Social Europe Journal debating progressive politics in Europe and beyond Fri, 31 Oct 2014 13:21:45 +0000 hourly 1 "Why The Eurozone Is Once Again Staring Into The Abyss" by Robert Hancké Fri, 31 Oct 2014 13:21:45 +0000 Robert Hancké
Robert Hancké, Eurozone

Robert Hancké

Growth in the Eurozone has declined significantly over recent months, raising fears that Europe could be heading toward another economic crisis. Bob Hancké writes on what it would take to generate growth in Eurozone states. He argues that the best – and possibly only – option for European governments is to adopt a strategy of public investment in infrastructure, human capital, public health and welfare. Crucially, there should be a balance between fiscal expansion and fiscal consolidation policies based on the state of individual economies, not on the blind application of one or the other principle across the entirety of the single currency area.

Here we go again. Two years after Mario Draghi’s ‘whatever it takes‘ moment, the Eurozone is again staring into the abyss. Growth has collapsed over the last six months, inflation is now so low it no longer greases the machine – some of the EMU member states are facing deflation, in fact – unemployment is stable at a very high level, and even the economic locomotive, Germany, is stalling. Debt, public or private is rising or stuck at a high level, and governments seem, to put it mildly, unable to do much about it all.

France and Italy are engaged in a contradictory balancing act, along the lines of ‘yes, we will balance our budget, but not quite yet, since our economies need some oxygen’. And the ECB seems slightly overwhelmed, running against the wind; it’s not even clear if the central bank can do all that much, given where we are, and the infighting within the ECB makes it likely that action from Frankfurt will be slow and not nearly of the shock and awe variety that Europe needs.

The conundrum is, in essence, one of growth. In the words of Keynes: ‘if you take care of growth, the deficit will take care of itself.’ Since deficits and debts are a function of government revenue, and that itself is a function of how fast the economy grows, the numerator (expenditure) can stay stable, or even grow, as long as the economy – and thus tax intake – grows at the same pace or faster. How, then, do you produce growth in the Eurozone?

Since deficits and debts are a function of government revenue, and that itself is a function of how fast the economy grows, the numerator (expenditure) can stay stable, or even grow, as long as the economy – and thus tax intake – grows at the same pace or faster.

The answer is quite simple, really. Forget, for a moment, so-called structural reforms – usually a euphemism for cutting wages and making labour markets more flexible. Even if they had a positive effect in the complex economies of the Eurozone – a big if, as they have never been shown to work outside economics textbooks – that effect would be several years away, and we need growth now. In fact, real wages have been falling in most Eurozone economies over the past decade or more, without any of the beneficial effects that, supposedly, would emerge spontaneously.

Then look at the big aggregates in a modern economy. Private consumption is, as a result of the wage squeeze, not growing all that fast either: middle-class families have lower incomes to spend, their future is more uncertain and, reasonably enough, they save what they have left at the end of the month. Exports could rise, yes, but not if everybody is adopting austerity policies: a fall in demand In countries A, B and C means that D – an export machine – no longer has growing markets for its own goods and, therefore, slowly slips into recession, with the inadvertent effect that demand in D for goods from A, B and C also drops sharply.


The ECB in Frankfurt seems slightly overwhelmed tackling the Eurozone’s economic woes on its own. (photo: CC BY 2.0 Carsten Frenzel)

Governments in the Eurozone are constrained by a recent commitment to semi-balanced budgets overseen by the Commission and can therefore not spend their way out of a recession (assuming that was ever as easily done as early Keynesians thought). All that’s left, really, is investment. But private investment depends on the growth prospects of businesses; that turns this strategy into a catch-22. Investment is necessary for growth, but also dependent on growth.

That leaves us with one, and possibly only one, strategy: public investment, in infrastructure such as roads, broadband and green technologies, in human capital through education and further training, and in public health and active welfare services that raise the life chances of low income groups. The problem is not one of cost. Public investment can easily be paid for through new government bonds; in fact, much of the Eurozone can borrow at extremely low, almost negative real interest rates. And, since such investments have positive effects now by boosting demand, and later by raising the sustainable growth rate, they pay for themselves. They might be slightly inflationary, sure – excellent news, with an inflation rate stuck far below what is considered the neutral 2 per cent rate. And they may raise the incomes of poor people – even better, as they spend more of the income boost than wealthier people, thus multiplying the effect of the initial boost throughout the rest of the economy.

Public investment can easily be paid for through new government bonds; in fact, much of the Eurozone can borrow at extremely low, almost negative real interest rates. And, since such investments have positive effects now by boosting demand, and later by raising the sustainable growth rate, they pay for themselves.

What Europe needs, therefore, is a political settlement in which responsible fiscal policies are defined as balancing expansion and consolidation, depending on the state of the economy, not the blind application of outdated and dangerous policies that we see today. EMU as a whole today has, and yesterday had, an aggregate fiscal position that is pretty much in balance, and can therefore spend on expansive policies without running into unsustainable fiscal positions. Anyone with a sense of history must be shocked by the parallels between what’s going on today in the Eurozone and the retrenchment policies of the 1930s, when adherence to the Gold Standard forced governments into draconian fiscal positions. Without wanting to be (too) alarmist: that did not end well.

A new political-economic settlement also needs to take into account that EMU is a collective project. What happens in one member state is a matter of economic and moral concern for the others. The first Greek crisis would have been solved faster and far more cheaply in 2010 with a collective rescue package that linked cash to administrative reform (Greece, as the closest thing to a failed state in the EU, almost certainly would benefit from some structural reforms which make it match expenditure and revenue a bit more closely). Instead everyone accused the Greek governments of doing nothing before the crisis. To borrow a metaphor coined by my colleague Paul De Grauwe: rather than calling the fire brigade when they saw their neighbour’s house on fire, they called the police.

What I’m advocating is not blind solidarity, but a measured form of mutual trust based on enlightened self-interest, and which plays out over time. High-growth countries, for example, such as Spain and Greece in the first decade of EMU, would pool part of their growing income with low-growth economies (Germany before 2008), with the flow reversed after the crisis hit. That would have kept growth and inflation on a sustainable path everywhere, prevented the massive balance of payments crisis that erupted in the late 2000s, and built a modicum of trust vis-à-vis the Mediterranean economies among the German and North European public, to be used when we need it most.

