In my book Industrial Poverty I diagnose the European economic crisis as being a permanent state of economic stagnation, caused by a fiscally unsustainable welfare state. The deficits that plague the continent’s welfare states are caused by a structural imbalance between tax revenue growth and growth in government spending. In other words, the deficits that the EU-IMF-ECB troika and member-state governments have been fighting so hard over the past 5-6 years are actually in large part structural.
As I explain in this paper, you cannot fight structural deficits with business-cycle policy measures. That is what the Europeans have tried to do for half a decade now, to no avail. In fact, their problems have only gotten worse, with no recovery in sight.
Today I am happy to report on yet another depressing angle of the crisis. A structural budget deficit is a deficit that a government cannot pay for over a long period of time. While there is no set-in-stone definition of a structural deficit, the conventional definition has been that it is the deficit that remains when the economy is operating at full employment. However, the definition of full employment changes over time; what was considered serious unemployment in the 1980s is now acceptable as full employment in many countries. With that change, obviously the definition of the structural deficit would change as well, even though government has done nothing to reduce the deficit.
A better definition of a structural deficit is one that still rises above the regular business cycle but at the same time is independent of the level of employment. In the aforementioned paper I suggested a definition based on, at minimum, ten years of economic performance: a ten-year long trend in government spending (or a specific share thereof) is compared to a ten-year long trend in tax-base growth. If spending outgrows the tax base, then the government is having to deal with a structural deficit; if the tax base grows faster than spending, then there is a structural surplus in the government budget.
To get a good idea of whether or not Europe has a structural-deficit problem, I pulled the following numbers from the Eurostat database:
Government spending defined as welfare-state spending: housing and community development; health; culture, religion and recreation; education; and social protection; and
Current-price and inflation-adjusted growth in GDP.
Not all member states report these numbers down to the level needed for a ten-year trend study; in addition to 13 EU member states I also pulled data for Norway, which turned out to be interesting.
The results are as follows (time period 2004-2013). A ratio of 100 means a perfect growth balance where welfare-state spending is growing on par with the tax base; an index number below 100 is a structural deficit while an index number higher than 100 represents a structural surplus. For current-price GDP, four of the 14 countries actually run a surplus:
|CURRENT PRICE STRUCTURAL|
While the Polish government’s broadest possible tax base is growing by 120.5 euros per 100 euros of welfare-state spending, the Portuguese tax base only grows by 53 cents per euro of growth in welfare-state spending.
This indicates structural deficits in ten of these 14 countries. It does not mean that there is an actual deficit of this magnitude, but it means that the economy of these ten countries is unable to sustain the spending that goes out through their entitlement programs.
But that aside, it looks kind of good, doesn’t it, to have such a prominent welfare state as Sweden in the structural surplus category. Does that not mean that the welfare state can be paid for?
Let us answer that question with a look at the same spending numbers, but now compared to inflation-adjusted GDP:
|REAL GROWTH STRUCTURAL|
All of a sudden, Poland can only pay for 61.8 cents of every euro they spend on welfare-state programs. Sweden cannot pay for half of its welfare state. But worst of all: welfare-state spending in Portugal and Italy is so structurally under-funded that it outgrows the tax base by more than a euro, per euro in increased spending!
This means, in a nutshell, that the Portuguese and Italian governments draw taxes from a shrinking tax base to pay for what is undoubtedly an out-of-control welfare state.
Even if the actual growth of their tax revenues does not track the growth of GDP at all times, the GDP growth rate provides the most comprehensive picture of what the economy – and thereby taxpayers – could afford in terms of welfare-state spending. The bottom line for today, therefore, is that governments of welfare states from all corners of Europe are lucky if they see their tax revenues grow half as fast as their spending. And that is regardless of where the business cycle is: again, these numbers cover the period from 2004 through 2013.
As the Germans, the Greeks and the European Union leadership try to hash out a reasonable plan for Greece to secede from the currency union, the underlying question remains: has Europe managed to deal with the structural problems that brought many of its member states to their fiscal knees?
