Europe is really having a lost decade

I am sick of reading about Europe’s lost decade. For example, in the UK Guardian article (July 27, 2012) – Spanish recession to last until 2014, IMF warns – the economics editor Larry Elliot says that the IMF is “Predicting a lost decade of growth for the eurozone’s fourth biggest economy”. The lost decade terminology emerged to describe the experience of Japan in the 1990s after its spectacularly damaging property crash. But I think it is offensive to use the term in relation to the Eurozone crisis. We are not seeing a lost decade emerge Japanese-style. Rather, we are witnessing a self-imposed humanitarian disaster driven by the ideological arrogance of the Euro elites (aided and abetted by the OECD and IMF). The experience of Japan in the 1990s was nothing compared to what these elites are doing in the name of neo-liberalism. Journalists should stop making the comparison and, instead, call the current crisis in Europe for what it is.

The IMF Survey Magazine article (July 27, 2012) – Spain Needs to Deliver on Reforms to Stabilize Economy – indicates that the IMF has learned very little from the crisis and is intent on getting back to business as normal as soon as they can – ignoring the devastation that the policies they advocate and force onto nations are creating.

I thought the photo that accompanied the article was a disgrace (reproduced below). The caption read “Shoppers in Cádiz, Spain”.

The Survey Magazine article accompanied the major IMF report (released July 2012) – IMF Country Report No. 12/202 – Spain – which reports on the bilateral discussions between the Spanish government and the IMF (part of the obligations of the IMF under its Articles of Agreement).

The Report summarised the latest pernicious austerity program that the EU in partnership with the IMF have imposed on Spain. The July 10 recommendations from the EC amounted to a “loosening the targets for 2012-14” but what remains is still a vicious austerity program

The Spanish government reacted like lapdogs and:

1. Increased the VAT from 18 to 21 per cent (and pushed more low-rated products into the standard rate).

2. Cut the December extra payment to public servants – “equivalent to nearly a monthly wage.”

3. Reduce income tax deductions on mortgages.

4. REDUCE the unemployment benefit to be paid.

5. etc

The IMF Report concludes that:

… the new fiscal consolidation measures to have a significant impact on growth, especially in 2013. While the large role of indirect taxes should lead to a relatively low multiplier, preliminary estimates suggest that the level of output would be lowered by about 1 percent by 2014. Unemployment would also increase, although this might be mitigated by the effect of lower social security contributions and unemployment benefits, as well as the recent labor market reform. The VAT increase, combined with electricity price increases, will also lead to temporarily higher inflation.

The IMF are forecasting a modest return to grwoth in 2014 but on present form that is not a likely outcome. The unemployment rate will remain above 20 per cent at least until 2017.

Study the above quote carefully because it tells you a lot about the IMF mentality. They know that slashing demand will cause the recession to deepen and endure at least for another two years. If the Spaniards thought this year was bad then the next will be worse.

They also know that unemployment will rise. But then they come out – true to form – and insinuate that the increase in unemployment will be attenuated because people will react to the lower unemployment benefits in an adverse manner.

Really? What will these people do instead? With jobs growth continuing to shrink and the probability of getting a job falling do they really think that the unemployed workers are choosing at the margin to be jobless or not depending on the level of the unemployment benefit?

The reality is that cutting the unemployment benefit will make the recession deeper because the capacity of the unemployment to spend will be further compromised.

Unemployment benefits support aggregate demand – albeit in a modest way given the level that is usually offered by governments to their most disadvantaged citizens.

In a recession, if the government is unwilling to take the first-best option and directly create work to prevent unemployment from escalating, then the second-best option is to increase the unemployment benefit and give a boost to demand.

The IMF also think that undermining the job security of workers (the “recent labor market reforms”) also reduces unemployment.

The IMF clearly hasn’t been briefed on this by the OECD. In the face of the mounting criticism and empirical argument, the OECD began to back away from its hard-line 1994 Jobs Study position (which demanded widespread deregulation as the solution to unemployment).

In the 2004 Employment Outlook, OECD (2004: 81, 165) admitted that “the evidence of the role played by employment protection legislation on aggregate employment and unemployment remains mixed” and that the evidence supporting their Jobs Study view that high real wages cause unemployment “is somewhat fragile.”

Then in 2006, the OECD Employment Outlook entitled Boosting Jobs and Incomes, which claimed to be a comprehensive econometric analysis of employment outcomes across 20 OECD countries between 1983 and 2003 went further. The study sample for the econometric modelling included those who adopted the Jobs Study as a policy template and those who resisted labour market deregulation. The Report revealed a significant shift in the OECD position.

OECD (2006) finds that:

• There is no significant correlation between unemployment and employment protection legislation;
• The level of the minimum wage has no significant direct impact on unemployment; and
• Highly centralised wage bargaining significantly reduces unemployment.

The only robust finding that the OECD (2006) demonstrated was that employment protections do not impact on the level of unemployment but merely redistribute it towards the most disadvantaged – including the youth who have not yet developed skills and have little work experience.

