-sized regional economic power. It is an agonizing and injurious process and Grundig is only among the first of many of its victims to come. |
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