Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
I haven’t much time to write a blog today (travel and other commitments). But I have been examining tax revenue data for the EU in the last day or so as part of another project and thought the following might be of interest. The analysis is still unfinished (by a long way). But to the news – I laughed when I read the story from Der Spiegel (March 12, 2012) – Germany Fails To Meet Its Own Austerity Goals – which listed Germany as a serial offender in the hypocrisy stakes. I also laughed when I read that the German Finance Minister, in between games of Sudoku, told a gathering in Berlin yesterday that (as reported in a Bloomberg video) “deficit spending is the wrong way to bolster economic growth” and that “People who believe you can generate growth without pursuing budget consolidation have “learned nothing from the experience of the crisis.” The combination of staggering hypocrisy and manifest arrogance (thinking that the world is so stupid that they actually believe austerity will deliver growth) seems to have reached new heights.
Der Spiegel reports that while EU nations:
… are expected to implement tough austerity measures amid the debt crisis … Germany isn’t setting a very good example.
Apparently, “Berlin failed to reach its own austerity goals in 2011. And despite pressuring its neighbors to save, Germany is behind this year too.”
We learn that while the Germans have been prosletysing about austerity throughout Europe and essentially pushing the damaging fiscal compact onto the region, they have failed to exercise the same degree of discipline over their own fiscal aggregates.
Der Spiegel reported that:
… the German government didn’t reach even half of its planned savings in the federal budget. Only 42 percent of the spending cuts …. [proposed] … were actually not implemented … only €4.7 billion ($6.16 billion) of the €11.2 billion in austerity measures stipulated by the savings package actually took shape in 2011.
That is clearly one of the reasons that the Germany economy has not tanked in the same way that the Greek economy has.
Appparently, while the German government has “planned €19.1 billion in savings” for this fiscal year, they have implemented “less than half” and so will miss that target too.
This hypocrisy is not new. Please read my blog – The hypocrisy of the Euro cabal is staggering – which documents how the Germans violated the SGP for several years from 2001 to 2005.
At that time, if they had have operated within the SGP rules (that is not maintained the level of fiscal stimulus they actually did) then their economy would have probably fallen into recession.
Consider the following two graphs taken from the detailed government expenditure and revenue data available from Eurostat. The first graph shows the annual evolution of the Budget Deficits (as per cent of GDP) for the “core” EMU nations (Germany, France, Italy) from 1990 into the convergence period leading to the creation of the common currency and to 2010.
The red line is the SGP upper limit deficits (3 per cent). Between 2001 and 2005, Germany violated the Treaty without penalty. France violated it between 2002 and 2004 and Italy between 2001 and 2006.
Why didn’t the Troika form then and along with all the rest of the mainstream commentators demand fiscal austerity for these nations. Why didn’t the EU pursue penalties under the Treaty (which the SGP is contained) against France and Germany?
The so-called corrective arm of the Stability and Growth Pact is called the excessive deficit procedure (EDP) which the EU’s ECFIN calls the “dissuasive arm”.
ECFIN write that:
The EDP is triggered by the deficit breaching the 3% of GDP threshold of the Treaty. If it is decided that the deficit is excessive in the meaning of the Treaty, the Council issues recommendations to the Member States concerned to correct the excessive deficit and gives a time frame for doing so. Non compliance with the recommendations triggers further steps in the procedures, including for euro area Member States the possibility of sanctions.
Fines of up to 0.5% of GDP are allowed for in the Treaty.
Germany was the nation that insisted on the inclusion of the SGP (and as I have noted previously wanted it to be called the “Stability Pact”). They were the first to trangress against it.
This ECB Occasional Paper (published September 2011) – The stability and growth pact crisis and reform says:
When it came to implementing the Stability and Growth Pact in a rigorous manner, the first test was failed. Faced with a need to fully apply the provisions of the corrective arm of the Pact in the autumn of 2003, France and Germany, among others, blocked its strict implementation by colluding in order to reject a Commission recommendation to move a step further in the direction of sanctions under the excessive deficit procedure.
Now consider this graph which shows the budget history since joining the EMU of Greece, Spain, Ireland and Portugal. The intense cyclical deficits are clear in the recent years.
If you consider the two graphs together you would find that the only nations that actually ran surpluses in the common period were Ireland and Spain.
While Germany and France were “living it up” on budget deficits and then bullying the EU Council of Ministers to turn a blind eye to their (stupid) regulations, Ireland and Spain were acting like model EMU citizens.
This juxtaposition is not making a case for punitive action against Germany or France but is rather arguing that the rules are contrary to sound fiscal management and their presence (rather than enforcement) creates an environment – a pretext – for the bullies of Europe – the Troika – to impose whatever ideological slant they want on things.
And now, Der Spiegel reports that Germany is at it again. Laughable really.
