In May 2023, when the British Office of National Statistics (ONS) released the March-quarter national…
Today I have been studying data from the EMU economies where the individual member states surrendered their currency sovereignty and comparing it to other nations which have sovereign currencies (Australia, Denmark, Japan, the UK and the US). This is part of a larger project I am involved in. While the glare of the spotlight is currently on Greece and how the EMU handles the issue, most commentators conveniently forget that this problem has been many years in the making and is both a product of initial design folly and subsequent behaviour by some member states.
From the outset, as I have noted in several blogs the initial structural design of the Eurozone was never compatible with a federal arrangement that could cope with large asymmetric shocks.
The selection of EMU nations never formed an optimal currency area despite the bevy of lackey economists who wrote a plethora of mathematical papers purporting to “prove” that it was. Please see the blog – España se está muriendo for a detailed discussion on that specific aspect of the EMU debacle.
Not having an OCA was one thing. But then the neo-liberal ideologues entered the fray, driven in part by political prejudices that go back into time (particularly World War 2), and conjured up the Stability and Growth Pact (SGP). The restrictions imposed by the SGP were claimed to reflect economic sense but there is nothing in any economic theory that tells us that the design principles of the SGP were optimal.
In fact, from the perspective of modern monetary theory (MMT) the 3 per cent budget deficit to GDP rule is nonsensical. It would be an extraordinary coincidence for a 3 per cent ratio to be consistent with full employment – that is, taking into account the saving preferences of the households and the trade accounts for each country.
In a 2006 book I published with Joan Muysken and Tom Van Veen – Growth and cohesion in the European Union: The Impact of Macroeconomic Policy – we showed that it is widely recognised that these figures were highly arbitrary and were without any solid theoretical foundation or internal consistency.
The current crisis is just the last straw in the myth that the SGP would provide a platform for stability and growth in the EMU. In my recent book (published just before the crisis) with Joan Muysken – Full Employment abandoned – we provided evidence to support the thesis that the SGP failed on both counts – it had provided neither stability nor growth. The crisis has echoed that claim very loudly.
The rationale of controlling government debt and budget deficits were consistent with the rising neo-liberal orthodoxy that promoted inflation control as the macroeconomic policy priority and asserted the primacy of monetary policy (a narrow conception notwithstanding) over fiscal policy. Fiscal policy was forced by this inflation first ideology to become a passive actor on the macroeconomic stage.
As a result of the establishment of the European Central Bank (ECB), European member states now share a common monetary stance. The SGP was designed to place nationally-determined fiscal policy in a straitjacket to avoid the problems that would arise if some runaway member states might follow a reckless spending policy, which in its turn would force the ECB to increase its interest rates. Germany, in particular, wanted fiscal constraints put on countries like Italy and Spain to prevent reckless government spending which could damage compliant countries through higher ECB interest rates.
The indisputable empirical reality is that the EMU countries have never got close to achieving full employment in the period they have had to succumb to the SGP. And the blowout in unemployment in some nations during the crisis is certainly clear evidence that the SGP is incapable of attenuating the magnitude of a serious crisis.
There is a very interesting article published by Lars Jonung, Eoin Drea in the January 2010 edition of Econ Journal Watch, 7(1), 4-52 entitled – It Can’t Happen, It’s a Bad Idea, It Won’t Last: U.S. Economists on the EMU and the Euro, 1989-2002.
It examines how US economists viewed the development and implementation of the EMU from the time of the Delors Report in 1989 through “to the introduction of euro notes and coins in January 2002”. They trace the evolution of ideas on whether the system would work. Most “were skeptical towards the single currency” although they “adjusted their views as European monetary unification progressed.”
I don’t agree with its conclusions but it is an interesting methodology (tracing the evolution of argument) and many of the skeptical comments were prescient.
On February 9, 1998, the Financial Times carried a story which began with the following:
It is a remarkable achievement getting two economics professors to agree on anything. Getting 155 to speak as one is almost unheard of.
