Options for Europe – Part 88

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

Part III – Options for Europe

[THIS IS THE LAST SUBSTANTIVE CHAPTER – IT INTRODUCES THE APPROACH THAT THE EURO LEADERS HAVE TAKEN AND WHY A DRAMATIC CHANGE IN POLICY IS REQUIRED – IT LEADS INTO THE FINAL SEVERAL CHAPTERS WHICH DISCUSS THE SPECIFIC OPTIONS – WHICH YOU HAVE ALREADY READ. I WILL FINISH THIS CHAPTER BY THE END OF THE WEEKEND AND THEN NEXT WEEK WRITE THE INTRODUCTION AND START CHECKING]

Chapter 18 The European Groupthink – failing to take the correct path

[PRIOR MATERIAL HERE]

[NEW MATERIAL TODAY – CONTINUING SECTION ON BAILOUTS]

Ireland, received its bailout loan of €85bn in late November 2010 (of which the Irish government contribute €17.5 billion from the National Pension Reserve Fund). A sum of €35bn would be allocated to bail out its zombie banks, which was the main aim of the exercise. In return, the Troika demanded it make drastic public spending cuts, cut pensions (4 per cent) and the minimum wage by €1 per hour, impose a swathe of tax increases, and implement extensive retrenchments to working conditions. In total, Ireland committed to cutting €15 billion from its net spending, which was double its original 2009 austerity plan. It amounted to a cut of around 26 per cent.

Ireland was the first euro-zone nation to introduce a harsh austerity program by cutting public spending and increasing taxes. In early 2009, the Irish Prime Minister said that a primary consideration was that Ireland had to address the crisis “in a way which would be seen to be credible by international markets”. The priorities in favour of the amorphous ‘bond markets’ were clear and the Irish citizens would suffer as a result. Before the crisis, the so-called Celtic Tiger was held out as the poster nation for others to follow, particularly in terms of deregulation and tax concesssions to foreign businesses. George Osborne, then the British Shadow Chancellor wrote “A generation ago, the very idea that a British politician would go to Ireland to see how to run an economy would have been laughable. The Irish Republic was seen as Britain’s poor and troubled country cousin, a rural backwater on the edge of Europe. Today things are different. Ireland stands as a shining example of the art of the possible in long-term economic policy making, and that is why I am in Dublin: to listen and to learn” (Osborne, 2006). That assessment was as ludicrous then as are the claims that Ireland represents the austerity template for other nations to follow now. After more than 5 years of austerity, the Irish Central Statistics Office (CSO) tells us that GDP growth was negative in 2013, as were net exports; employment was more 13 per cent lower than it was in 2008, the unemployment rate was at 11.7 per cent. However, given the labour force participation rate in 2013 was well below its 2007 peak, the real unemployment rate is closer to 18.6 per cent. The CSO also reported that in the year to April 2013 “among Irish nationals, net outward migration is estimated to have increased significantly, rising from 25,900 to 35,200”. The young and the skilled have left Ireland in search of work in Australia, Canada and elsewhere. The hollowing out of the productive workforce will undermine Ireland’s growth potential in the future. Taken together, the Irish experience only looks like a template on what not to do when confronted with a major banking and spending collapse. Economists Peter Boone and Simon Johnson, who showed that the Irish growth ‘miracle’ prior to the crisis was a mirage “driven by clever use of tax-haven rules” and that “20 percent of Irish gross domestic product is actually ‘profit transfers’ that raise little tax for Ireland and are owned by foreign companies”. They considered the decision to impose austerity was “making things ever worse” and concluded that “adjustment to this awful situation would be far easier outside the euro zone” (Boone and Johnson, 2010). It is hard to disagree with that assessment, both then and now.