More specifically: are the problems that have sent Greece into a depression and possibly out of the euro zone unique to Greece – or are they just more concentrated there than elsewhere in Europe?
The answer to this question, presented in my book Industrial Poverty, is that the Greek crisis is merely a concentrate of an endemic European problem: a welfare state that is structurally and permanently too costly for the private sector to pay for. So long as the Europeans keep their welfare state they will continue to dwell in economic stagnation, with chronic problems of growth and budget deficits.
Over the past year countless forecasts of a strong recovery – or even a moderate recovery – in the European economy have been proven wrong. There are two reasons for this: economists normally rely on econometrics when they make their forecasts, a methodology that is not well tuned for large institutional and structural problems in the economy; and the focus on – obsession with – econometrics leads economists to ignore long-term structural trends in the economy.
Europe’s crisis is a structural one, caused by a long trend of weakening growth and increasingly persistent budget deficits. The over-arching problem, again, is the structure of entitlements imposed on the economy by the welfare state, a fact that is visible in the following, rather compelling data.
Figure 1 reports data on GDP growth and government deficits as share of GDP. The data is from 12 European welfare states, selected first and foremost based on data availability. The 12 states are then observed over a period of 48 quarters, fourth quarter of 2002 through third quarter of 2014, for annual, inflation-adjusted GDP growth and the deficit-GDP ratio. The result is a clearly visible correlation between the deficit ratio and GDP growth:
The better the deficit-to-GDP ratio, the stronger is GDP growth.
Now, let’s not rush to conclusions here. The immediate reaction among crude Austrians and crude Keynesians would be, respectively:
- “Yes, this proves that austerity is king!”
- “No, this can’t be – everybody knows that deficit spending is king!”
Truth is, neither side is correct. The reason why budget surpluses, or small deficits, correlate with high growth and deficits with slow or no growth, is as simple as it is independent of political-economic theory. Put simply, modern, mature welfare states are so big and difficult to pay for that a budget deficit is the normal state of affairs. Since the welfare state also depresses growth, by means of high taxes and sloth-inducing entitlements, it creates a combination of deficits and low growth.
Under unusual circumstances, high growth combines with surpluses not because government spending is low, but because GDP growth is high. In other words, observations of surpluses in Figure 1 are due entirely to a fortunate period of strong growth.
To further reinforce the point that growth is the only way to a reduced deficit in modern welfare states, consider Figure 2:
Note how the deficit-to-GDP ratio improves from 2005-2006. The reason is an improvement in GDP growth that started already in 2003. Next, note how GDP growth stagnates and starts declining in 2007 and how the deficit ratio follows downward in 2008. The upturn in the deficit ratio does not come until 2010, a year after GDP started improving.
In a nutshell: it is growth, not austerity, that fixes European budgets. (The same holds true, obviously, for the United States as well.) In absence of growth the budget deficits overwhelm their host economies and pile up more and more unsustainable debt.
Earlier this week I summed up some recent observations of macroeconomic differences between the United States and Europe. Those differences, which explain why the euro has plunged from $1.39 in May last year to its current $1.06, are not going to go away any time soon. I recently did an overview of the fundamentals that constitute the strength of the U.S. economy (see part 1, part 2, part 3 and part 4); today’s article takes a closer look at the European economy.*
As the latest national-accounts data from Eurostat reports, the European economy remains in a state of de facto stagnation. According to inflation-adjusted numbers, GDP growth for 2014 stood at 1.3 percent; while much better than 0.04 percent for 2013, a closer examination shows that it is neither impressive nor sustainable.
Unlike the growth in the U.S. economy, which originates in sustained growth of domestic, private-sector activity, Europe’s increase in growth is driven primarily by exports. In 2013 exports from the European Union grew by 2.16 percent in inflation-adjusted numbers, a number that increased to 3.53 percent in 2014.