And then there was the comment by the German Finance Minister Wolfgang Schäuble that:
People who believe you can generate growth without pursuing budget consolidation have “learned nothing from the experience of the crisis
Which has to rank among one of the quotes of this century really – for the sheer arrogance of it.
If you were to believe him then he must think exactly the opposite to what almost everyone else, other than the neo-liberal deficit terrorist zealots, have actually learned from the crisis. The countries that are going backwards are, largely, those who have engaged in Troika-style fiscal consolidation whereas those that are showing signs of life have not attempted to go down this path, although their senior politicians keep trying to steer their nations in that destructive direction (for example, Japan).
By definition, a nation cannot grow without spending. That is, the way we define economic growth. I know there are controversies about how we measure growth, especially in relation to broader concerns relating to environmental damage, non-paid household work predominantly performed by women, and other issues.
But within the national accounting framework, growth in spending equals GDP growth – in both real and nominal terms.
There are 3 broad sectors – the private domestic sector, the external sector, and the government sector. The. first two sectors sum of the non-government sector.
Spending has to come from these sectors. A recession is typically characterised by a reduction in the growth of private domestic spending (consumption and investment) which also impacts on the external sector balance because one nation’s imports are another’s exports. Import spending is a function of domestic income growth, which is driven by domestic expenditure.
This is typical behaviour has been very evident in the recent crisis, and the Eurozone hasn’t escaped the trend.
Fiscal consolidation, by definition, involves reductions in net public spending, which imposes fiscal drag on the economy. In certain circumstances, that is, when non-government spending growth is robust enough, this will not damage economic growth.
But it is clear, in the current climate, that non-government spending growth is not robust. In that situation, fiscal consolidation undermines growth.
The neo-liberal mantra of the 1990s that active fiscal intervention would damage economic growth because the private sector would react to the rising deficits by increasing their own saving (to fund expected future tax hikes), has been categorically shown to be false in the current crisis.
There is no empirical content in the German finance minister’s claim.
The evidence is clear – austerity is killing growth and private confidence is deteriorating not improving. Any claim that fiscal consolidation will promote growth and that a private recovery is imminent is just a statement of religious doctrine – there is no theory or evidence to support it.
There was an interesting Working Paper from the Bank of Spain (its central bank) early in 2011 – Endogenous fiscal consolidations – by bank researchers Pablo Hernández de Cos and Enrique Moral-Benito. I have referred to it before.
This paper sought to validate the claims that nations like Denmark had grown after a major fiscal contraction. It is not widely quoted by the journalists, presumably because it refutes the findings of the “darlings of austerity” (such as Alesina, A., and S. Ardagna (2010) “Large Changes in Fiscal Policy: Taxes versus Spending”, Tax Policy and the Economy, Editor: R. Brown, vol. 24. NBER. and Giavazzi, F., and M. Pagano (1990) “Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries”, NBER Macroeconomics Annual, pp.95-122, MIT Press., etc).
But it is a thorough piece of research with very foreboding conclusions.
Essentially the research is motivated by the claims made by economists (and policy makers) that “fiscal consolidation episodes could be expansionary for an economy” which challenge “the broadly accepted Keynesian notion concerning the existence of a positive fiscal policy multiplier”.
They explicitly say that the empirical studies which are used to justify austerity:
… are based on empirical analyses in which they first identify periods of drastic and sizeable budget cuts within a panel of OECD countries, and then perform a descriptive analysis of the sample characteristics of macroeconomic aggregates, mainly GDP, before, during, and after the year in which the consolidation episode took place. The main conclusion from this literature is that fiscal adjustments are often followed by an improved growth performance, which is interpreted as evidence of non-Keynesian effects during fiscal consolidation episodes.
The important point to note is that a “positive correlation between fiscal consolidation episodes and GDP growth does not necessarily mean that fiscal consolidations generate economic growth”.
The authors argue that the extant literature claiming fiscal austerity drives growth makes a major error – it “assumes that the consolidation episode is exogenous to GDP” which ignores the causality issue.
They say that it is also possible that the “positive correlation between fiscal adjustments and economic growth may be the result of a positive effect from GDP growth to fiscal consolidation instead of the other way around ….
Their contribution is to conduct the investigation between fiscal consolidation and economic growth within a framework that a allows for the fiscal response to be endogenous – that is, reactive to the state of economic activity.
What do they conclude? Their main conclusion:
… is that endogeneity biases are chiefly responsible for the non-Keynesian results previously found in the literature; hence, fiscal adjustments are found to have a negative effect on GDP growth.
That is, the studies that provide justification for imposing fiscal austerity in the belief that it will generate economic growth are fatally flawed because their research design assumes causality is only one way.
Overall, the paper concludes that once you control for “endogeneity biases”:
… fiscal adjustments are found to have a negative effect on GDP growth.