It was referring to a letter from 150 German economics professors which called for an “orderly postponement” of the EMU and the FT said the sentiment expressed “also reflects the views of many ordinary Germans who have remained deeply dubious about the benefits of a single currency, in spite of their political leaders.”
The letter questioned “the progress towards economic convergence made by some member states” and claimed there had not been enough fiscal austerity to prepare the region for the introduction of the common currency. They correctly argued that “the euro will not solve Europe’s unemployment problem”. As an aside, you will not find an unemployment target (even a general statement) in the Maastricht criteria – they were all focused on budget and debt targets which tells you how misconstrued the whole arrangement was from the outset.
You can read a collection of news stories and the full letter from the professors HERE.
But all these skeptics for different reasons were correct – the EMU was a bodgy arrangement and would come asunder when the first real crisis hit – that would be now.
But the crisis is one thing. The other important point is that conduct by some of the member states, in particular, Germany, was undermining the logic of the Eurozone from the outset.
Der Spiegel carried an interesting article yesterday (February 9, 2010) entitled – Part 2: Is Germany to Blame?. It was a two-part series the first part being – How Brussels Is Trying to Prevent a Collapse of the Euro.
The article notes that various EMU nations (Spain, France, Portgugal) are being told to pursue harsh austerity packages and in some cases restructure their economies to promotes “economic sectors with higher productivity”. Labour deregulation is also being pushed.
In relation to these pressures, Der Spiegel says:
Resentment is growing in the countries most directly affected. But that frustration is not directed, as might be expected, toward the Commission. Instead, it is increasingly surplus countries coming under fire — with Germany at the forefront.
Representatives from Spain and Portugal especially — but also from France — hold Germany accountable for their current woes. They aren’t alone in that opinion either. “The Greek crisis has German roots,” says Heiner Flassbeck, chief economist at the United Nations Conference on Trade and Development (UNCTAD), in Geneva. It was German wage dumping that got the country’s European neighbors in trouble, he says.
The point being made is that Germany pursued an aggressive low-wage strategy which hammered their workers to ensure that their export prices relative to the other EMU nations would be attractive.
The Germans have always been obsessed with its export competitiveness and in the period before the common currency they would let the Deutschmark do the adjustment for them. With that capacity gone in the EMU arrangement, they pursued another strategy which was to deflate labour costs not via high productivity growth but rather by punitive labour market deregulation.
Der Spiegel reports that “Germany’s position is that the countries now in crisis are themselves at fault for their situation. They lived beyond their means for years, the German government says, financing their economic boom on credit. Now the financial crisis has revealed their weaknesses”.
There is truth in both positions of-course.
But the Germans were aggressive in implementing their so-called “Hartz package of welfare reforms”. A few years ago we did a detailed study of the so-called Hartz reforms in the German labour market. One publicly available Working Paper is available describing some of that research.
The Hartz reforms were the exemplar of the neo-liberal approach to labour market deregulation. They were an integral part of the German government’s “Agenda 2010”. They are a set of recommendations into the German labour market resulting from a 2002 commission, presided by and named after Peter Hartz, a key executive from German car manufacturer Volkswagen.
The recommendations were fully endorsed by the Schroeder government and introduced in four trenches: Hartz I to IV. The reforms of Hartz I to Hartz III, took place in January 2003-2004, while Hartz IV began in January 2005. The reforms represent extremely far reaching in terms of the labour market policy that had been stable for several decades.
The Hartz process was broadly inline with reforms that have been pursued in other industrialised countries, following the OECD’s job study in 1994; a focus on supply side measures and privatisation of public employment agencies to reduce unemployment. The underlying claim was that unemployment was a supply-side problem rather than a systemic failure of the economy to produce enough jobs.
The reforms accelerated the casualisation of the labour market (so-called mini/midi jobs) and there was a sharp fall in regular employment after the introduction of the Hartz reforms.
