Options for Europe – Part 89

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 FISCAL COMPACT]

The euro-zone leaders were not satisfied with these new restrictions. They decided to introduce an even more onerous set of fiscal rules under the guise of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG), also known as the ‘Fiscal Compact’ (European Union, 2012). All the euro-zone nations are bound by the treaty provisions. The treaty was driven by the Germans, who in 2009 enshrined a ‘balanced budget rule’ or ‘debt brake’ in their Basic Law (Constitution). From 2016, the rule will make it illegal for the federal government to run a structural deficit larger than 0.35 per cent of GDP, while from 2020 the German states are prohibited from running any deficits. This effectively means that once operational, that outstanding public debt will eventually disappear. Previously there were debt limits in place to guide German economic policy but after 2016, the ceiling cannot be breached. Only in exceptional and rare situations, which are beyond the control of the government can the rules be temporarily breached but any deficits incurred would have to be offset by surpluses soon after.

Predictably, the Deutsche Bundesbank (2011: 15) considered the move to be “a very welcome development and a clear improvement”. Consistent with their deflationary bias, they recommended that all levels of government “incorporate a safety margin below the constitutional ceiling” to avoid “the need for short-term adjustments that could have a procyclical impact, particularly given unexpected adverse developments”. In other words, run fiscal surpluses as a matter of course imparting a constant fiscal drag onto economic growth. In the context of German domestic policy, this means the only source of growth would be net exports. We will discuss the export issue later in the chapter. A debt brake means that all investment in public infrastructure has to come out of current revenue, which violates the basic economic principle that the costs and benefits of such provision should be spread out over time so the current generation doesn’t bear the costs and the future generation the benefits. Further, it works on the assumption of symmetrical economic cycles, that any deficits incurred in a downturn can be more than offset by surpluses in periods of stronger growth. But cycles are typically asymmetrical and deep recessions can require extended fiscal deficits to sustain the recovery. The problems pertaining to the SGP, which we discussed in detail in Chapter 11 are magnified under a ‘balanced budget rule’. In particular, the techniques used by the multilateral agencies to estimate the structural component of the fiscal balance always produce biased results, overstating the size of the deficit. In other words, they always suggest the cyclical component is smaller than it actually is. The application of fiscal rules based on these estimates will then always ensure policy settings are excessively restrictive in the context of private spending and thus biases economic outcomes towards slower growth and higher unemployment, if not worse. Even the conservative Financial Times journalist Wolfgang Münchau considered that the policy “is going to be hugely damaging to the eurozone”, either because “the German economy would become a structural basket case, and would drag down the rest of Europe for a generation” or because “economic and political tensions inside the eurozone are going to become unbearable” as a result of diverging trade imbalances (Münchau, 2009b).

The Fiscal Compact adopted by the European Union, unfortunately, embodied much of the German approach including the preference that the ‘balanced budget rule’ be binding and permanent “constitutional provisions” (p.5). Article 3 of the treaty specifies that a ‘balanced budget’ would be normally defined as a structural deficit under 0.5 per cent of GDP. Member States can only exceed this in ‘exceptional’ circumstances. The so-called ‘independent’ surveillance and monitoring bodies would quickly refer infractions to the Court of Justice of the European Union, which, under Article 8, was given “radical new powers to ensure compliance with permanent austerity in the eurozone and most of the not-so-eurozone (the UK and the Czech Republic excepted)” (Phillips, 2013). Phillips (2013) concludes that:

The reason the court was given these powers was to remove the exiguous remaining sliver of democratic control over such matters. EU leaders of course don’t put it quite this way. They say instead that giving the court these powers will ‘depoliticise such decisions’. But it is exactly the same thing. De-politicise = de-democratise.

Portugal has already witnessed this tendency to disregard national institutions. When the Portuguese Constitutional Court, who seemed to understand the limits of how far the government can undermine the well-being of pensioners, and those on sickness benefits and others, declared the 2013 national budget illegal all hell broke loose. This fiscal package incorporated the harsh 2011 bailout requirements. The neo-liberal Portuguese government then determined that it would meet the spending cut targets imposed on them by the Troika by forcing larger cuts in health and education expenditure to get around the Court’s ruling. The response from the European Commission was swift and clear. On April 7, 2013, they said that “The European Commission welcomes that, following the decision of the Portuguese Constitutional Court on the 2013 state budget, the Portuguese Government has confirmed its commitment to the adjustment programme, including its fiscal targets and timeline” (European Commission, 2013). This exposed an interesting hierarchy. The Court of Justice of the European Union was now the supreme arbiter on national economic policy and the national courts set up to defend the constitutional rights of the citizens in any country would be largely by-passed by agreements between co-opted national governments and the bullies in Brussels. And, all the time, both Brussels and the national governments are keeping a firm ear to what Germany wants.

The schizoid nature of the treaty is seen when comparing Article 3 which defines the harsh fiscal rules and Article 9, which says that all parties “shall take the necessary actions and measures in all the areas which are essential to the proper functioning of the euro area in pursuit of the objectives of fostering competitiveness, promoting employment, contributing further to the sustainability of public finances and reinforcing financial stability”. What exactly is the goal of government in this vision? Why is the ‘sustainability of public finances’ a separate objective given that fiscal policy should always be in service of prosperity, which requires full employment and price stability at least. It is clear that obedience to the fiscal rules under Article 3 will severely compromise the capacity of a government to promote employment on a recurring basis. Fiscal policy parameters have to be flexible enough up and down to allow a government to maintain adequate levels of total spending in the economy. This issue is considered in more detail in Chapter 17.

