Unemployment is skyrocketing – but we have treaty obligations!

And that is the problem. The Treaty (of Lisbon) and all the related Eurozone legalities that define the way the Brussels bureaucracy interacts with the member states is incapable of delivering prosperity to its citizens. In the last week, a senior Dutch economics official (boss of very conservative Centraal Planbureau) has delivered a wake-up call to European policy makers. In his departing press briefings the CPB chief, who is no Keynesian (rather he is a rigid supply-sider) has called for flexibility with respect to the application of the fiscal rules and an easing of the planned austerity because his nation’s economic performance is deteriorating fast. The Southern malaise is now impacting on the richer, more smug northern nations, as it always was going too. Many economists remain in denial of what is happening. It is 2013 not 2009. The world has been caught up in this crisis for 5 years. It is an entrenched crisis and the data is now showing us that the recent manifestation of the crisis is being driven by fiscal austerity. The initial impacts of the GFC were large but recovery had commenced and have now been killed off by the fiscal zealots. While the departing CPB boss called on the Dutch government to ignore the Stability and Growth Pact rules for the next few years, he also observed, that the nation had “treaty obligations”. That is the problem. These obligations prevent responsible fiscal positions, which in the current circumstances, would suggest budget deficits of several more percent of GDP than the 3 per cent rule being fully supported by the ECB.

Here is the evidence that austerity kills growth. The following graph uses data from the – ECB Data Warehouse – and shows the Euro area 17 (fixed composition) – Industrial Production Index, Total Industry (excluding construction) Working day and seasonally adjusted.

Obviously, the GFC downturn was very sharp and deep. Then the expansion of the budget deficits, mostly but not exclusively due to the automatic stabilisers, restored growth and a recovery was underway.

Then ideology got in the way and the rest is obvious. Just keep reminding yourself that the economists were advising these Eurozone policy makers that all they had to do was start hacking into public spending to signal to the private sector that they would be bringing deficits (and public debt down) and the latter would be so happy that they weren’t going to be taxed out of existence in the future that they would abandon saving up for the higher taxes and spend, spend, spend.

So confident would they be that they would ignore the deflationary impact of unemployment and lack of orders coming into firms. Soon, they would spend up big. The Ricardian myth was paraded by many political leaders.

Rogoff and Reinhart were touted around the place as the answer. They did lecture tours and conducted interviews telling everyone about the 90 per cent disaster threshold. They forgot to mention that they didn’t work their Excel worksheet in a competent manner. Or was it not a matter of incompetence?

It was obvious what was going to happen. And it did. Keep looking for statements from mainstream economists from 2009, 2010 etc about how fiscal contraction expansion was the way to go.

And the Netherlands …

On April 18, 2013, the Dutch national statistical agency – Statistics Netherlands (Centraal Bureau voor de Statiskiek) announced that – Unemployment rises to over 8 percent.

There were 30 thousand extra unemployed (now at 643 thousand) in March 2013. Those receiving benefits rose by only 3 million (to 380 thousand) putting paid to the mainstream economic argument that the provision of benefits lures people onto the unemployment queue.

In December 2012, the unemployment rate was 7.2 per cent. We are thus seeing the sharp rise in unemployment consistent with a significant turn in the economy.

The agency confirmed that the crisis is now penetrating those typically the last affected – the prime-age workers:

In the last three months, the increase was strongest among 25-44 year-olds. In this age group an average 11 thousand people per month became unemployed. Unemployment among over-45s rose by 8 thousand a month, among under-25s it increased by 4 thousand a month. Unemployment according to the definition used by the ILO was 6.4 percent, up from 6.2 percent in February.

On April 19, 2013, the Dutch Volskrant newspaper ran the story – Teulings: verlaat 3 procent, schrap extra bezuinigingen – (Teulings: Forget the 3 per cent, do not make the extra cuts).

Coen Teulings is the retiring head of the – Centraal Planbureau (CPB) – which is part of the Dutch Ministry of Economic Affairs and provides the government with economic analysis and forecasting, and advises the Dutch Cabinet.