The German approach had overtones of the old canard of a federal system – “smokestack chasing”. One of the problems that federal systems can encounter is disparate regional development (in states or sub-state regions). A typical issue that arose as countries engaged in the strong growth period after World War 2 was the tax and other concession that states in various countries offered business firms in return for location.
There is a large literature which shows how this practice not only undermines the welfare of other regions in the federal system but also compromise the position of the state doing the “chasing”.
In the current context, the way in which the Germans pursued the Hartz reforms not only meant that they were undermining the welfare of the other EMU nations but also drove the living standards of German workers down.
The following graph shows real hourly earnings index for manufacturing (March 2000 = 100) in selected EMU nations plus Denmark which wisely stayed out of the EMU mess (data taken from the Main Economic Indicators). You can see that real hourly wage indexes were all growing steadily (more or less in line with labour productivity) in the period leading up to the introduction of the common currency.
But after 2000 the trends in the individual nations deviated substantially. Italy and Germany basically set about cutting real hourly earnings as an explicit strategy to retain their export shares whereas the other nations continued to pass on labour productivity growth in the form of real earnings increases. Ireland stands out as as providing much stronger real wages growth for their workers throughout the period shown.
Overall the EMU flatted real hourly earnings growth for workers in the common area.
It is interesting that Denmark, which did not enter the EMU, maintained strong growth in real hourly earnings and has not been damaged nearly as much by the crisis as some of the EMU nations.
Another view of these trends is to consider the relationship between real wages and labour productivity. The following graph shows real unit labour costs (derived from the benchmark ULC series and the consumer price indexes provided by the Main Economic Indicators) for EMU area, Ireland, Italy, Germany, Greece, and Spain from March 2000 to June 2009 (the latest data available).
Real unit labour costs (RULC) are identical to the wage share in national income and are constructed in the following way. ULC = Wage rate times employment divided by total output = W.L/Y. Note that L/Y is the inverse of labour productivity. RULC = ULC/P (where P is the price index). So RULC = (W.L/P.Y), that is the wage share (W.L is the total income payments to labour and P.Y is GDP). It can also be written as (W/P)/(Y/L), which is the ratio of the real wage (W/P) to labour productivity (Y/L).
In the 1970s it was thought to be a valuable measure to test the proposition that real wages growth in excess of labour productivity (so RULC rising) would cause unemployment. This was the prediction of the erroneous mainstream (neo-classical) marginal productivity theory. So there was an industry of economists running regressions and drawing graphs etc to show that when RULC rose employment fell – just as they told the Keynesians it would!
The problem with all that hoo-ha was that RULC is a somewhat ambiguous measure because its movements are influenced by both the numerator and the denominator and the latter is highly pro-cyclical – that is, it falls in a recession and rises in the boom (because of hoarding).
So RULC can fall because the real wage is falling as a result of discretionary policies to deregulate the labour market and attack unions. But, equally, it can fall because the economy is booming and productivity growth is strong. So correlations between RULC and employment will render what is referred to as “observational equivalence” with respect to macro theories of employment. Both the mainstream and Keynesians predict a negative correlation between real wages and employment but for vastly different reasons. Anyway, that is all as an aside.
What the graph shows how even prior to the crash the introduction of the Euro has been very damaging for German workers who a result of these developments, the euro has been a costly disaster for almost everyone involved: for German workers, who have had to live with almost non-existent real wage increases; and for the rest of Europe, where economies were once again subjugated by the German export steamroller.
Der Spiegel reports that the attitude of the European Commission is that:
… the currency union can exist in the long term only if member countries’ governments implement reforms and coordinate their economic policies.
Which translates into a major victory for the neo-liberals who want to redistribute income away from workers towards profits – that is, the German model. These adjustment processes are now being forced on the Latin EMU nations and Ireland.
When I step back and think about all this in a longer context, the only conclusion I can consistently reach is that there is a madness present.
