Are the Euro bosses going all growth on us?

I am still in Darwin today and have limited time to write. It seems, however, that the Euro bosses have gone all growth on us. For non-English speakers – going all growth on us – is terrible slang meaning are they becoming enamoured with the idea that growth is important. Apparently, austerity is “so yesterday”, if not “last week” and the mantra is now about “growth compacts”. Forget the fiscal compact which most of the EU states have signed up for which if realised will drive their economies into the ground so harsh are the proposed rules on budgets and public debt. Now there is a growth compact proposal – which Mario has suggested Europe follows. Angie is right in behind him – has Madame Austerity – has gone all growth on us too?. It has been a bad week for the Troika (IMF, ECB, EU) – what with the UK now officially in a double-dip due to the deliberate strategy of its government (emulating the EMU) and across the Channel, the impending success of François Hollande is now becoming obvious. Merkoz will now have to morph into Mollande. And while on “olland”, the Dutch government also collapsed as a direct result of the backlash over the fiscal austerity. Apparently, the likely new French president is not particularly keen to join the fiscal austerity conga line although all his public statements to date would suggest he is committed to the SGP principles. So what is this all about? Are the Euro bosses going “all growth on us”? Answer: there will be no “growth compact” other than in the title of some EU Summit paper. The growth spin is mounting but the EU elites remain firmly wedded to doing everything they can to undermine growth.

The UK Guardian even thinks the Euro bosses are “going all growth on us”. In the article (April 25, 2012) – To the left: a likely new direction for France and Germany – we read that:

Quite suddenly, there is talk of change in the eurozone’s economic strategy and, in particular, of the need for urgent action by the European Union to reverse the downward spiral of negative growth and rising unemployment.

Bloomberg News reported (April 26, 2012) – Hollande Says He Disagrees With Draghi’s Method for Growth – that François Hollande considered “Draghi’s comments yesterday were a step in the right direction”. But he also said that the French government would still want to negotiate changes to the fiscal compact.

The likely next French President said of Draghi’s call for a “growth compact” that:

There is a very big change in the mindset … He has realized that we can’t reach deficit-reduction targets and debt control if there isn’t growth so he is talking about a growth pact.

But he also said that a French Socialist government would spend more but tax more while still meeting the SGP fiscal targets.

What he clearly doesn’t understand is that the European economies need more fiscal stimulus overall which means the deficits need to increase. His strategy of reducing the French deficit but redistributing the burden of the fiscal austerity (for example, by taxing high income earners more) will have no hope of providing a net stimulus to French aggregate demand.

He also doesn’t understand what Draghi and the other EU bosses were meaning when they said there needs to be a growth compact to supplement the anti-growth fiscal compact.

On April 25, 2012, ECB boss Mario Draghi appeared before the European Parliament’s Economic and Monetary Affairs – and called for a “plan to boost growth in the Eurozone” because the ECB were disappointed that its monetary policy efforts “were not having as rapid an effect as first hoped”.

He told the EU Parliament that:

We’ve had a fiscal compact … What is most present in my mind now is to have a growth compact. I think that’s what we have to have. … This was anticipated by the “six pack” … We now need to go back and have a ‘growth compact …

In a speech the following day (April 26, 2012) – Welcome remarks at the ECB-EC conference on financial integration and stability – the ECB boss said that:

Where economic governance is concerned, new crisis resolution instruments have been created … A key milestone in this respect is also the adoption of the “six-pack”. Let me take this opportunity to warmly thank the Commission for the work that has been done in these areas through difficult times in the last years.

The “Six-Pack”, which I considered in this recent blog – The left – entranced by the fiscal austerity mantra sold to them by the conservatives – provides no crisis resolution capacity to the Eurozone. The reality is that by further restricting the fiscal response capacity of member governments the fiscal compact promises to hasten crisis and make any aggregate demand shock deeper and longer.

In the current circumstances, where private spending is flat and/or in decline, the fiscal compact ensures that recession or stagnation becomes entrenched.