It was established in 1945 and the great economist Jan Tinbergen was appointed as its first director. Tinbergen, by the way, had a war with an intolerant John Maynard Keynes about matters econometrics and I did some work on that debate some years ago, which I might reprise at some point because it is very interesting.

By way of background, – de Volkskrant – it started life as a Catholic politicial daily newspaper (in 1919, although it only went daily in 1921). After the Second World War, it became a left-wing paper for the more intelligent reader (by contrast with De Telegraaf, for example). But in this neo-liberal era, it has progressively diluted its political slant and is now a centrist paper, which means in this era of the shifting centre, that it is a vehicle for right-wing (but toned-down) economic propaganda.

While the CPB had noble origins, it went downhill over the last 30 years or so as it became one of the spearheads of the neo-liberal onslaught against welfare entitlements, minimum wages, job protection etc.

I was very critical of it some years ago (with my co-author Joan Muysken) for publishing work that wasn’t that far removed from the fudged Rogoff and Reinhart standards of excellence.

For example, there were a series of papers from CPB (Broer et al, Van Horst etc) which sought to establish the proposition that the so-called equilibrium unemployment rate was driven by structural factors. This was in the context of the persistently high European unemployment rates and the release of the 1994 OECD Jobs Study, which sought to blame welfare entitlements and labour market protections (regulations).

The CPB led the charge and produced some extremely shoddy analysis across a number of papers to support the OECD line and the prevailing neo-liberal orthodoxy against using aggregate demand policies to bring down the unemployment.

Unlike the recent problem of getting hold of the data that Rogoff and Reinhart used (and now we know fudged), the CPB database was available so we could replicate the results relatively easily although we had to do a lot of reverse engineering of rather complex equations to understand what restrictions (a technical term describing setting unknown parameters that would normally be estimated to a given value) had been imposed to get the final forms of the equations in their models.

While our attacks were very technical in nature the substance can be summarised in the following way:

1. The final equations were highly restricted by prior beliefs consistent with the theory they were claiming to be shedding light about.

So, as an unrelated example, if I contend that A impacts on B but I am unclear how (negative, positive, magnitude) then I have an conjectured relationship such as A = xB where x is the parameter of interest but is unknown. The task of econometrics is to estimate x – that is, put a number on it using real world data for A and B.

Further, the value of x might be the difference between two competing theories of the relationship and so assumes central importance in the enquiry.

If I then just impose the value x = 1 on this study then clearly I am saying that all changes in B immediately impact fully on A in a positive manner. That restriction might suit my particular theory but in imposing the restriction I am not allowing the data to tell me anything about the plausibility of the hypothesis.

The underlying data might tell me that x = -0.0001, for example, which would mean the theory was implausible, given the data.

Imposing restrictions on econometric models in the process of estimation is a legitimate practice and allows us to simplify otherwise complex relationships so that we can get to the heart of what is going on.

But good practice tells us that you have to perform special statistical tests on these restrictions to ensure they are “data accepted”. That means we can say that the data supports a particular hypothesis about the value of x and so we can impose that value to simplify matters.

I realise that will not be fully appreciated by the average reader but it relates to much more complex models than our simple A-B model here and we get more precise results when there are fewer unknowns to estimate. So by eliminating some of the unknowns we do ourselves a favour. But that is only acceptable if the formal tests of the restrictions have been satisfactory.

The CPB would impose all sorts of key restrictions, which supported the natural rate view of unemployment (in essence, the neo-liberal party line), That is, they created estimating equations that replicated the theoretical specification that they were advocating.

This practice immediately carries with it the interpretation that if the restriction(s) fail then the empirical work cannot reasonably be concluded to support the theoretical structure. To avoid this sort of confrontation, the restrictions were simply imposed by the CPB authors without further ado and the discussion of the empirical results proceeded at a pace as if there were no basic issues.

Upon examination we found that the key restrictions could not be maintained. The restrictions were mostly invalid.

Further, we found that once we relaxed the restrictions (that is, were forced to estimate these key unknown parameters), the results from the exercise were very sensitive. That is, the key outcomes reported in these CPB papers were no longer consistent with the data when produced using more general (but valid) representations of the relationships.