First, the nations’ leaders agree to surrender their currency sovereignty – they didn’t have to but chose to. They largely mislead their citizens with spurious arguments about optimal currency areas and the rest of the sophistry that the neo-liberal economists happily fed them.
In doing so, they give up their monetary policy independence and so differential circumstances cannot be dealt with by variations in interest rates.
Second, they then invented ridiculous fiscal constraints which have no basis in anything that relates to the way the real economy and the monetary system interacts. Mostly these constraints were a reflection of long-standing suspicions (racism, etc) – that is, they were ideological and political.
Third, Germany then introduces harsh labour market reforms to not only screw their own workers but also to ensure that the other EMU partners are behind the 8-ball.
Fourth, the EMU bosses refuse to introduce any fiscal redistribution capacity to ensure the member states achieve similar growth in real living standards.
Fifth, when the whole things meltdowns due to its design and the German strategy, the nations which are now in extreme crisis are told they have to introduce harsh pro-cyclical fiscal policies to savage living standards of their citizens.
No reasonable economist would ever advocate pro-cyclical fiscal policy. It is the exemplar of the abandonment of public purpose.
All of this also tells us that this is no federation which cares about its individual components. The way the ECB and Brussels is approaching the Greek disaster (and statements coming out of Germany – read the Der Spiegel article) demonstrates that there is no “federal-state” solidarity. The question that arises is why bother then.
Australia is a federation of common language and culture enriched over the years by new entrants from different ethnic backgrounds. But although their is a rich cultural diversity here we all row the same boat and fiscal redistributions are use to ensure that the real standard of living is similar across the vast geographic space.
But not in EMU.
And once you put all that together you realise all of this is voluntary and a product of political choices. There were no financial constraints on the nations and no economic imperative to enter the EMU. The citizens were blinded by a range of spurious arguments and lies coming from economists in the 1990s.
If they realised that they would always be better off as sovereign nations and there were no financial constraints on them retaining that status then they could better compare the decision to stay in the EMU – a political/ideological choice favouring the elites rather than the common folk – with the other political choices now being made and imposed on them by their leaders – the austerity programs.
What the crisis has demonstrated is that the EMU is not an efficient common currency zone. The design of the system will always lead to these destructive outcomes whenever a major economic downturn occurs.
I would choose to leave the Eurozone if I knew that all the choices were voluntary.
I particularly liked the closing comments in an article published by The Australian today (February 10, 2010).
It is even clearer now than it was in 1998 that Europe is not ready for a common currency. The problems that have emerged so far will only get worse if monetary union continues.
The renewed political failure to act on this economic analysis only demonstrates that, far from being an inspired economic project, the euro has always just been one thing: a megalomaniac piece of folly designed by economically illiterate political leaders.
A comment received today on another post asked me to explain my statement:
My aim is to expose the fallacies that exist in the modern debate. I aim to show people that what they think and are told are financial constraints are in fact just political constraints which should be compared to other political decisions – like running harsh austerity programs that impoverish generations of people. Once people understand that some of these so-called financial constraints are political choices then the comparisons become more stark and government may act differently.
The point is as above. We are being continually told that certain policy options are denied or unwise because of financial constraints. So deficits are bad because they “force” the government to go into debt. Rising debt “has to” be paid back via “higher taxes”. Deficits will cause “hyperinflation” and comments like that.
The uninformed voter cannot determine whether these statements which are reinforced by a host of mindless economic commentators are in fact “financial issues” or whether they reflect the ideology of the ruling class. In the latter instance, the politicians making political choices to cement their power bases – that is, making donors happy and whatever.
If people really knew the so-called financial constraints were no such thing and the fiscal austerity programs are thus political choices and alternative political choices not involving harsh austerity are available – then I think the public debate would be different and ultimately different outcomes would emerge.
This is particularly so in the case of the EMU and the choices that citizens now have to stay in and be smashed or leave and face a difficult adjustment period but ultimately enjoy the benefits of the currency sovereignty.
That is enough for today!