Draghi also didn’t provide any detailed elaboration to the EU Parliament on what a growth compact might involve.

Bloomberg News reported (April 25, 2102) – Draghi Softens Tone on Inflation, Calls for Growth Compact – that

Draghi, whose call for a fiscal compact to toughen budget rules was adopted by European Union leaders, today urged them to take similar steps to foster growth

He said that “(g)rowth should be supported by foreign demand, the very low short-term interest rates as well as our non-standard measures” even though he was surprised the standard and non-standard measures deployed by the central bank had not broken the downward real growth spiral. It is an astounding admission for a central banker to express “disappoint” that monetary policy is such a weak policy when it comes to manipulating aggregate demand.

The whole neo-liberal macroeconomic edifice is constructed on the erroneous claim that fiscal policy is ultimately useless and should be avoided (it only adds public debt and inflation) and that the major aggregate demand management initiatives should be left to monetary policy.

The reliance on monetary policy (low interest rates, quantitative easing, and the loans to banks) has allowed the crisis to worsen. The response of aggregate demand to these measures is clearly weak and lagged. This recession has demonstrated just how effective fiscal policy has been to stimulate growth (as some nations adopted significant fiscal stimulus packages early in the recession) and also, unfortunately, to undermine growth as nations have moved into a fiscal austerity mindset.

The difference between Europe and the US is mostly down to the fact that the latter national government has maintained fiscal stimulus for longer and is yet to engage in substantial fiscal cuts (although its idiot politicians are doing what they can to get on the fiscal austerity bandwagon).

In relation to a fiscal and growth compact, are you starting to shift uncomfortably in your chair as you try to piece together what all this means. In December 2012, Draghi was extolling the virtues of austerity (that is, the fiscal compact) – a few months later he urges the EU leaders to “take similar steps to foster growth”.

Does that mean he wants to abandon the fiscal compact because it quite obviously prevents growth under most circumstances?

German Chancellor certainly doesn’t think that is what he meant. Apparently, German Chancellor Angela Merkel (Angie to those who know her!) backed Draghi’s call for a growth compact telling a Berlin conference that growth as well as fiscal austerity was need in Europe to end the crisis.

The Financial Times reported (April 25, 2012) – Draghi calls for Europe ‘growth compact’ – quoted Merkel as saying:

We need growth in the form of sustainable initiatives, not simply economic stimulus programmes that just increase government debt …

She also apparently told her Christian Democrat party that “Sustainable fiscal policy … is a necessary but not sufficient method of overcoming the crisis because we also need growth”.

First, I wouldn’t use the word sustainable to describe the imposition of fiscal austerity on nations that are no where near to full employment and have no inflation risk. Fiscal austerity in the current European environment is fiscal vandalism.

It is clear that sustainable fiscal policy is a necessary condition for growth. But from a Modern Monetary Theory (MMT) perspective, the meaning of “sustainability” is not even remotely similar to the concept that the Troika, the OECD and most mainstream economists employ.

Please read my blogs – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3 – for more detailed elaboration of the concept.

But you start to get the picture.

Dr Merkel also said:

We need growth in the form of sustainable initiatives, not stimulus programmes which would increase debt, but growth in the form of structural reform …

And there you have it. They are not talking about growth at all. They are talking about supply-side measures to undermine the working conditions of wage and salary earners because they consider the problem in the Eurozone to be a lack of competitiveness driven by excessive costs which undermines the export potential of these nations.

However, if all nations are imposing austerity then there is little hope that a single nation can “internally deflate” their way to export growth. That strategy is failing at present – noting that German’s own exports are in decline and its manufacturing powerhouse is going backwards at present as austerity kills growth everywhere.

Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

Further, the reason the Euro elites are advocating internal devaluation (that is, harsh cuts in wages and salaries for workers) is that they have a system where exchange rate adjustment (the normal way in which external variations in real unit labour costs are mediated) is precluded by design.