Finally, the ‘Macroeconomic Imbalance Procedure’ embedded in the Six-pack exposes the inherent, anti-people biases that dominate European policy making. The stated aim of the MIP surveillance mechanism is to “to identify potential risks early on, prevent the emergence of harmful macroeconomic imbalances and correct the imbalances that are already in place”. The so-called MIP Scoreboard uses ten ‘early warning’ indicators, which provide information about “macroeconomic imbalances and competitiveness losses” which are easy to compute and communicate (European Commission, 2012; 4). Threshold values (positive and negative) are provided to assess when there is a imbalance. A detailed examination of the indicators is beyond the scope of our narrative but the priorities are clear. A nation that had endured an unemployment rate of say 9.9 per cent for the last three years is not considered to be imbalanced, given the warning threshold is 10 per cent. The Commission chose this very high threshold due to a “focus on adjustment in labour markets and not on cyclical fluctuations” (p.23). In other words, they do not consider the unemployment problem in terms of insufficient jobs being caused by deficient levels of spending but, rather, consider the only policy concern to be so-called ‘structural’ issues. This, in turn, concentrates their attention of ‘market impediments’, the standard neo-liberal, supply-side bias that has failed since it became the dominant approach in the early 1990s. In the Commission’s annual ‘Alert Mechanism Report’, which is based on a review of the MIP scoreboard, any reference to unemployment is usually accompanied by some conclusion that wages are too high and need to be reduced in line with productivity growth. There is no recognition that the enduring recession has both caused productivity growth to slump and jobs to disappear due to a lack of spending. The European policy makers are thus ‘content’ with very high levels of unemployment. Another bias is evident in the way they deal with current account deficits and surpluses. They conclude that “sustained current account surpluses do not raise the same concerns about the sustainability of external debt and financing capacities, concerns that can affect the smooth functioning of the euro area” (p.6) as do current account deficits. The MIP thus accords a “a greater degree of urgency” to “countries with large current account deficits and competitiveness losses” (p.6). The upper warning threshold (for a surplus) is 6 per cent of GDP. If the balanced budget rule is satisfied by a nation sitting on the current account surplus threshold, then its private domestic sector will be saving overall 6 per cent of GDP. Where will those savings go? In Chapter 14, we discussed how Germany maintained its external competitiveness once it could no longer manipulate the exchange rate. The Hartz reforms reduced the capacity of workers to share in the productivity growth of the economy and suppressed domestic demand. Profitable investment opportunities were limited in the German economy as a result and capital sought profits elsewhere. The persistently large external surpluses (and 6 per cent is large) were the reason that so much debt was incurred in Spain and elsewhere.

In the ‘Alert Mechanism Report 2014’, issued on March 3, 2014, the European Commission concluded that Germany had a macroeconomic imbalance as a result of its current account surplus being above the 6 per cent threshold. The Commission acknowledge that the large surpluses have been, in part, due to the suppression of domestic spending and hence imports. But they praise the surpluses because they “provide savings to be invested abroad” (European Commission, 2014: 9-10). The conclusion is that Germany will have to find ways to “strengthen domestic demand and the economy’s growth potential” (p.14). However, they dodge the main issue. Higher domestic demand will require faster wages growth both to boost the very modest consumption performance and to attract investment into the domestic market. But such a change would be at odds with the mercantile mindset that dominates the nation because it would reduce the competitive advantage that Germany enjoys over other nations that have treated their workers more equitably.

This also raises the question of inequality. There is no indicator for national income or wealth inequality in the MIP Scoreboard. Despite the neo-liberal denial the income inequalities undermines economic growth, even the IMF has now acknowledged that “countries with more equal income distributions tend to have significantly longer growth spells.” (Berg and Ostry, 2011: 16). According to the German Socio-Economic Panel (SOEP), which is a wide-ranging representative longitudinal study of private households, located at the German Institute for Economic Research, DIW Berlin, income inequality in Germany has risen sharply since it joined the euro-zone. While the poorest 10 per cent of income earners in Germany achieved 15 per cent gains in their annual median incomes between 1997 and 2008, the richest 10 per cent enjoyed gains of 28 per cent (Inequality Watch, 2012). The Hartz reforms and the export imperatives were an important part of this rising inequality. A substantial redistribution of income is required within Germany if domestic spending is to increase.

The requirement that fiscal deficits should be balanced not only restricts the fiscal powers that governments would ordinarily enjoy in fiat currency regimes, but also violates an understanding of the way fiscal outcomes are effectively beyond the control of the government. Any economist with even the simplest understanding of the way in which automatic stabilisers operate will see the lack of wisdom in a SGP-type rule. A sharp negative spending shock which causes an economic downturn will reduce tax receipts and increase benefits, automatically increasing the deficit. The scale of these responses can clearly breach the fiscal rules without the government changing any spending or tax policy settings. Under the Fiscal Compact (and the SGP) such a government would be forced to reduce their expenditures to meet the rule, which then runs the danger of prolonging the recession and forcing the nation into further SGP-type rule violations.

None of the reforms proposed since the crisis have altered the fact that the euro-zone rules bias fiscal policy to be pro-cyclical in times of stress, which violates any sensible ambitions that are the ambit of responsible fiscal management. It is often said that the European economies are sclerotic, which is usually taken to mean that their labour markets are overly protected and their welfare systems are overly generous. However, the real European sclerosis is found in the inflexible macroeconomic policy regime that the euro countries have chosen to contrive. The rigid monetary arrangements conducted by the undemocratic ECB and the irrational fiscal constraints that are required if the SGP is to be adhered to, render the nation states within the Eurozone incapable of achieving low levels of unemployment and increasing income growth.

[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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