In March 2011, Portugal received 78 billions euros from the Troika. The Government had already been pressured by Brussels to implement a harsh austerity program encompassing tax increases, cuts to public sector wages and conditions while unemployment soared. The bailout conditions made matters worse. The spread on ten-year Portuguese government bonds went astral early in 2012, reflecting the lack of confidence the bond markets had in the austerity strategy. Investors knew that a government which didn’t issue its own currency and was overseeing a dying economy would be an ideal candidate for default. In his best-selling book Porque Debemos Sair do Euro (Why We Should Leave The Euro), Portuguese economist João Ferreira do Amaral described the adjustment programs imposed on Portugal by the Troika as absurd (“O absurdo dos programas de ajustamento” Chapter 5.1) (do Amaral, 2013) because imposing austerity upon austerity would exacerbate the economic and social collapse, without solving the problem of funding (“consiste em forçar ainda mais a austeridade, o que irá agravar o descalabro económico e social, sem resolver o problema do financiamento” Chapter 5.1). He described the European Commission as Germany’s new foreman (“A posição da Comissão Europeia, novo capataz da Alemanha” Chapter 5.1). The translation of the synopsis provided by the publisher places the modern calamity alongside Portugal’s 60 years of colonial repression under Phillip II of Spain:

In 1581 Portugal surrendered to Spain. In 1992 it laid itself at the feet of a European Commission increasingly answering to Germany’s tune. There was no referendum, the voters were never consulted. The Portuguese elites, who hoped to benefit richly from European Structural Funds, cavalierly handed over our currency – and with it our monetary sovereignty. The rest is history. From 2008 onwards, the European Commission broke with tradition and became an organ at the service of a new power. The Portuguese economy succumbed, choked by the new Mark. The tragedy was widely foretold in advance. In the 1990s several voices had alerted us to the dangers of joining the single currency.

As economic and social conditions deteriorated in Greece, it became obvious that the country would not be able to meet its on-going liabilities without further financial assistance and would be forced into default by March 2012. After an emergency European leaders’ summit in July 2011, the 10th in 18 months concerning Greece, a second Greek bailout package was proposed. This bailout was the first to suggest that the private banks and other private bond holders would provide some of the debt relief (European Council, 2011). The so-called ‘haircut’ or private-sector involvement (PSI) – proposed that investors would either roll over their stock of maturing Greek government bonds or sell the bonds back to the government at a discount. The PSI and the ‘haircut’ are also discussed in Chapter 22. In return, the Greek government agreed to even harsher austerity measures including further tax increases, more public sector job cuts, a 20 per cent cut in workers’ wages, pension cuts and reduced trade union rights. On September 2011 the Greek parliament passed some of the tax increases but civil unrest was on the increase. On October 19, the day before the vote on the rest of the austerity measures in parliament, a national strike began supporting large-scale protests in Athens. Amidst violent riots outside the parliament, the Government passed the bill. On October 26, 2011 that the detail was fully worked out between the parties. The Troika would extend €130 billion to Greece in return for more austerity and all private Greek government bond holders would be invited to accept lower yields and discounts on the face value. The total bailout sum included an estimated €30 billion in revenue, which the Troika hoped Greece would get from the large-scale privatisation plan it had agreed on as part of the first bailout. Further, some 40 billion euros of the bailout sum would go to buying back debt (safeguarding banks) or recapitalising zombie Greek banks. In other words, the interests of capital were privileged. Virtually no new funds were made available to support spending in the Greek economy. Further, For all the angst surrounding the negotiations, it was estimated that the deal “would cut €26bn off the country’s €350bn debt pile by 2014” (Spiegel et al., 2011). In other words, it was not going to provide any significant debt relief. While the political leaders and the ECB did not refer to this as a default, it was clearly a default. The German government once again dominated the negotiations by constructing a plan, which would force the private banks to take some of the loss. The French and ECB had been opposed to such a move.