That point is obvious. In a job-rationed economy, supply-side characteristics will always serve to only shuffle the unemployment queue. The problem is a shortage of jobs. Unemployment dances very closely to labour demand not labour supply.

But then the IMF operates in a world of concocted evidence and blithe ideological disregard for logical consistency.

In their Spain Report, the IMF claim the problem is the “mounting market pressure and costly market access” although they are forced to admit that Spain:

… is in the midst of an unprecedented double-dip recession with unemployment already unacceptably high, public debt increasing rapidly, and segments of the financial sector lacking capital and market access. Headwinds from household and corporate deleveraging, combined with unavoidable fiscal consolidation and persistent capital outflows, will likely translate into output contractions this year and next.

They claim that “(t)he modest recovery from the 2008-09 crisis gave way to a new slowdown in the second half of 2011 as financial tensions rose” but fail to implicate the austerity programs in this decline.

We learn that “(i)ncome inequality and poverty are on the rise, especially among the young” due to unemployment and the widening disadvantage of temporary workers relative to those on permanent contracts.

At the behest of the OECD and the IMF, Spain led the way in the pre-crisis growth period in creating a dual labour market with an increasing number of workers being denied the chance to enjoy secure, well-paid work. This secondary labour market workforce, already at the bottom of the pile, we disproportionately hammered by the current crisis and government policy responses.

We learn that the household savings ratio improved as the deficits promoted recovery in the early stages of the crisis but have now “declined back towards pre-crisis levels in 2011 amidst weakening disposable income and housing investment”. Once again, the IMF is silent on the obvious point that it was the rising deficits that put a floor in the downward spiral in real GDP growth and provided the conditions (income growth) for households to save and reduce their precarious debt levels.

Any reasonable economist would look at this situation and urge the Spanish government to expand its net spending (increase its deficit) – target wide-scale job creation with an emphasis on getting the youth into work – and generate the conditions where the private sector could more quickly recover from the massive housing crash.

The same economist would urge the government to put into place industry strategies to help the economy rebalance away from private housing construction, which accelerated beyond any sustainable proportions in the lead up to the crisis.

The economist would also urge the government to either cooperate with the central bank (ECB) to minimise yields on its debt or better still stop issuing debt altogether and fund the deficit spending directly from the currency-issuing capacity of the bank.

If the ECB was unwilling to be a growth partner then the economist would recommend the Spanish economy re-create its own central bank and restore its currency sovereignty.

That is the only way that the economy will get out of this mess quickly and put a limit on the rise in unemployment and poverty.

But of-course, the IMF is not a “reasonable economist”. It claims that:

Large fiscal consolidation is … unavoidable.

Which is a lie. If the ECB acted as a growth-oriented central bank then there would be no need at present for any discretionary fiscal contraction. The deficit would decline over time as fiscal-led growth stimulated tax revenue and reduce welfare payments.

Real output could be increased immediately if the government acted responsibility and introduced large-scale public employment programs.

Under the IMF plan, “(o)utput will likely decline this year and next, and over the medium term because of the “fiscal consolidation”. That is, the IMF support the deliberate sabotaging of economic growth and increased poverty.

Further, they project that “(p)otential output growth … [will] … turn negative” partly due to “a permanent decline in capital
accumulation” which means that Spain’s growth trajectory will be damaged for years to come – further reducing the capacity of the economy to generate prosperity.

What madness is it that deliberately undermines prosperity? This is a pure ideological attack on the people of Spain. The Spanish government could very quickly restore confidence in the economy and gets growth going again. Why aren’t they doing it? Because the country is being choked by neo-liberals, backed up by the despicable IMF machine, none of who suffer the costs of their policy approaches.

One of the things a student of economics learns early on is that there are costs and benefits to all resource allocation decisions and policy choices.

The fact is that the none of these agencies (EC, IMF, OECD, ECB) have provided a convincing cost-benefit analysis of their austerity policies. There is no paper I can find where they catalogue the costs of a decade of high unemployment, the destruction of productive capital, the breakdown of public health and safety, and sadly, the breakdown of order in communities, families and individuals.

Where is the cost-benefit analysis of the policies that will leave European youth unemployed for at least a decade – meaning they transit from being teenagers to adults having never had a job; never gaining work experience; and dropping out of the education system admist forced cutbacks to public schools.

The current generation of economists will stand dammed for their actions in the current crisis.

All the IMF can say in the Spain Report is that once again they got it wrong:

The 2011 fiscal slippage was much worse than expected, underlining the challenges of fiscal consolidation at all levels of government.

And given the deteriorating growth, they acknowledge that it will be even harder for the Spanish government to stay on track in its deficit reduction plans.

Their solution?