There is a sharp contrast between these growth numbers and those for private consumption: -0.1 percent in 2013 turned into growth of 1.29 percent in 2014, hardly an impressive number.
To further emphasize the role of exports for Europe, consider the strong correlation between exports and business investments, vs. the apparent absence of consumption-investment correlation:
Since private consumption barely moves, businesses have no reason to invest for the domestic market. They therefore tailor their business expansions – to the extent such expansions take place – to fluctuations in foreign markets.
The dependency on exports is even more apparent at the member-state level. Over the past two years, exports has been the leading absorption variable in 17 of the 26 countries included here (Ireland and Luxembourg have not yet reported fourth-quarter data). In five of the countries exports was the only absorption category that shows any growth; in Spain private consumption barely squeezed into positive territory:
|Consumption||Investm.||Govt cons.||Exports||GDP avg|
The long-term trend of growing dependency on exports is visible across the board in the EU. From 2011 to 2014 (4th quarters), exports share of GDP increased in 23 of the 26 member states included here.
While there is nothing wrong inherently with growing exports, there is a problem when an economy almost entirely depends on exports. Contrary to prevailing wisdom among, primarily, European economists there is no lasting positive “multiplier” effect from exports to the rest of the economy – except, as mentioned, the business investments that relate specifically to exports.
The lack of positive multiplier effects from exports to, e.g., private consumption is reinforced by the fact that government spending is the strongest or second-strongest growth variable in 15 of the 26 countries. This is remarkable: for all of EU-28 government absorption grew at an annual rate of 0.6 percent per year over the 2013-2014 eight quarters. The fact that this was enough to finish second speaks volumes to the overall weakness of the European economy.
So long as this weakness remains, there will be no reversal of the long-term decline of EU economy.
*) Eurostat, 2005 chain-linked national accounts data.
I normally do not write about momentary events, such as the daily fluctuations on the international currency market. But today’s exchange rate between the dollar and the euro, which according to Bloomberg happens to be $1.06 per euro right now, is worth a broader analysis. The trend toward euro-dollar parity has gained a fair amount of attention in the media, and rightly so: when the euro was launched a decade and a half ago it was sold as a stellar currency, backed by some kind of European integrity, and certainty way above that flimsy greenback.
Reality turned out different. The euro and the dollar would have reached parity many years ago had it not been for the excessive money printing during Bernanke’s QE programs. But now that the Federal Reserve has cooled down its printing presses and the European Central Bank, on their end, have cranked up theirs, it is only logical that the two currencies are re-evaluated on the global currency market.
Immediately, one could question the case for parity based on the fact that the Federal Reserve Board of Governors meet tomorrow, Wednesday and likely will throw some cold water on the surge of the dollar. However, a postponed interest-rate hike will not make much of a difference over time: while only about three percent of all short-term rate changes are related to real-sector events, long-term trends are determined by the macroeconomic performance of the two economies. From this perspective, euro-dollar parity is a historic event. Its underlying cause is a long-term, widening gap between GDP growth, consumer spending, business investments and job creation in the United States and in Europe.
I have on several occasions analyzed the differences between the European and American economies. This is a good time for a quick recap. To begin with, the American economy is a much stronger job-producing machine than the European economy:
Our job creation record in this recovery is not exactly stellar, but our unemployment is nevertheless almost half of what it is in the euro zone. The EU as a whole is doing microscopically better than the euro zone, but that is almost entirely thanks to the comparatively positive trend in the British economy.
The American advantage in terms of job creation originates in a still-overall business friendly institutional framework. On the one hand, the Obama administration has a penchant for regulations; on the other hand this president has a comparatively modest spending record – far better than his predecessor – which has allowed Congress to combine largely unchanged taxes with an expansion of private-sector business opportunities. As a result, GDP growth is comparatively strong here:
It is important to understand the driving forces behind growth. If it is private consumption and business investments, it means that the private sector is doing well. In my recent blog series “State of the U.S. Economy” I pointed to these variables as being essential to the growth of our economy. What is particularly interesting is the visibly stronger confidence in business investments.