It was not smooth sailing though. The social unrest translated into political instability. The Greek Prime Minister George Papandreou, who had been a pliant conduit for the Troika to impose their will on Greece, faced major political resistance from an electorate already reeling from the austerity package associated with the first bailout in 2010. As a political stunt, he indicated that he would take the bailout package to a popular vote, a move that sent shock waves among the political elites in Europe. They knew the Greek people would reject the package and an exit from the euro-zone would then be inevitable. A plan had to be devised. On November 3, 2011, Papandreou withdrew the referendum threat after being ‘dressed down’ by G-20 leaders at the November Cannes Forum. He claimed that the back down was because the opposition parties decided they would support the package after all. But the neo-liberal New Democracy Party, who had, for political gain, been holding out against any ratification of the second bailout package, denied that was the case (Donadio and Kitsantonis, 2011). Papandreou, in desperation, promoted the idea of a ‘national unity’ government with the neo-liberal New Democracy Party, as a last effort to preserve his political position. On November 6, 2011 he resigned his post. Four days later, a deal driven by New Democracy and heartily endorsed by the Troika saw an unelected Lucas Papademos installed as the Prime Minister of Greece. He was a neo-liberal central banker totally supportive of the Troika. He soon became the mouth of the Troika telling the citizens that unless they were prepared to accept major cuts in their incomes that the Government would have to default and exit the euro-zone. He then claimed that “the country would be unable to pay salaries and pensions and keep schools and hospital running” (Granitsas and Stevis, 2012). Of-course, that claim was an absolute lie. Once the Greek government regained its own currency it could pay for anything that was for sale in that currency including all the workers’ wages and pensions.

All parties finally agreed to the deal on February 21, 2012 and the ‘haircut’ was agreed at 53.5 per cent on the face value of any bonds held. The Troika demanded that the Greek government set up a special ‘off-budget’ escrow account which had to be prioritised and contain enough cash at all times to service its liabilities. The Germans and French had at one stage proposed that a European Commissioner take over running economic policy in Greece. Douzinas (2012) noted that this plan “was more than a little insensitive for a country that has suffered a brutal Nazi occupation”. Facing increasing hostility, the Troika deided to create a ‘task force’ of inspectors who would rough ride over the democratic process to make sure that the Troika got their pound of flesh. Later in 2012, the Greek government was forced to ratchet up the austerity cuts in order to receive the next instalment from the Troika. By June 2013, the Government closed its public broadcaster, marking a further blow to democracy. Greece was now, more or less, a German colony.

The reality was that Greece could never fulfill its obligations under the agreement given the harshness of the austerity measures, which guaranteed that it would remain in Depression for many years to come. Even with the reduced debt burden, insolvency was a continual threat and increasing poverty was a certainty. The bailout conditions were so harsh and doomed to fail that Guardian journalist Larry Elliot (2012) suggested “whatever eurozone finance ministers were smoking in their all-night marathon talks it must have been something strong”.

There were other bailouts all following the same pattern – money to prop up private banks in return for massive austerity being imposed on the citizens. Not a great bargain! Cyprus became another Troika zombie state in late 2012 when they agreed to steal depositors funds to ‘save’ the banks. A long-term recession is that nation’s future. Spain never formally entered a bailout agreement with the Troika. Instead, it borrowed €41 billion from the EU to prop up its zombie banks. The Government was forced to count these funds against its public debt, which worsened its position in relation to the SGP procedures. Germany refused to allow the loans to be ‘off-budget’. It would have been much better if Spanish government had allowed the banks to crash and provided depositor guarantees within newly nationalised structures with ECB backing. But that would have been constructed using the twisted Bundesbank logic as monetising fiscal deficits. Spain has earlier been bullied by the IMF into imposing austerity anyway. On May 24, 2010, the IMF demanded that Spain continue to aggressively cut its deficit and radically deregulate the labour market (removing job protections and cutting wages).

The Six-pack, the Two-pack and the Fiscal Compact

By the time the European Council met in Brussels in March 2010, the shape of the response that the political leaders would take was clear. The official statement said that the “current situation demonstrates the need to strengthen and complement the existing framework to ensure fiscal sustainability in the euro zone … For the future, surveillance of economic and budgetary risks and the instruments for their prevention, including the Excessive Deficit Procedure, must be strengthened” (European Council, 2010: 2). The German agenda was clearly to make the SGP conditions even more onerous so as to further constrain discretionary fiscal policy, which means that only nations with strong export positions would have any chance of sustained growth. Conservative German academic Hans-Werner Sinn called for a new SGP, “one that would be formulated to impose ironclad debt discipline. What is needed are modified debt rules, hefty sanctions, and, most of all, a system of rules that automates the levying of penalties, leaving no room for political meddling” (Sinn, 2010)