Staff expects an overall deficit of around 7 percent of GDP, a deviation with respect to target of around 1 1⁄2 percent of GDP. Structural slippage should be resisted, but given the weak growth outlook, it should not be made up in a compressed timeframe. This could imply, for example, immediately taking additional measures of at least 1 percent of GDP on a full year basis to reach a 2012 deficit of about 6 1⁄4 to 6 1⁄2 percent of GDP. The additional measures could usefully include eliminating some VAT exemptions, raising VAT rates (especially reduced rates) and other indirect taxes, taxing the thirteenth salary, and cutting fourth quarter capital expenditure.

That is, when the wound in the head is bleeding more than you planned during the torture the only solution is to get a bigger hammer and bash harder. That should fix it.

The IMF wants more tax increases (“there is considerable scope to reduce tax expenditures and increase indirect tax revenue by broadening the base and raising and unifying rates”) – further cuts in spending (” future public wage cuts to reduce the wage bill”) and more public asset sales (“privatization on remaining assets should be more aggressively pursued”).

They have the audacity to claim that if the austerity is “front-loaded” – that is, tougher now – “should boost market confidence and reduce borrowing need”.

Their proposals in this regard will worsen private sector confidence and increase social instability. I predict that the markets will never be confident with that sort of scenario.

The markets want stable places to invest and prefer growth scenarios.

In the Survey Article, the IMFs mission chief for Spain, one James Daniel is interviewed. I will spare you the agony of reading it.

He just reiterates the nonsensical claim that the austerity merchants are repeating constantly now that the Spanish government has to make:

… sure the measures to reduce the fiscal deficit are as growth-friendly as possible …

With the private sector in retreat, cutting public deficits is never “growth-friendly”. The IMF projections themselves show that the fiscal austerity will undermine growth by at least 1.5 per cent in the coming year.

What they mean is that the aim is to minimise the damage the policy causes.

James Daniel also had the indecency to reiterate the IMF line that mass unemployment is so high in Spain because the labour market is not flexible enough.

And what of the lost decade comparison?

Real GDP

The following graph uses OECD Real GDP data to compare how the current crisis in the four worst-hit EMU nations compares with the crisis that Japan experiences when its property market collapsed in the early 1990s.

The indexes are set to 100 at the respective real GDP peaks and then trace the evolution of the economies in the quarters that preceded the peaks.

The respective peaks in real GDP were September 2008 for Greece; March 2007 for Ireland (hence the longer time series); December 2007 for Portugal; March 2008 for Spain and March 1993 for Japan.

Unemployment rates

The unemployment data came from Eurostat.

The low-point unemployment rates as the crisis hit were Greece 7.3 per cent in May 2008; Ireland 4.3 per cent in November 2006; Portugal 8.2 per cent in April 2008; and Spain 7.9 per cent in May 2007. At the time of its major property bust recession, Japan recorded a low-point unemployment rate of 2 per cent in February 1992.

On July 2, 2012, Eurostat released their most recent unemployment data for May 2012 which showed that the overall Euro area unemployment rate had risen to 11 per cent – the highest in the monetary union’s history.

The data showed that the unemployment rate in Greece (as at March 2012) was 21.9 per cent (now close to 25 per cent); Ireland 14.6 per cent; Portugal 15.1 per cent; and Spain 24.6 per cent (now above 25 per cent). At the same time, the unemployment rate in Japan was 4.4 per cent.

Youth unemployment rates (under 25 years of age) in Greece (March 2012) and Spain (May 2012) were 52.1 per cent and the situation has deteriorated since then.

The following graph compares the evolution of the unemployment rate in the four EMU nations in the current crisis with Japan in the 1990s with the series indexed to 100 at the respective low-point unemployment rates.

Why did Japan perform much better even though its property crash was probably larger than that experienced in Spain or Ireland in recent years?

First, it has its own currency and its own central bank.

Second, it floats the yen.

Third, it used budget deficits deliberately in the early 1990s to buttress aggregate demand. In fact, despite the massive property crash and the retreat of private investment, Japan only had a mild recession – with real GDP growth declining in June 1993 (-1.1 per cent) and September 1993 (-0.5 per cent). There were other quarters during this period where negative real GDP growth was recorded but never two successive quarters of negative growth.

In fact, the next recession, larger than in 1993 came in 1997-98 as a result of the conservatives forcing fiscal austerity (tax increases) on the government as the budget deficit rose.

Once the austerity was reversed in 1998, the economy resumed growth relatively quickly.

Fourth, the rise in unemployment was held down because the government prioritised low unemployment.

Conclusion

There is no comparison between Japan’s low growth decade in the 1990s as it struggled with a spectacular property crash and what is happening in Europe at present.

The former was made possible because the government for the most part used deficit spending to ensure growth was maintained in the face of unprecedented private sector spending cut backs.

The latter is a deliberately created disaster – ideologues running amok. A human tragedy is being created but none of the elites will bear the costs.

Alternative Olympic Games Medal Tally

My Alternative Olympic Games Medal Tally is now active.

I update it early in the day and again around lunchtime when all the sports are concluded for the day.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.