These results are being borne out every day all around the world. The US is growing and unemployment is falling because their failing polity cannot get their austerity act into gear as yet. The economy is still enjoying the fiscal stimulus (although it was never large enough).
Many economies in Europe are declining fast and unemployment is rising because they have imposed fiscal austerity on vulnerable economies. Spending creates income. Cutting spending destroys income. Private confidence is not engendered by cutting public spending – exactly the opposite.
There is a time when fiscal consolidation occurs without damaging growth. It is when growth becomes robust enough to turn the automatic stabilisers around – so that they start to boost tax revenue and reduce welfare spending.
The reason the “slippage” is occurring in the EMU is because the automatic stabilisers are undermining the discretionary cuts in net spending being imposed by the Troika. But that is no surprise. It is exactly what we would expect. By imposing pro-cyclical discretionary cuts, the governments are ensuring the counter-cyclical automatic stabilisers will kick in hard.
Tax revenue falls, welfare spending rises (if it hasn’t been hacked) and budget deficits rise – slippage.
Exactly the opposite happens when discretionary net spending is increased – the counter-cyclical discretionary net spending stimulates growth which turns the automatic stabilisers around.
The Bank of Spain research paper finds exactly that. Again – no surprise. The German ideologues provide no credible evidence. Just mantra.
In this context, I have been examining trends in tax data in the EU. I will provide a more comprehensive report in due course but the following may be of interest.
This Eurostat site – Tax revenue statistics is very helpful if you wish to learn about how Eurostat deals with tax revenue data.
The first graph shows the relationship between average real GDP growth between 2000 and 2008 (horizontal axis) and the average growth in tax revenue over the same period (vertical axis). The black line is a simple linear regression (equation statistics noted) and there is clearly a positive relationship over this period, which is consistent with both intuition and credible economic theory.
Stronger real GDP growth is typically associated with stronger employment growth and stronger tax revenue growth from both wage and salary earners and the corporate sector.
There is nothing exceptional about Greece – it experienced mid-range real GDP growth and mid-range growth in tax revenue over that period. The Baltic nations are out to the right of the graph.
If I was to model this relationship more rigorously, I would find a very strong positive, statistically-significant relationship consistent with the information in the graph.
The next graph plots the same relationship for 2009 (blue diamonds) and 2010 (red squares). The Baltic states are once again the extreme observations for 2009 only this time at the opposite end of the growth continuum.
It is interesting, that for 2009 the relationship remains positive but has weakened. I haven’t done any serious econometric analysis of this data, but I’m sure that tests for asymmetries in the time series would find that to be so.
If you consult the accompanying table (see below), you will see that Greece is still unexceptionable – in the sense, but the decline in its tax revenue was consistent with the decline in real GDP.
However what is interesting, and unexplained at this stage, is what happens to the relationship in 2010. Greece is now the outlier and the relationship appears to switched to being negative – that is, rising growth is associated with declining growth in tax revenue. I’m investigating this in more detail and will report back when I understand it better.
2010 was the year that fiscal austerity was broadly imposed on the Eurozone nations. However some of the other nations did not follow suit. I suspect that divergence in policy stances may be at the bottom of this story.
This table provides the underlying data for the previous 2 graphs.
In a later blog, I will show the extent to which the lost tax revenue impacted on the budget outcomes for various EU nations. Preliminary analysis shows that the cyclical decline of tax revenue impacted to the order of several percentage points on the budget bottom-line for several EU nations.
What the data shows is that the so-called automatic stabilisers drove the budget outcomes in many EMU nations beyond the SGP threshold. So without the government making any discretionary changes in its spending and tax policies in response to the collapse in aggregate demand, the fiscal rules would have been violated in many cases.
The fact that a cyclical swing can produce such an outcome raises questions about the validity of the fiscal rules.
The German-inspired fiscal compact, which the EU nations are now signing up for will be even worse. The dynamic they impose upon the region is one of entrenched stagnation.
I have run out of time today. I was also going to comment on last Thursday’s ECB Press Conference (March 8, 2012) as well because the new ECB boss really outlined his conceptualisation of fiscal austerity. There is no doubt that they consider “union” to be more important than prosperity. I will come back to that another day.
The Press Conference also demonstrated categorically that the ECB is not an independent, impartial player in the EMU. Mr Draghi was lecturing member states about their fiscal policy settings. But then the German government were pressuring the ECB to stop its provision of liquidity to the banks.
In the article – Germany Turns Up Pressure on ECB – (March 10, 2012), an ally of Dr Merkel said:
I hope that the ECB acknowledges its limits and quickly rakes in the money
Which limits are they exactly?
The general point is that with political leaders that Europe is burdened with the outlook is very gloomy.
That is enough for today!