The flawed design of the EMU and the imposition of the SGP (and now the fiscal compact) leaves on one adjustment mechanism – scorching domestic wages.

The Troika and all the other neo-liberal hangers-on (such as the OECD etc) all preach the virtues of internal devaluation and have been forecasting massive boosts to export growth for several years now in nations that push the interntal develauation the fastest.

But the problem with these so-called structural adjustment programs is that they don’t even guarantee that international competitiveness improves, quite apart from what they do for equity.

The real exchange rate (R) is typically used as an indicator of international competitive. It is defined as:

R = (e.Pw/P)

where P is the domestic price level specified in $A, and Pw is the foreign price level specified in foreign currency units, say $US and e is the nominal exchange rate.

There are also non-price dimensions to competitiveness, including quality and reliability of supply, which are assumed to be constant, when considering movements in the real exchange rate.

This Bank of Japan explanation of the real effective exchange rate is informative.

The nominal exchange rate is the number of units of one currency that can be purchased with one unit of another currency. There are two ways in which we can quote a bi-lateral exchange rate but I typically use the following convention (for example, expressed as the relationship between the $A and the $US) – e is the amount of $A which is required to buy one unit of the foreign currency.

To understand whether a nation’s goods are becoming more or less competitive with respect to goods and services produced overseas we need to know about;

• movements in the exchange rate, ee; and
• relative inflation rates (domestic and foreign).

Clearly within the EMU, the nominal exchange rate is fixed between nations so changes in competitiveness all come down to the second source and here foreign (for any particular member state) means other nations within the EMU as well as nations beyond the EMU.

We can define the ratio of domestic prices (P) to the rest of the world (Pw) as Pw/P.

For a nation running a flexible exchange rate, and domestic prices of goods, say in the USA and Australia remaining unchanged, a depreciation in Australia’s exchange means that our goods have become relatively cheaper than US goods. So our imports should fall and exports rise. An exchange rate appreciation has the opposite effect which is what is occurring at present.

But this option is not available to an EMU nation so the only way goods in say Greece can become cheaper relative to goods in say, Germany is for the relative price ratio (Pw/P) to change:

• If Pw is rising faster than P, then Greek goods are becoming relatively cheaper within the EMU; and
• If Pw is rising slower than P, then Greek goods are becoming relatively more expensive within the EMU.

The inverse of the relative price ratio, namely (P/Pw) measures the ratio of export prices to import prices and is known as the terms of trade.

A rise in the real exchange rate can occur if:

• the nominal e depreciates; and/or
• Pw rises more than P, other things equal.

A rise in the real exchange rate should increase our exports and reduce our imports.

A fall in the real exchange rate can occur if:

• the nominal e appreciates; and/or
• Pw rises less than P, other things equal.

A fall in the real exchange rate should reduce our exports and increase our imports.

In the case of the EMU nation we have to consider what factors will drive Pw/P up and increase the competitive of a particular nation.

Given prices are typically set as a mark-up on unit labour costs, then the way to decrease the price level relative to the rest of the world is to reduce unit labour costs faster than everywhere else.

That is the logic of the structural adjustment that Draghi and Merkel desire.

Unit labour costs are defined as cost per unit of output and are thus ratios of wage (and other costs) to output. If labour costs are dominant (we can ignore other costs for the moment) so total labour costs are the wage rate times total employment = w.L. Real output is Y.

So unit labour costs (ULC) = w.L/Y.

L/Y is the inverse of labour productivity(LP) so ULCs can be expressed as the w/(Y/L) = w/LP.

So if the rate of growth in wages is faster than labour productivity growth then ULCs rise and vice-versa. So one way of cutting ULCs is to cut wage levels which is what the austerity programs in the EMU nations (Ireland, Greece, Portugal etc) are attempting to do.

But LP is not constant. If morale falls, sabotage rises, absenteeism rises and overall investment falls in reaction to the extended period of recession and wage cuts then productivity is likely to fall as well. Thus there is no guarantee that ULCs will fall by any significant amount.