We are not there at the moment, and we may never get there. And we probably wouldn’t start from here if we had a chance to do it all over again. But a sensible expansion of political union, coupled with a demonstration by EMU that there is leadership after all, also beyond the ECB, might reignite some of the popular enthusiasm for the European project. It is sorely needed.

This column was first published on EUROPP@LSE

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]]> 0 Robert Hancke Robert Hancké frankfurt There is not much more the ECB in Frankfurt can do to help growth (photo: CC BY 2.0 Carsten Frenzel)
"Is The New Belgian Government Creating New Jobs?" by Frank Roels Fri, 31 Oct 2014 07:00:39 +0000 Frank Roels
Frank Roels

Frank Roels

By reducing labour costs, we will increase the number of jobs. This prophecy has been repeated since the crises, not only by journalists and politicians, but also by at least one economist in each university department. The new Belgian government is now putting this theory into practice.

The plans are to reduce labour costs by more than 3%. Social security contributions paid by employers will be lowered from 33% tot 25%; an automatic adjustment of wages to the cost of living will be skipped; the age of early pension in case of lay-off (paid in part by the employer) will be raised; the definition of overtime is narrowed, and so on.

The new Minister of Work is Kris Peeters, from the Catholic Democratic Party. He was previously President of the Flemish government, and in a earlier life chairman of UNIZO, the federation of SMEs. After the government program was released, he said:

I expect that employers will be clever enough to take care that the effort that we make and that the people make in skipping the index is effective and say: “Yes, now we have a stronger competitive position, we are going to transform this into employment”. That is not mandatory, but it is my opinion that employers should positively transform this offer, this decision, into employment and internships, et cetera.

The new finance minister, Johan Van Overtveldt, from the nationalist party N-VA, expects that 80.000 jobs can be created, on the basis of calculations by Professor Joep Konings of the Catholic University Leuven. The Minister of Pensions, Daniel Bacquelaine (Mouvement Reformateur), also predicts the creation of new jobs.

The realistic reply to these wishes comes from the CEO of the Federation of Belgian businesses, Pieter Timmermans. When asked by a TV journalist whether there is now a guarantee for extra jobs, he said: “Nobody never has a guarantee”. On the VBO website he writes:

Neither the government nor laws can create jobs (…). How many extra jobs? No one can predict the future with certainty.

It should be pointed out, that the plans of the new government come on top of existing support for companies: wage subsidies and lower social security contributions for specified workers.

The clear contradiction between the standpoint of the employers federation and the prophecy proclaimed by the government and many economists sounds like a joke, but it is not. We must learn that in order to evaluate employment measures, we should question the employers, and study their decisions. Running algorithms based on ancient data, or taking wishes for facts amounts to lying to people. In the end, the decrease in labour costs will be added to net profit of businesses.

These considerations all relate to the private, corporate sector. But the new government also decided to reduce public funding in other areas: education and culture, scientific institutions, public broadcasting systems, social security and health, the public railway as well as for the bus & tramway company. Public servants in the administration who retire will not be replaced for in full numbers; even given that internal revenue services, the police, and the justice department are already underperforming due to personnel constraints.

Take changes to the public and private sectors together and you’ll see that new government measures will reduce total employment considerably. Family budgets will shrink and so will demand and business earnings. Nevertheless, corporations will benefit because of the large cut in labour costs and the constant rise in productivity that permits further staff reductions.

The alternative policy of adding jobs in the non-profit and social profit sectors where stringent needs are obvious and rising, is not even mentioned by planners.

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"The Untold Story Of The Eurozone Crisis" by Simon Wren-Lewis Thu, 30 Oct 2014 16:45:02 +0000 Simon Wren-Lewis
Simon Wren-Lewis, Eurozone Crisis

Simon Wren-Lewis

Everyone knows that the Eurozone suffered a crisis from 2010 to 2012, as periphery countries could no longer sell their debt. A superficial analysis puts this down to profligate governments, but look more closely and it becomes clear that the formation of the Euro itself led to an excessive monetary stimulus in these periphery countries. This is widely understood.

But this is not the whole story. It leaves out one key element that is vital if we are to understand the situation today. Here is a chart of nominal wage growth (compensation per employee) in the Eurozone and selected countries within it before the Great Recession.

Eurozone Crisis

Percentage change in compensation per employee (annual): source OECD Economic Outlook

Between 2000 and 2007 German wages increased by less than 10% compared to over 20% in the Eurozone as a whole (which of course includes Germany). This difference was not primarily caused by excessive growth in the periphery countries: wages in France, Belgium, the Netherlands, Italy and Spain all increased by between 20% and 30%. The outlier was Germany.

Of course growth in nominal wages of less than 2%, and sometimes less than 1%, is not consistent with a consumer price inflation target of close to 2%. It was for this reason that the ECB lowered short term interest rates from 4.4% in 2000 to 2.1% in 2004. They were not worried by excessive inflation in the periphery – they had to lower rates to counteract the effect of low nominal wage growth in Germany.[1]

So the reason why Germany seems to have largely escaped the second Eurozone recession of 2012/3 is that it pursued (perhaps unintentionally) a beggar my neighbour policy within the Eurozone. Low nominal wage growth in Germany led to lower production costs and prices, which allowed German goods to displace goods produced in other Eurozone countries both in the Eurozone and in third markets. This might make sense if Germany had entered the Eurozone at an uncompetitive exchange rate, but my own analysis suggests it did not, and Germany’s current relative cyclical position and its current account surplus confirm this.

As I argued in an earlier post, I do not think this divergence in cyclical position is the main reason why Germany resists expansionary measures in the Eurozone. But it is a lot easier to take up these obstructive positions when you are benefiting from this beggar my neighbour policy, and other countries that have suffered as a result appear not to understand what you have done.

Postscript: Simon Tilford of the Centre for European Reform makes much the same argument here (HT Zoe Keller).