Therefore, we can safely conclude that we have a growth period in the U.S. economy that is well grounded and could last for a couple of more years.
The European economy, on the other hand, is not as lucky. Whatever growth they have appears to be driven by exports more than anything else. Private consumption is not playing a key role here:
The differences are striking in terms of private-consumption growth. Americans are now back at a level of consumption where they can maintain their standard of living and even start getting ahead a little bit. In Europe, by contrast, the standard of living has been declining consistently for over a decade: consumption growth has been below the Industrial Poverty threshold since the Millennium Recession.*
This points to a fundamental weakness in the European economy. While government has assumed more responsibilities for people’s lives in Europe than here – and as a result has a higher level of spending – it is important to understand that this does not compensate for lack of private-consumption growth. Government spending in Europe has been held back by welfare-statist austerity policies for a good six years now, which only pours more salt in the growth-stopping wounds on the European economy.
For all the macroeconomic reasons reported above, Europe will not return to growth any time soon. The American economy will continue to grow at moderate rates for another couple of years, during which we will see a reversal of the exchange rate between the euro and the dollar.
*) For an explanation of the two-percent growth threshold in private consumption, see my book Industrial Poverty, specifically the section about applying Okun’s Law to private consumption.
Two years ago Caritas, the charity arm of the Catholic church, published a study of the socio-economic effects of the European crisis. They reported:
The prioritisation by the EU and its Member States of economic policies at the expense of social policies during the current crisis is having a devastating impact on people – especially in the five countries worst affected – according to a new study published today by Caritas Europa. The … failure of the EU and its Member States to provide concrete support on the scale required to assist those experiencing difficulties, to protect essential public services and create employment is likely to prolong the crisis.
Their report presented…
a picture of a Europe in which social risks are increasing, social systems are being tested and individuals and families are under stress. The report strongly challenges current official attempts to suggest that the worst of the economic crisis is over. It highlights the extremely negative impact of austerity policies on the lives of vulnerable people, and reveals that many others are being driven into poverty for the first time.
This was, again, two years ago. Since then, things have gotten worse, which Caritas reflects in its 2015 study of the European crisis. Sadly, the report not only accurately presents the socio-economic disaster in southern Europe, but it also makes requests for a bigger welfare state.
Starting with the effects of the crisis, Caritas points to widespread cuts in income-security entitlements and health care, especially in the worst-off countries like Greece, Italy, Rumania, Portugal and Cyprus:
[From] 2011, social expenditure declined … and social challenges have grown further during the second dip of the recession … for example, in a number of countries the number of long-term unemployed losing their entitlements has increased, the level or duration of benefits has been reduced, eligibility rules have been tightened to increase incentives to take up work and this has also led to excluding beneficiaries from some [entitlement programs].
The study also criticizes the hand of austerity that has been particularly heavy on southern Europe:
[The] policy of requiring countries with the weakest social protection systems to impose fiscal consolidation and successive rounds of austerity measures within very short timetables is placing the burden of adjustments on the shoulders of those who did not create the crisis in Europe and are least able to bear the burden.
[Austerity] policies pursued during the crisis in Europe and the structural reforms aimed at economic and budgetary stabilisation have had negative effects with regard to social justice in most countries
This is the problem facing Europe in the next few years. An economic crisis hit; governments responded by slashing welfare-state entitlements and raising taxes; people respond by getting angry – not over the crisis, but over lost entitlements. As a result, socialist parties are gaining strength from Paris to Lisbon, from Athens to Madrid, pushing an agenda of restored entitlements. Caritas reinforces this movement by suggesting that “social justice” – a politically undefinable concept – should be the guideline for post-austerity policy.
A battle cry for more social justice is a battle cry for higher taxes and more income redistribution. Or, as Caritas puts it, “the impacts [of austerity] have not been shouldered equally”. If by “equally” they mean “spread out evenly across the citizenry”, then yes, they are entirely correct. But the reason for this is – obviously – that only a select segment of the population receives entitlements from the welfare state. That is the very reason for the welfare state’s existence.