That might sound very technical but the bottom line is this. Just as Rogoff and Reinhart’s results collapsed once the Excel coding error was addressed (and additional data that they had excluded was included), the CPB results collapsed and the opposite message was produced from their dataset.

In other words, the results were fudged, made-up, connived, use whatever word you like. Motivation? It is hard to tell but when a researcher who knows full well that restrictions should be tested and also knows the importance of the particular restriction in terms of the theoretical and policy debates, imposes the restriction and doesn’t test its validity, then you can might conclude that that is rather deliberate behaviour and contrary to best practice.

The problem is that the press releases sound scientific and the headlines reported by the co-opted journalists don’t ever penetrate the smokescreen. And so we read next morning – Welfare benefits too high, inducing people to remain on the dole – for example.

2. We also found that the estimates that the researchers at CPB produced – key results to substantiate their claim that structural variables were highly significant determinants of the persistent unemployment – were highly sensitive to the sample period used to estimate the equations. That is, they seemed to exclude data observations without justification.

In one case, the AMECO dataset was used. This is an annual dataset and at the time the studies were being conducted (late 1990s, early 2000s) the number of observations were barely sufficient to meet the minimum sample size requirements for best practice (for example, central limit theorem requirements).

In that context, one would want to use the maximum number of observations available, given the study was precarious anyway.

We replicated their results and found they had used shorter samples than were available. That aroused suspicion immediately given the issue just noted. When we estimated the models over the longest sample available what do you think we found?

Many of the so-called key structural variables lost their statistical significance (meaning they had no impact in the equation) and the coefficients no longer had the same sign (direction of impact) or magnitude (size of impact).

In other words, the CPB equations, upon which the policy advice was being based were sample dependent – which means in English they were unreliable and worthless.

3. If all that wasn’t enough, the crowning glory of this interrogation of their work revealed that the so-called “structural” variables – replacement ratio, tax wedge etc – which were found by the CPB to be statistically significant factors driving their estimates of the equilibrium unemployment rate up, were, in fact, highly cyclical once we did the correct time series decompositions including spectral analysis.

What does that mean? It means that they moved with the economic cycle – with movements in aggregate demand. So fiscal policy interventions, previously excluded as being ineffective by this “structural” hypothesis, actually drove the so-called structural variables.

Once the cyclical component was taken out of the variables and the regressions repeated there was no remaining statistically significant effect. What does that mean? That their hypothesis was totally rejected by their data.

That is, there was no basis for the claims that governments could not reduce unemployment using expansionary fiscal policy. It meant that attacks on the welfare system and/or attacks on workers’ protections and job security and/or attempts to cut the minimum wage could not be supported by the evidence.

It was clear that the persistent unemployment was because aggregate demand was being starved by ideologically misguided policy.

At the time, the late Franco Modigliani, who introduced the term NAIRU to the economics profession (Modigliani and Papademos, 1975), seriously reconsidered his position. He wrote in 2000:

Unemployment is primarily due to lack of aggregate demand. This is mainly the outcome of erroneous macroeconomic policies … [the decisions of Central Banks] … inspired by an obsessive fear of inflation, … coupled with a benign neglect for unemployment … have resulted in systematically over tight monetary policy decisions, apparently based on an objectionable use of the so-called NAIRU approach. The contractive effects of these policies have been reinforced by common, very tight fiscal policies.

[Reference: Modigliani, Franco (2000), “Europe’s Economic Problems”, Carpe Oeconomiam Papers in Economics, 3rd Monetary and Finance Lecture, Freiburg, April 6, Page 3, emphasis in original]

Anyway, that was our dealings with the CPB! There was more to this dispute and we wrote several papers.

A lot of this discussion (the technicalities etc) appeared in our 2008 book – Full Employment abandoned.

Coen Teulings has just stepped down as the director of the Centraal Planbureau and his interview really brings into relief the conflict between ideology and praxis in the Eurozone at the moment.