[1] One of the comments on my earlier post tried to justify this beggar my neighbour policy using the following argument. Although the ECB’s inflation target was close to 2%, they suggested that inflation below this was clearly desirable. What the Eurozone provided was an incentive system to try and achieve below target inflation by becoming more competitive. Germany had successfully risen to this challenge, and now it was up to other countries to try and do the same. Now if this competitiveness had been achieved by improvements in productivity, then this idea – although still mistaken – would be worth discussing. When it is achieved by cutting nominal wages (such that real wage increases are below productivity growth), it is not clear what efficiency gains are being achieved.

This blog was first published on Mainly Macro

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"The Moral Economy Of Debt" by Robert Skidelsky Tue, 28 Oct 2014 09:30:49 +0000 Robert Skidelsky
Robert Skidelsky, Economy Of Debt

Robert Skidelsky

Every economic collapse brings a demand for debt forgiveness. The incomes needed to repay loans have evaporated, and assets posted as collateral have lost value. Creditors demand their pound of flesh; debtors clamor for relief.

Consider Strike Debt, an offshoot of the Occupy movement, which calls itself “a nationwide movement of debt resisters fighting for economic justice and democratic freedom.” Its website argues that “[w]ith stagnant wages, systemic unemployment, and public service cuts” people are being forced into debt in order to obtain the most basic necessities of life, leading them to “surrender [their] futures to the banks.”

One of Strike Debt’s initiatives, “Rolling Jubilee,” crowd-sources funds to buy up and extinguish debt, a process that it calls “collective refusal.” The group’s progress has been impressive, raising more than $700,000 so far and extinguishing debt worth almost $18.6 million.

It is the existence of a secondary debt market that enables Rolling Jubilee to buy debt so cheaply. Financial institutions that have come to doubt their borrowers’ ability to repay sell the debt to third parties at knock-down prices, often for as little as five cents on the dollar. Buyers then attempt to profit by recouping some or all of the debt from the borrowers. The US student-loan provider Sallie Mae admitted that it sells repackaged debt for as little as 15 cents on the dollar.

To draw attention to the often-nefarious practices of debt collectors, Rolling Jubilee recently canceled student debt for 2,761 students of Everest College, a for-profit school whose parent company, Corinthian Colleges, is being sued by the US government for predatory lending. Everest College’s loan portfolio was valued at almost $3.9 million. Rolling Jubilee bought it for $106,709.48, or about three cents on the dollar.

But that is a drop in the ocean. In the US alone, students owe more than $1 trillion, or around 6% of GDP. And the student population is just one of many social groups that lives on debt.

Indeed, throughout the world, the economic downturn of 2008-2009 increased the burden of private and public debt alike – to the point that the public-private distinction became blurred. In a recent speech in Chicago, Irish President Michael D. Higgins explained how private debt became sovereign debt: “As a consequence of the need to borrow so as to finance current expenditure and, above all, as a result of the blanket guarantee extended to the main Irish banks’ assets and liabilities, Ireland’s general government debt increased from 25% of GDP in 2007 to 124% in 2013.”

The Irish government’s aim, of course, was to save the banking system. But the unintended consequence of the bailout was to shatter confidence in the government’s solvency. In the eurozone, Ireland, Greece, Portugal, and Cyprus all had to restructure their sovereign debt to avoid outright default. Rising debt/GDP ratios cast a pall over fiscal policy, and became the main justification for austerity policies that prolonged the slump.

Creditor - Debtor relationships are always socially negotiated according to Robert Skidelsky.

Creditor – Debtor relationships are always socially negotiated according to Robert Skidelsky.

None of this is new. Creditor-debtor conflict has been the stuff of politics since Babylonian times. Orthodoxy has always upheld the sacred rights of the creditor; political necessity has frequently demanded relief for the debtor. Which side wins in any situation depends on the extent of debtor distress and the strength of the opposing creditor-debtor coalitions.

Morality has always been the intellectual coin of these conflicts. Creditors, asserting their right to be repaid in full, historically have created as many legal and political obstacles to default as possible, insisting on harsh sanctions – garnishment of income, for example, and, at the extreme, imprisonment or even slavery – for borrowers’ failure to honor their debt obligations. Governments that incurred debt in costly wars have been expected to set aside annual “sinking funds” for repayment.

Morality, however, has not been entirely on the side of the creditor. In New Testament Greek, debt means “sin.” But, though it might be sinful to go into debt, Matthew 6:12 supports absolution: “forgive us our debts, as we also have forgiven our debtors.” Widespread social resistance to creditors’ claims on debtors’ property for non-payment has meant that “foreclosure” has rarely been carried to extremes.

The position of debtors was further strengthened by the prohibition of usury – charging unreasonably high interest on money. Interest-rate caps were abolished in Britain only in 1835; the near-zero central-bank rates prevailing since 2009 are a current example of efforts to protect borrowers.

The truth of the matter, as David Graeber points out in his majestic Debt: The First 5,000 Years, is that that the creditor-debtor relationship embodies no iron law of morality; rather, it is a social relationship that always must be negotiated. When quantitative precision and an unyielding approach to debt obligations are the rule, conflict and penury soon follow.

In an effort to stem recurrent debt crises, traditional societies embraced the “Law of Jubilee,” a ceremonial wiping clean of the slate. “The Law of Jubilee,” writes Graeber, “stipulated that all debts be automatically canceled ‘in the Sabbath year’ (that is, after seven years had passed), and that all who languished in bondage owing to such debts would be released.” The Rolling Jubilee is a timely reminder of the continuing relevance of one of the oldest laws of social life.

The moral of the tale is not, as Polonius instructed his son Laertes, “neither a borrower nor a lender be.” Without both, humanity might still be living in caves. Rather, we need to limit the supply of and demand for credit to what the economy is capable of producing. How to do this and maintain freedom of enterprise is one of the great unsettled questions of political economy.

© Project Syndicate

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"Why Current Global Inequality Is Unsustainable" by Danny Dorling Tue, 28 Oct 2014 08:30:20 +0000 Danny Dorling
Danny Dorling

Danny Dorling

Rising inequality is one of the most controversial issues in European politics. In an interview with EUROPP’s editor Stuart Brown, Danny Dorling discusses the problems posed by inequality, the situation within the UK, and why the current trends are likely to prove unsustainable.

Although many social scientists, most notably Thomas Piketty, have provided evidence of rising inequality across Europe and the rest of the world, there is little consensus on how the problem can be addressed. Is a solution to social and economic inequality feasible? 