The European Union’s response to this pressure was embodied in three new ‘governance’ measures – the Six-pack, the Two-pack and the Fiscal Compact. All three initiatives sought to further restrict the fiscal flexibility of the national governments. All three took the monetary union further into the mire and further away from an effective solution to its woes. The presumption was that if the fiscal rules are tighter and behaviour is more closely monitored and controlled, the SGP will be enforceable and the so-called fiscal crisis will dissipate. Clearly, the reasoning meant that the European leadership was prepared to let unemployment and poverty be the adjustment mechanism rather than government spending. That is the explicit choice they have made and the costs will be huge. It is also likely that the fiscal straitjackets will still be insufficient to contain government deficits within the allowable thresholds when the next large private spending collapse occurs.

In late 2011, the European Commission proposed a major revision of the SGP, which was approved by the Member States and the European Parliament in October 2011. The so-called “reinforced Stability and Growth Pact (SGP)” became operational on December 13, 2011 (European Commission, 2011). The Official Memorandum said the so-called “Six-Pack” is “made of five regulations and one directive” (p.1). The innovation was the creation of a new ‘Macroeconomic Imbalance Procedure’, which was described as a “new surveillance and enforcement mechanism” (p.3). Essentially it aims to put nations into the EDP more quickly and to impose harsher sanctions for compliance failure. The Six-Pack specified a more rigourous imposition of financial sanctions if a nation fails to follow “specific recommendations” (p.1) to get their deficits below 3 per cent of GDP. Further, if the “60% reference for the debt-to-GDP ratio is not respected” then the EDP will begin “even if its deficit is below 3%” and the nation will have to reduce “gap between its debt level and the 60% reference … by 1/20th annually (on average over 3 years)” (p.2). The Six-Pack also introduce “expenditure benchmarks” which will enforce “a cap on the annual growth of public expenditure according to a medium-term rate of growth” (p.2). Finally, series of interventions were detailed under the so-called Excessive Imbalances Procedure (EIP), which aims to reduce macroeconomic imbalances (particularly unit costs etc) and will force nations to submit “a clear roadmap and deadlines for implementing corrective action” (p.3). The whole system is subjected to a huge surveillance operation (EU monitoring) with rigorous enforcement (fines equal to 0.1 per cent of GDP) and central intervention in a nation’s budgetary process.

The Two-pack, which became enforceable on May 30, 2013, extended the surveillance mechanisms by requiring national governments to submit detailed fiscal plans to the European Commission prior to their own enacting legislation. The Commission would not have the right to veto the plan but could warn a national government of potential for breach. Further, any government receiving bailout money or in an EDP, would be subject to more detailed scrutiny by the Commission. In other words, more centralised bullying.

If one was to ask how these measures will help a euro-zone nation cope with rising unemployment and lost output as a result of a collapse in private spending the answer is clear – it provides for no extra capacity but further undermines necessary fiscal flexibility. The GFC proved that the existing SGP fiscal rules were too restrictive and the shift in the economic cycle alone, which triggered the so-called automatic stabilisers (mainly lost tax revenue) was enough to breach the deficit reference values. More flexibility not less is required if the Member States are to fulfill their responsibilities – to advance the welfare of their citizens. The restrictions effectively redefine the purpose of government to one of satisfying two arbitrary and unworkable financial ratios at the expense of all that really matters. That is a very strange vision for a prosperous Europe. These new rules invoke visions of a nasty controlling, big brother sort of world where the worker in the village in Greece or the Netherlands will basically be casting a vote in futility if their respective governments stay in the euro-zone because at any time an European Commission official will be able to intervene and coerce the elected government into following the Troika dictates rather than their elected mandate.

[TOPICS LEFT TO COVER IN THIS CHAPTER – THE EXPORT-LED GROWTH MANIA AND THE SMP]

Additional references

This list will be progressively compiled.

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(c) Copyright 2014 Bill Mitchell. All Rights Reserved.