He told the interviewer:

De komende drie jaar moet het kabinet het oorspronkelijke bezuinigingsprogramma voortzetten zonder op de Brusselse eis van 3 procent te letten. Ook extra bezuinigingen horen daar niet bij, zoals het pakket van 4,3 miljard euro dat het kabinet tot augustus in de ijskast heeft gezet.

That is, the Dutch government should continue for the next three years with its current plan and not try to satisfy the SGP requirement imposed by Brussels of a 3 per cent deficit. They should not make further cuts and that includes the 4.3 billion package of cuts that the government has put on hold until August.

The new Dutch government, which came to power on March 1, 2013 proposed cuts of 4.3 billion Euros because the CPB had told them that their budget deficit would come in at 3.4 per cent of GDP, which would then bring them into a Excessive Deficit Mechanism process, such is the mindless rules that these nations have signed up to.

It was interesting that he acknowledged in the interview that, on the hand, it would not be sensible to be slaves of the 3 per cent rule, but then he said that the nation still had obligations under EU treaties.

The clear intent of his message was that these treaties are political and ideological statements and are too rigid to provide for prosperity. It is clear that he considers the Dutch economy is going backwards fast and any attempt to cut further as a way of delivering the agreed 3 per cent of GDP budget deficit would make things worse.

I think this is a very important statement in the debate because as I noted above the CPB has been at the forefront of the promotion of neo-liberal thinking in Europe. Their research has continually promoted deregulation and welfare reform and budget surplus obsessions.

Now, it seems, the evidence that has accumulated, which shows that this policy approach has dramatically failed, is almost too difficult to deny, even by the CPB.

Teulings also said:

Houdt Nederland Brussel een tekort voor dat groter is dan 3 procent, dan wekt dat de toorn van eurocommissaris Olli Rehn die de eurolanden tot begrotingsdiscipline moet bewegen. Rehn heeft juist mede door Nederlandse druk meer bevoegdheden gekregen. Uiterlijk 30 april dient het kabinet Rehn een ontwerpbegroting te sturen waaruit moet blijken dat Nederland zich aan de Europese normen houdt.

That is, if the Dutch deficit is greater than 3 per cent then it will arouse the wrath of the European Union’s Commissioner for Economic and Monetary Affairs, Olli Rehn who will demand that the Euro countries maintain fiscal discipline. Rehn will demand that the Dutch government comply by the SGP standards by April 30.

This is the same Rehn, who on June 1, 2011 addressed the Council on Foreign Relations on – Debt, Governance, and Growth: A Eurozone Perspective.

There he blithely told the audience:

… we are convinced that putting the debt-to-GDP ratios on a downward path is a pressing priority for all EU member states …

He then channelled the Witch with her TINA bullying:

For some member states, like Greece, there has simply been no alternative to fiscal consolidation.

Which is a lie. The alternative was clear. Within the Euro, the ECB could have announced it was funding a growth strategy and allowed Greece’s deficit to move with the cycle.

But, more preferable, would have been for Greece to show some national pride and leadership and exit the corrupt and dysfunctional monetary arrangement.

Rehn, who I am forming the view has lost perspective completely, then channelled his modern mentors:

Carmen Reinhart and Kenneth Rogoff, in their wonderful book, “This Time is Different,” have coined the 90-percent rule, or should I say rule of thumb, that countries with public debt exceeding 90 percent of annual economic output grow — tend to grow more slowly. High debt levels can crowd out economic activity and entrepreneurial dynamism, and thus simply hamper growth. This conclusion is particularly relevant at a time when debt levels in Europe are now approaching the 90-percent threshold — it’s currently, on average, around 85 percent — and when the U.S. has already passed this threshold.

Which is another lie. We now know to be the product of research incompetence, fudged results, which do not hold when the data is examined correctly. And all of that is not to mention the obvious causality issues, which I have written about, as have others, several times in the past.

But it is clear Rhen hasn’t much idea himself.