The best analogy I can give to the current debate over inequality is that it’s a bit like talking about population growth in 1968. Around about 1968 was the point in human history when population growth had never been faster. The human population was growing by about 2-2.2 per cent a year. If that had continued then within 300 years the planet would have been unable to sustain our species and life as we know it would have ended.

A whole series of books were written between 1968 and 1970, the most famous of which was The Population Bomb, predicting famines, mass starvation and the general disintegration of human society. Now at the time these books were entirely rational because there was absolutely no way that kind of population growth could have continued. But what these authors didn’t know was that we’d actually hit a peak – at least in terms of accelerating growth.

After 1971, population growth across the world began to slow down rapidly, so that by 1990 we hit the peak number of births. Now we’re looking at a situation where well over half of the planet is below the ‘replacement level’ needed to maintain the current population. We’re looking at the end of human population growth for the first time since the Black Death. Essentially the problem of population growth written about in the late 1960s and early 1970s has gone away.

So while statistics about inequality can be incredibly depressing, the population growth problem has some lessons for how we deal with it. Although I’m not against some ‘grand plan’ for solving inequality, when you look at the population story you see that it wasn’t a grand plan that made the breakthrough – the turnaround resulted from the actions of millions of largely poor women taking control of their lives. So if I were being optimistic, where I think we’re currently heading is that inequality won’t be solved by a grand plan, but by millions of people acting out of necessity.

If a similar situation to the population growth example occurred, how would we know when rising inequality had hit its peak? 

Well let’s look at some of the worst statistics for the world. Earlier this year, Oxfam produced a report – the most successful report in the history of Oxfam – where they worked out that the richest 85 people on the planet had the wealth of the poorest half of humanity. Within a few months, Forbes magazine had updated that to say that the number was actually now 67 people – three days later they posted a correction to say that it was now 66 people.

Just this month, Credit Suisse produced a report on global wealth. The most striking statistic in this report was that while last year the richest 70 million people had 41 per cent of the wealth of the planet, this year the richest 70 million people held 48 per cent. That’s a seven per cent increase in a single year – if that were to continue, the richest one per cent of the planet would have everything within five years and the poor would have nothing. When things become this bad you can tell you’re at a peak because the current increase in global inequality is completely unsustainable.

Current levels of global inequality are completely unsustainable, says Danny Dorling.

Current levels of global inequality are completely unsustainable, says Danny Dorling.

You have previously discussed the situation in the UK in great detail. Is Britain facing a larger problem with inequality than other states in Europe?

The UK in this picture is the only one of the G7 countries where inequality had increased both before and after the crash – indeed, it rose four times faster after the crash than before. This wasn’t always the case in the UK. Around a hundred years ago, the richest one per cent in Britain received around a quarter of the country’s income. That proportion fell from around 1913 pretty steadily until 1978. Half of the fall occurred before the Second World War and by 1978 the richest one per cent received around six per cent of all income (four per cent after tax). Of the six largest countries in Europe, the UK was the second most equal.

Since 1978 inequality has risen to the extent that around 15 per cent of all income goes to the richest one per cent. This is the highest rate in Europe. The UK would have to look beyond Europe to the United States to find somewhere that is more unequal by this measure. Now some people might imagine there has been a ‘trickle down’ effect from the accumulation of wealth in the UK, but if you look at the median income in Britain it’s lower than the figure in France and Germany. That’s before you include housing costs, which are more expensive in the UK, so there hasn’t been much benefit ‘trickling down’ from those at the top. If you compare the UK on most measures to the rest of Europe we stand out like a sore thumb.

Yet one of the most remarkable things is that since 2008 and the financial crisis we have actually seen an increase in equality for everyone except the top one per cent. The reason we don’t notice it is that the one per cent have carried on moving upwards. But among the 99 per cent, partly because of national insurance rises and child benefit cuts at the top, inequality levels have fallen back to the level they were at in 1990. The UK is becoming more equal, more ‘all in it together’, for everyone except the one per cent.

Indeed the one per cent itself is not a unified group. There is more inequality within the one per cent than there is among the rest of society and there is a growing gap between those at the lower end of the one per cent and those at the top – the 0.1 per cent. What I think we’re witnessing in the UK is a change from the old model where the one per cent ran the country with the support of the nine per cent below them, to a new model where the country is run by the 0.1 per cent, with the support of the rest of the one per cent. The cleavage in society is no longer between the richest ten per cent and the rest, but between the richest one per cent and the rest. This began in 2008 when the nine per cent in the upper middle class (below the very richest in society) began to see their incomes fall.

Politically, this is fascinating because you can run a country with the support of the top ten per cent in society. You can fool another 20 per cent into thinking that they too could get into this group, but how do you address a country in which it begins to become obvious to people that everyone in the 99 per cent is on the losing side? How can this kind of situation be sustainable? I suspect that, much like a hundred years ago with the First World War and the revolution in Russia, it will take an external crisis to bring about a change. But we have to recognise that such a change is very likely to happen.

For more on this subject, a video of the lecture Danny Dorling recently gave at the LSE is available hereThe information covered in this interview relates to his 2014 book, Inequality and the 1%and his earlier work, Population 10 Billion, which was published in 2013. The interview draws on material he presented at the Bristol Politics Festival on 18 October 2014. This interview was first published by EUROPP@LSE.

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"Why Austerity Is Contagious" by Ronald Janssen Mon, 27 Oct 2014 10:21:21 +0000 Ronald Janssen
Ronald Janssen, Austerity Is Contagious

Ronald Janssen

Austerity is contagious: The case of France

France is finding itself between a rock and a hard place. On the one hand, with 54% of companies reporting in the third quarter 2014 that they find activity constrained by a lack of customers, the main problem is clearly on the side of demand. On the other hand, its government has clearly abdicated from using fiscal policy to support aggregate demand and is in fact trying to do the opposite by further cutting public expenditure.

Here, it’s not just the pressure from the Commission and the Stability Pact that is pushing France further down the road of austerity. It is also and most importantly the fact that France cannot risk not to keep up with the pace of austerity as pursued by its trade partners.