Further, the reduction in nominal wage levels threatens the contractual viability of workers (with mortgages etc). It is likely that the cuts in wages would have to be so severe that widespread mortgage defaults etc would result. The instability that this would lead to makes the final outcome uncertain.

Given all the likely coincident outcomes (with fiscal austerity and internal devaluation), external competitive will not be automatically restored by deflating nominal wages and price levels.

The other obvious reality is that the damage done to domestic demand as a result of fiscal austerity (and internal devaluation) is unlikely to be offset by any net exports growth, should the latter actually occur.

Further, rising inequality, a marked characteristic of the neo-liberal period has also been shown to undermine growth. Nations that enjoy the longest periods of growth are those that are also moving toward greater equality of income and wealth.

If you would like to read more about that – see this IMF paper – Inequality and Unsustainable Growth: Two Sides of the Same Coin – from April 2011.

I will write more about this in a later blog.

The Euro observer also said reported (April 26, 2012) that there would be an – Informal EU summit on growth possible before June.

That is everything the region needs right now – another summit complete with fine wines and dinners to the tastes of the EU elites.

The article said that EC boss Herman Van Rompuy considered this to be “the highest priority for European leaders”. It has been the highest priority of the workers for more than 4 years now. The “leaders” take a while to catch on.

Van Rompuy said there would be a meeting in June but that he did “not exclude convening an informal leaders’ dinner at an earlier date for an open exchange of views on how best to prepare matters for June”. You can see why I noted the nutritional information above!

Van Rompuy also was reported as saying:

… there was no simple answer to get the eurozone back to growth … [and calls for state stimulus] … schizophrenic … There are 2 million job vacancies in the EU. I presume not for 2 million Albert Einsteins. Skills are needed at all levels … Structural reforms … will make a difference over time … We must tell the truth. There are no magic formulas, reforms take time and so does their impact on jobs and growth.

From which you can conclude that Mr Van Rompuy either doesn’t know what the truth is or is lying through his teeth.

His attempt to deflect the massive unemployment problem and reconstruct it as a “matching” problem (vacancies to unemployed) is a disgrace

Eurostat data shows that there were 24.4 million persons unemployed in the EU ((Source) and that around 8.5 million part-time workers in the EU27 wished to work more hours, which is equivalent to 4.6 per cent of the current labour force (Source).

If you add all that labour wastage together, the resulting figure swamps the 2 million or not Albert Einsteins that Van Rompuy considers to be in demand.

Further, the use of the term “schizophrenic” is odd indeed. It is not particlarly consoling for the millions of people afflicted with mental illness who are at the back of the labour market queue at the best of times but in an impossible situation with respect to gaining employment in the current situation.

But if private spending is weak and net exports are not sufficient to boost aggregate demand then where does Mr Van Rompuy think the spending growth that is required to create the extra jobs – millions of them – will come from?

The only source of the extra demand under current circumstances is a state stimulus.

Here are the magic formulas:

1. Spending equals income equal output which drives employment.

2. Total spending equals government and non-government spending.

3. To increase employment and reduce unemployment, real GDP growth has to outstrip the growth in the labour force and productivity.

4. If non-government spending is insufficient to drive that growth – then unmagically – there is only sector left.

Would someone please E-mail Mr Van Rompuy with these magic formulas? Thanks!

Conclusion

In relation to my initial question: Are the Euro bosses going “all growth on us”? We can be secure tonight as we tuck into bed for sleep that the answer is no!

All they are doing is repackaging the same fiscal expansion contraction myth. They intend to continue killing demand with the fiscal cutbacks and attacks on workers’ rights and pay.

The rising unemployment that they will continue to foster then provides strong negative feedback into aggregate demand. And then … things get worse.

Saturday Quiz

While I am flying home from Darwin overnight (that is, not tucking into my bed for sleep tonight), the Saturday Quiz will become available. I hope you enjoy it.

That is enough for today!