As Wolfgang Münchau wrote in his recent (April 21, 2013) Financial Times article – Perils of placing faith in a thin theory:

Policy makers, such as Mr Rehn, are always on the lookout for economic theories that seem plausible and accord with their deep beliefs. In Europe, most of them have little exposure to macroeconomists who think out of the box … If two of the world’s most respected economists then come along and tell them that their gut instincts have been right all along, this is the conservative policy maker’s equivalent of birthday and Christmas coinciding. At last, the message they always wanted to hear.

Hopefully, these two economists will be significantly less respected now as a result of the discovery of their Excel shenanigans.

Teulings also thinks that while Rehn may have the strict legal framework of the Eurozone on his side, just looking at the numbers is not very sensible. He thinks that if he was Rehn he would just say something like “your doing okay on the budget front and these are exceptional circumstances” – like your unemployment rate is going through the roof – we can be a bit flexible.

Finally, Teulings now admits that the benefits of European integration could have been gained without the common currency:

Teulings stelt dat door de ‘3 procent’ Nederland ‘bij ieder wissewasje het begrotingssaldo politiek gaat sturen. Met weer een nieuwe bezuinigingsronde.’ De Europese eisen zijn bedacht bij de invoering van de euro. Europa is wat Teulings betreft weinig opgeschoten met de eenheidsmunt. ‘Uit onze analyse blijkt dat als je de euro niet had ingevoerd en door was gegaan als handelsunie en die had uitgebreid, dan had je het leeuwendeel van de voordelen van de Europese integratie ook wel geïncasseerd. Maar ontbinding van de monetaire unie is nu buitengewoon kostbaar.’

Which says that the SGP rules were devised for the common currency but he considers there has been very little positive progress as a result of its introduction. He believes that a simple expansion of the European trade area would have allowed the nations to capture the lions’ share of the benefits of European integration (“dan had je het leeuwendeel van de voordelen van de Europese integratie ook wel geïncasseerd”).

In other words, he is admitting the failure of the currency arrangement.

This is why he is coming clean and admitting to the failed strategy. The following graph shows the national unemployment rate in the Netherlands since January 2003.

The impact of the GFC and the following recovery courtesy of the rising budget deficit is clear. But the stark fact is that the subsequent damage from the fiscal austerity is now worse than the initial downturn in 2009 and the rising unemployment is accelerating upwards now.

When we observe a sharp rise in unemployment like that of the last three or so months it is a sign that the economy has turned and will get worse if there is no policy intervention to arrest the deterioration.

That is what Teulings is seeking. However, he is not seeking a reversal in the austerity – just a delay in adding more spending cuts into an already depressed situation.

To see what is happening on the demand-side of the labour market, the next graph shows the vacancy rate (Vacancies as a % of labour force) from 2001 to December 2012.

The very sharp impact of the GFC is evident and the recovery was weak and barely underway before the austerity mania killed it.

Anyone who looks at data like this who actually knows what is going on would conclude that this is a massive aggregate demand failure. The collapse of labour demand pushes up the excess supply (unemployment). There is no structural explanation that is plausible. What changed within a month or so to cause vacancies, that had been growing nicely for several years, to collapse?

Why did the nascent recovery collapse? These are demand-side effects and nothing at all to do with welfare entitlements, minimum wages, job protection, and the rest of it.

The third graph brings this information together and shows the unemployment to vacancy ratio for the Netherlands from 2001 to December 2012. Before the imposition of austerity, the ratio fell to 1.2 persons per vacancy. It has risen sharply in recent months and is now at 5.3 and rising.

Conclusion

The departing CPB chief is no Keynesian. He is a rigid supply-sider. But that makes his calls for flexibility and an easing of the planned austerity quite compelling.

Many economists remain in denial of what is happening. It is 2013 not 2009. The world has been caught up in this crisis for 5 years. It is an entrenched crisis and the data is now showing us that its recent manifestation is being driven by fiscal austerity.

The initial impacts of the GFC were large but recovery had commenced and was then killed off by the zealots, like Rehn and his ilk.

They should fade into oblivion like Rogoff and Reinhart surely should and let the world have new leaders who have a sense of purpose and an understanding of how things operate.

Even a semblance of comprehension would be better than we are enduring at present.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.