The latter has to do with the fact that the deficit and wage cuts in Spain, Italy and Portugal depress domestic demand in these countries. However, their domestic demand constitutes at the same time the export markets for goods and services made in France. As a result, French exports to these countries go down, thereby also worsening the balance of external trade of France. The graphs below document this in detail and show how, in each case, exports from France have fallen over the past years and this in a systematic and continuous way.

1, Austerity Is Contagious

2, Austerity Is Contagious

In fact, the wider picture is that France is now the only remaining member of the monetary union still registering a significant current account deficit, now reaching 38 billion or 2% of GDP.

Why is this a problem? The key concern is that, by having annual deficits in external trade, France is also running up its external debt position and this year after year. However, the Euro crisis has shown that the latter is not sustainable. This is especially not sustainable for members of the single currency who are, by definition, issuing debt in a currency that is not managed by themselves but by the European Central Bank. Sooner or later, and this is what did happen with Greece in 2010, financial markets will pick up on this, go into a ‘financial market strike’ and refuse further finance.

The bottom line is that austerity policy is contagious. At the risk of being singled out by financial markets because of rising external deficits, a country cannot afford to stay outside the European austerity squad completely. If surrounding economies are dragging down French export markets and exports, France is sooner or later forced to “return the favour”, squeeze its own domestic demand and in turn weaken the export market perspectives for the economies and trade partners that surround France. If not, its external deficit or, as the Commission likes to call it, its external ‘imbalance’, will increase further and become ‘excessive’.

A German locomotive?

It is against this background that French ministers Michel Sapin and Emmanuel Macron, when visiting their counterparts in Berlin recently, launched a proposal to match the 50 billion of public and social expenditure cuts that are planned in France for the next three years with a corresponding amount of new investments to be launched in Germany. The philosophy behind it is to reach a sort of European equilibrium, with cuts in aggregate demand in one part of Europe (France) being offset by a demand stimulus in another part (Germany).

The proposal certainly makes sense in terms of political strategy since it clearly puts the responsibility of internal euro adjustment also on the surplus countries, in other words on those countries that actually have the means and the opportunity to launch aggregate demand.

In economic terms, however, the proposal has one major flaw. Even if European and Euro Area member states mainly trade with each other, this intra-European trade does not function like perfectly communicating barrels. It is not correct to assume that taking away one unit of aggregate demand in France can be neatly compensated by adding another unit of demand in Germany.

This becomes clear when looking at the actual importance of trade flows between France and Germany. As is shown in the next graph, exports of goods from France to Germany only account for 4% of French GDP (5% of GDP if goods and services exports are taken together).

This presents a major problem for the Sapin/Macron proposal since it implies that their equation does not really add up. With domestic demand supporting more than 80% of French GDP and German demand for imports made in France limited to 5% of French GDP, the idea that an increase of the latter can offset a cut in the former is an illusion. Unless Germany boosts its demand by a big multiple of French expenditure cuts, the net overall effect of such an operation will be hugely negative for the French economy.


In a paper from 2013, DG ECFIN formalises this finding further. This paper was, by the way, at the time reported in public media as DG ECFIN delivering itself the evidence that coordinated fiscal austerity across Europe was very detrimental for short term growth. An additional simulation carried out in the paper was to simulate the effect on the rest of Europe of a two year 2% of GDP demand injection carried out in the surplus countries of Germany, Austria and the Netherlands.

It turns out that, as could be expected on the basis of the graph above that such a 2% of GDP demand stimulus by the surplus countries would increase the level of economic activity in the rest of the Euro Area by 0,25% of their GDP only. The proposal of cutting demand and wages in one set of member states while at the same time boosting demand in the surplus member state(s) does of course help somewhat to alleviate some of the tensions but it is not the ‘silver bullet’ solution policy makers are looking for to address the dismal perspective of prolonged stagnation in big parts of the Euro Area.

What hen should be done? Surplus countries, and Germany in particular with its public investment rates at an all time low, should certainly boost investment. This, however, should be part of a European wide investment effort, with finance for this investment being mobilized and channelled through European instruments. To start rebalancing the Euro Area, we need a European investment plan.

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"Why The Eurozone Suffers From A Germany Problem" by Simon Wren-Lewis Mon, 27 Oct 2014 08:30:46 +0000 Simon Wren-Lewis
Simon Wren-Lewis, Germany Problem

Simon Wren-Lewis

When, almost a year ago, Paul Krugman wrote six posts within three days laying into the stance of Germany on the Eurozone’s macroeconomic problems, even I thought that maybe this was a bit too strong, although there was nothing in what he wrote that I disagreed with. Yet as Germany’s stance proved unyielding in the face of the Eurozone’s continued woes, I found myself a couple of months ago doing much the same thing (123456), although at a slightly more leisurely pace. Now it seems the whole world (apart from Germany, or course) is at it: here is a particularly clear example from Matt O’Brien.

I’m not going to review the macroeconomics here. I’m going to take it as read that

1)    ECB monetary policy has been far too timid since the Great Recession began, in part because of the influence of its German members.

2)    This combined with austerity led to the second Eurozone recession, and austerity continues to be a drag on demand. The leading proponent of that austerity is Germany.

3)    Pretty well everyone outside Germany agrees that a Eurozone fiscal stimulus in the form of additional public investment, together with Quantitative Easing (QE) in the form of government debt purchases by the ECB, are required to help quickly end this second recession (see, for example, Guntram Wolff), and the main obstacle to both is the German government.

The question I want to raise is why Germany appears so successful in blocking or delaying these measures. At first the answer seems obvious: Germany is the dominant economy in the Eurozone. However that is too easy an explanation: while Germany’s GDP is less than a third of the Eurozone total, the combination of French, Italian and Spanish GDP is nearly one half. Now it could be that in the past France, Italy and Spain have failed to coordinate sufficiently to oppose Germany, in part because France has placed a high value on the French-German bilateral relationship. But that seems less of a problem today.

The puzzle remains if we just view these debates as being about national interest, rather than a battle over ideas. Germany is virtually unique in the Eurozone in not currently having a large negative output gap, and having low unemployment. So, you could argue, it is not in Germany’s national interest to allow Eurozone demand to expand, and inflation to rise. But Germany achieved this position because it undercut its Eurozone partners by keeping wages low before 2007. If political discourse was governed by basic macroeconomics, you would expect every other country to be very annoyed that this had happened, and be demanding that Germany put things right by restoring a sustainable relative competitive position through additional inflation.

These last two sentences contain a clue to resolving this puzzle. While nearly everyone recognises the internal competitiveness problem within the Eurozone, hardly anyone describes this as a problem caused by German policy. Instead, as Edward Hugh suggests for example, they believe “Germany’s unit labour costs are low not because Germans aren’t paid much, but because they are very productive, and at the end of the day, despite all the bleating about the current account this is the model other members of the Euro Area (including France) not only need to but are compelled to follow: high pay and high productivity”. I suspect many would agree with that sentiment.

Germany Problem

Too many people outside Germany buy into the German government’s wrong economics according to Simon Wren-Lewis.

Unfortunately it misses the point. International differences in productivity occur for a variety of reasons, and they are slow to change. The Eurozone’s current problem arises because one country – Germany – allowed nominal wage growth well below the Eurozone average, which undercut everyone else. (Thispost shows how real wage growth in Germany was below productivity growth in every year between 2000 and 2007.) Within a currency union, this is a beggar my neighbour policy.

In other words, as Simon Tilford suggests, Germany is viewed by many in the Eurozone as a model to follow, rather than as a source for their current problems. (He also plausibly suggests that Germany’s influence immediately after 2010 reflected its creditor position, but he argues that the importance of this factor should now be declining.) Of course in general terms Germany may well have many features which other countries might well want to emulate, like high levels of productivity, but the reason why it’s national interest is not currently aligned with other union members is because its inflation rate was too low from 2000 to 2007. That in itself was not a virtue (whatever the rights or wrongs of why it came about), and so if they had any sense other union members should be complaining bitterly about the German position.

I think the current Eurozone problem makes much more sense if we focus less on divergent national interests, and more on different macroeconomic points of view. The German perspective which sees the Eurozone problem in terms of profligate governments and lack of ‘structural reforms’ outside Germany is utterly inappropriate in understanding the Eurozone’s current position. Yet it is a point of view that too many outside Germany also share.

This is beginning to change. As this Reuters report makes clear, relations between Draghi and the Bundesbank have steadily deteriorated, as Draghi begins to understand the macroeconomic reality. (While I still have problems with the ECB’s current position, set out clearly in this speech by Benoît Cœuré, it makes much more sense than anything coming from the Bundesbank or German government.) Yet, as Simon Tilford notes, it is still not clear whether this will end in a significant departure from current policies, or just more of the minor adjustments we have seen so far.

It may well come down to the position taken by countries like the Netherlands. They have suffered as much as France in following the Eurozone’s fiscal rules to implement damaging fiscal contraction. As Giulio Mazzolini and Ashoka Mody note, “For the Netherlands …. less austerity would have been unambiguously better.” Yet until now, politicians in the Netherlands (and the central bank) appear to have taken the German line that this medicine is for their own good. If they can eat a bit of humble pie and support a kind of ‘grand bargain’ that would see fiscal expansion rather than contraction in the Eurozone as a whole, and a comprehensive QE programme by the ECB, then maybe some real progress can be made. Ultimately this is not the Eurozone’s Germany problem, but a problem created by the macroeconomic vision that German policymakers espouse.

This blogpost was first published on Mainly Macro

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]]> 4 simon wren-lewis Simon Wren-Lewis Angela Merkel Too many people outside Germany buy into the German government's economics.
"Europe Is Back At Square One" by Javier Lopez Fri, 24 Oct 2014 15:25:20 +0000 Javier Lopez
Javier Lopez

Javier Lopez

Europe is back at square one. On the verge of a third recession in five years, the relentless tide is even crashing against the insurmountable walls of the German factory powerhouse. Stagnation yet again in the Eurozone – this time accompanied by a certain whiff of Japanese-style deflation. Once more the markets are getting nervous: a volatile stock market, risk premiums are being stretched and another banking stress test is just around the corner. Brussels is holding its breath ahead of elections in Greece, and Europe is once more being blamed for the weak economic recovery worldwide.

The last chapter of the Great Recession is well known but by no means does this make it any less painful. We get self-imposed pain as a product of our economic policies of austerity at all costs and dogmatic recipes, arrogant and moralistic that come with Chancellor Merkel’s stamp, that get rid of all the tools the public sector has to escape a crisis imposed upon member states.

At the same time, the right is losing strength in the European Parliament. All analysts, editorials and international organisations are crying out: Stimulate public investment and print bank notes as leverage for demand! Simultaneously, France and Italy are betting all or nothing on budgets that fail to comply with deficit objectives.

Draghi and the ECB are making a move in Jackson Hole to call for expansive monetary policy. The Socialists are managing to extract a €300,000 million stimulus plan from the new President elect of the European Commission, Jean-Claude Juncker, which should be driven by the EIB.

The Commissioner hearings, a kind of democratically demanding parliamentary X Factor, have seen the traditional rolling of heads.

To all this, Spain reacts as if it had nothing to do with anything. Trying to play the pathetic role of the “A” student thinking: “We’re doing just fine”, while forgetting all about the unemployed and pensioners who have suffered cutbacks and are consumers of deteriorated public services. They don’t think about young people forced to emigrate or workers with devalued salaries in precarious conditions either.

Meanwhile, we elect a new European Commission after the lethargy of Barroso II. An election for governments to make but in which the European Parliament has gained hard earned influence. The Commissioner hearings, a kind of democratically demanding parliamentary X Factor, have seen the traditional rolling of heads (Bratusek) and marked various Commissioners changing portfolios and new supervisions.

Cañete and the Spanish Popular Party government come out especially bad. He has been pointed out and criticised by all. A candidacy stained by obvious incompatibilities, “inappropriate” statements, financial gaps and a management opposite to the objectives of the Union in reference to his own portfolio. Cañete saved his position only by throwing the entire weight of the European People’s Party behind his objective and using Moscovici, a key piece for the socialists, as a hostage in the negotiations. Efficient yet shameful, and there for everybody to see.

Europe is back to square one according to MEP Javier Lopez.

Europe is back to square one according to MEP Javier Lopez.

The Commission gains political clout, innovating its organization chart while repeating a painfully poor balance between men and women (19 to 9). There are a number of controversial Commissioners: Education and Culture, after Parliament removed Citizenship, Viktor Orban’s minister for foreign affairs, responsible for his peculiar justice “reform” (Navracsics). Immigration: the hard man in the Samaras government in the ministries of Defense, Foreign Affairs and Health (Avramopoulos). Financial Services: the Tory ex-lobbyist in the City (Hill).

The economic area, the real touchstone of the war of the Euro, is especially disturbing with two austerity hawks as vice-presidents of the area (Katainen and Dombrovskis). True cooks of the poison imposed by the Council as Prime Ministers of Finland and Latvia.

But among the new members of the Commission there are also European socialist leaders like Frans Timmermans, first vice president of the new institution; Federica Mogherini, appointed High Representative of the EU for Foreign Affairs and Security; and Pierre Moscovici, Commissioner for Economic and Financial Affairs. They have all repeated during their hearing in the European Parliament the necessity of changing and rethinking economic policy, the promotion of an investment plan of 300,000 million euros already announced and the recovery of the ambition of foreign policy in the EU.

The European institutions should start moving but those of us who want counter-cyclical policies, who want to recover the dignity of community institutions and reactivate what has up to now been the real motor of Europe, solidarity, must recognize that the battle for the Commission has not fallen on our side.

A ring of fire is being built around Europe, riddled with conflicts and with various failed states that reflect the impotence of our international policies.

The correlation of forces is moving and shifting and Europe is back at square one. But more importantly, being always brought back to the same place has in fact changed everything. The blackboard of macro-data is repeated, but the socio-political landscape is unrecognizable. Poverty, unemployment and misery in many places are unbearable. The European institutions are undergoing serious deterioration. Political crises are turned into regime crises in many countries. Populist parties torment long established democracies by waving the anti-European flag.

The world is barely recognizable from five years ago and the international order is crumbling. A ring of fire is being built around Europe, riddled with conflicts and with various failed states that reflect the impotence of our international policies, and lay bare our weaknesses, especially energy dependency.

A long walk through a minefield awaits those who wish to recover Europe’s soul: the vocation to build a space of shared dignity. But let us warn all beforehand: going back to square one so often could force us to fall on the square with the skull and crossbones. Like never before, everything is at stake.

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]]> 1 Javier Lopez Javier Lopez europe Europe is back to square one according to MEP Javier Lopez.
"Bizarre Surcharge Debate Shows British Establishment Just Doesn’t Get Europe" by Andrew Watt Fri, 24 Oct 2014 14:52:27 +0000 Andrew Watt
Andrew Watt

Andrew Watt

Great Britain is up in arms. The country has been asked to pay an additional €2.1 billion to the EU budget. Prime Minister David Cameron, we are told, feels “downright anger” and has refused to pay on the due date. Surprising no-one, Nigel Farage, the leader of UKIP, the party that wants Britain to leave the EU, luridly called the Union a “a thirsty vampire feasting on UK taxpayers’ blood”. Even Labour’s shadow chancellor (finance minister), Ed Balls, found the decision “unacceptable”.

This is bizarre.

Member States’ contributions are based on a complicated formula that takes as a starting point countries’ gross national income. If it turns out that this has been higher than had been assumed, then additional contributions become due. This is exactly what happens if you get a pay rise, earn some additional taxable income on the side or, as a company, report higher-than-expected profits. Sure enough, some countries (including France and Germany) will receive rebates, as national income came in lower than had been envisaged. This has nothing to do with punishing success and rewarding failure, as some have hyperventilated; it is just the normal working of any tax system. And it is worth noting that the sum of the rebates from Brussels exceeds that of the additional payments (on the figures available, which are provisional). Overall the Commission will return more than €400 million to national capitals. Some vampire!

Even the €2.1 bn figure needs to be put into context. This financial year the UK will borrow at least €120 bn to meet its fiscal shortfall.This mere fact will no doubt not prevent politicians and the press suggesting that “Europe” is to blame for a failure to meet fiscal targets.

Government representatives, including from other countries facing payment demands, are apparently appalled that this has all been done along a technical channel, by middle-ranking bureaucrats. But this is entirely appropriate to the matter at hand. You don’t get a personal letter from the finance minister every time your tax assessment changes.

David Cameron has called for a renegotiating of the UK's relationship to the European Union. (photo: CC BY 2.0 DFID)

David Cameron has called for a renegotiating of the UK’s relationship to the European Union. (photo: CC BY 2.0 DFID)

A number of the British officials interviewed have mumbled darkly that this is all symptomatic of the unacceptable way that the EU works, implying that it justifies and will feed the pronounced and growing euroscepticism on the island. In fact many of their remarks merely show the delusional nature of the attitudes of the UK establishment to Europe.

For instance take conservative MP John Redwood, who insisted that if the Commssion raises the contribution Britons must be told “what we will receive in return”. This is taking the juste retour principle, always dubious, to ridiculous lengths. (“I have had to pay a tax surcharge of one thousand pounds. How much more frequently will a police car drive past my house and the road be swept?).

One Downing Street source is quoted as follows: “The European Commission was not expecting this money and does not need this money and we will work with other countries similarly affected to do all we can to challenge this.” Would he or she tell his/her local tax office in response to a demand for a surcharge that the British government neither expected nor needed additional revenues – and refuse to pay? And note the typical inability to see that Britain is merely one of twenty-eight member states: on net the EU is paying out, not taking in additional money, so the argument has no basis at all.

On a similar note, horror is frequently expressed that the news is a gift to British Eurosceptics and will make the task of keeping Britain in the EU even harder. What should the Commission do? Wait for an opportune moment that suits the governments of all twenty-eight member states? The core problem is that the British authorities act like the parent who wants all class activities to be tailored to their own kid’s “special” needs: but there are twenty-seven other pupils in the class.

Of concern is that these bizarre hyperventilations have been given extended and uncritical coverage in the Financial Times, which, while UK-based and City-centred on some issues, normally offers balanced and reasoned discussions of European issues. What Britain’s yellow press will make of the issue will surprise no-one. I am a Brit. I would like the country to stay part of the EU. But not at any price. If Britain simply cannot “get” Europe it should go in peace.

]]> 16 Andrew Watt Andrew Watt David Cameron David Cameron has called for a renegotiating of the UK's relationship to the European Union. (photo: CC BY 2.0 DFID)
"Will The Juncker Commission Continue To Entrench Neoliberal Policies?" by Lukas Oberndorfer Wed, 22 Oct 2014 11:36:00 +0000 Lukas Oberndorfer
Lukas Oberndorfer, Juncker Commission

Lukas Oberndorfer

A few days ago, the designated European Commission finally showed its true colours: It wants to make sure that its economic policy recommendations become enforceable. Deregulation of rent setting systems, adjusting the retirement age to account for life expectancy and increased flexibility in wage-setting mechanisms were mere recommendations in 2014. That is supposed to change now. Its instruments are the competitiveness pacts 2.0 and a separate budget for the Euro area, even though there is no legal basis for such a measure. A decision is going to be made at upcoming meetings of the European.

Convergence and Competitiveness Instrument; Competitiveness Pacts; Partnerships for Growth, Jobs and Competitiveness – as numerous as their names are the attempts of the European Council to create consensus about binding contracts for neoliberal structural reforms.

Angela Merkel – the organic intellectual of a “reform alliance” consisting of trade associations, the financial industry, national ministries of finance and the economy, the EU Commission, neoliberal heads of state and government and the ECB – has been pursuing such plans since the beginning of 2013.

But is this about the countries who face financing difficulties on the financial markets or about the economies that show excessive trade deficits? No. For those countries, instruments were already put in place in the wake of the economic crisis that obligated them to accept the standards of the neoliberal reform alliance as economic policy.

The Neoliberal Reform Alliance Is Targeting The Remaining Countries

Now, the competitive pacts aim to include the remaining countries, such as France, Germany and Italy. For all Euro states, a mechanism shall be created that will, in the words of the Commission, overcome “political [...] deterrents to reform”: In binding contracts, the countries shall commit to “structural reforms of the labour market, the social security and health care systems and of retirement regulations”. Countries with timely adoption shall receive “financial” incentives.

No mention shall be made of the abuse that corporations inflict on social systems through tax evasion, which deprives public coffers of one billion euros yearly, according to estimates by the Commission itself. No mention of the ever quicker redistribution of wealth from the bottom to the top. And no mention of the erosion of democracy, in both economy and society, that is driven by financial markets. Rather, the competitiveness pacts strengthen those actors who have spent years calling for “painful but necessary” reforms of the social infrastructure. In times of tight budgets, who can afford to leave money in Brussels?

But for now, voting in the European Council has not been unanimous, as would be required for the competitiveness pacts. Resistance by the unions and by transnational alliances such as “Another Europe is possible,” among others, was too strong and the outgoing Commission too weak.

Will Jean-Claude Juncker's Commission continue the push to entrench neolibradl economic policies? Juncker Commission

Will Jean-Claude Juncker’s Commission continue the push to entrench neoliberal economic policies? (photo: CC BY-SA 2.0 euranet_plus)

Old Ideas, New Candour: Enforceability For The Commission’s Recommendations

That is supposed to change now. Just a few days ago, the Handelsblatt reported that EU commissioners Moscovici and Dombrovskis, who have been suggested as heads of the relevant departments, want to “ensure that governments follow the EU’s economic recommendations, which have so far been accorded little attention”. Even though this was “one of Merkel’s ideas which had been regarded as rejected,” parts of the proposal are new:

1) Up to now, the Commission has shied away from stating explicitly that its country-specific recommendations should be the object of the pacts.

2) In order to provide the financial incentives for fulfilment of the competitiveness pacts, a separate budget for the Euro zone shall be established in the medium term.

But what, exactly, is the content of the country-specific recommendations? Since the competitiveness pacts, according to all proposals to date, must be concluded between “the member states of the euro zone and the Commission,” it is worthwhile to take a look at the recommendations that the Commission issued in 2014, before they were toned down by the Council:

Belgium, for example, should aim for a “reform of the wage-setting system, including wage indexation [and] to provide for effective automatic corrections when needed”. Bulgaria is advised to lower its minimum wage. France should commit itself to the German model: The unemployment benefit system shall be “reformed” in such a way that “incentives to return to work” are strengthened. Germany, in turn, shall lead the way once more and “[increase] incentives for later retirement”. Slovenia and Croatia are called upon to privatize and Sweden is even asked to deregulate its rent setting system in order to ensure “more market-oriented rent levels”. For Austria, the Commission envisions linking the statutory retirement age to life expectancy and harmonizing the statutory retirement age for women and men sooner.

But are the competitiveness pacts really about a contest between the EU and the nation state? No. Rather, nation state actors belonging to the neoliberal reform alliance are trying to use the European level to further their interests — to push through demands that are, to date, not enforceable within the democracies of the nation states due to a power balance that does not favour these interests that strongly.

Overcoming Democratic Obstacles

The manner in which the competitiveness pacts are to be established makes it obvious that the main conflict is not between “the EU” and, say, “France,” but rather between the executive (both on the European and the national level) and representative democracy. Jean Claude Juncker, the new president of the Commission, lets us know on that point: “I want to launch legislative and non-legislative initiatives to deepen our Economic and Monetary Union during the first year of my mandate. These would include [...] proposals to encourage further structural reforms, if necessary through additional financial incentives and a targeted fiscal capacity at Euro zone level [...].”

The wording suggests that the competitiveness pacts are to be implemented through a regulation. However, the European Treaties clearly do not grant the Commission authority to establish competitiveness pacts or to pay out the financial incentives associated with them. It seems that also the new president of the Commission has chosen the path of authoritarian constitutionalism which will weaken both national parliaments and the European parliament by circumventing regular treaty amendment procedures.

Yet, you cannot accuse the Commission of being dishonest. For two years now, it has clearly articulated what this is all about: overcoming political obstacles. It remains to be seen, however, if the heads of states will join in this new instance of bypassing the parliaments where the wage-earning population is able to advance their interests with comparative ease. A landmark decision will probably be made at one of the next two upcoming European Councils (October 23 or December 18, 2014).

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]]> 0 Lukas Oberndorfer Lukas Oberndorfer Jean-Claude Juncker Will Jean-Claude Juncker's Commission continue the push to entrench neolibradl economic policies? (photo: CC BY-SA 2.0 euranet_plus)