Caritas and other advocates of social justice would respond that this is a moot point: those who earn the least cannot afford lose the entitlements they have. Others have money, they contend.
If the argument about the frugality of welfare-state entitlements were applied to the United States, it would not stand up to scrutiny. Michael Tanner and Charles Hughes have proven this beyond the shadow of a doubt. Things are a bit different in Europe, though, as Caritas actually show in their study. However, this does not mean that austerity could have been executed differently. More burden on those who do not receive entitlements automatically means higher taxes; as I show in my book Industrial Poverty austerity based on tax increases has even worse macroeconomic effects than austerity biased toward spending cuts. This means, in a nutshell, that if austerity had been profiled according to some “social justice” scale, it would have deprived even more Europeans of jobs and entrepreneurial opportunities.
Plain and simple: Europe must not fall for the temptation of “social justice”. It must charter a course away from collectivism and government “solutions”. The way to the future goes through fundamental, structural reforms toward a permanently smaller government.
While the talks between the EU and the Greek government has bought the euro a little bit more time, there is a growing undercurrent of a debate over the European crisis. More writers are trying to put their finger on where Europe is going and what the continent needs. Arthur Brooks, president of the American Enterprise Institute, looks at demographics and points to some of the deeper social and cultural problems that plague Europe:
[A] country or continent will be in decline if it rejects the culture of family, turns its back on work, and closes itself to strivers from the outside. Europe needs visionary leaders and a social movement to rediscover that people are assets to develop, not liabilities to manage. If it cannot or will not meet this existential challenge, a “lost decade” will look like a walk in the park for Grandma Europe.
There are reasons why a country turns away from family, work and social, demographic and cultural reproduction. Those reasons are closely tied to self determination: when people are demoted from independent individuals to subjects of the welfare state, their desire to assume responsibility for a family weakens accordingly. When government uses economic incentives to steer people toward certain life choices, and away from others, people become less inclined to participate in the reproduction of the society they inherited. They are happy to hand that responsibility over to government – precisely along the lines of the incentives that government has created.
In other words, when government has social-engineering ambitions the consequences of its incursions into the private lives of its citizens reach far beyond what government planners initially would anticipate. Collectivization of people’s daily lives destroys much more than just the economy.
The welfare state is the collectivization vehicle that rolls all over the values that formed the foundation of Western civilization. Proponents of individual and economic freedom chronically under-estimate the destructive force of the welfare state, both short-term and long-term. Brooks represents the view that the welfare state, over its long-term existence, is somehow isolated from the cultural and social traditions and institutions of a society.
The short-term perspective and under-estimation of the welfare state is well represented by former Polish deputy prime minister Leszek Balcerowicz. In the Fall 2014 issue of the Cato Journal, Balcerowicz offers a refreshing explanation of the crisis that caused the Great Recession. After initially attributing the crisis in the so called PIIGS countries to the financial sector, he develops a productive narrative of the crisis where the financial and fiscal sectors interact:
- In one direction the crisis causality runs from the financial sector to the fiscal sector – “fiscal-to-financial” by Balcerowicz’s terminology – when “sustained budgetary overspending … spills over ito the financial sector, as financial institutions are big buyers of government bonds”;
- In the other direction the crisis causality runs “financial-to-fiscal”, which Balcerowicz exemplifies with Ireland and Spain: “The spending boom in the housing sector fueled the growth of their economies and created a deceptively positive picture of their fiscal stance”.
While Balcerowicz is theoretically correct about the quality of the financial-to-fiscal causality, it still remains to be proven that there was enough economic activity at stake to cause such a brutal drop in employment and general economic activity as happened in 2008-2009. Balcerowicz does not offer any deeper insight into the causality, but adopts the narrative that has become the official explanation of how the Great Recession started.
Of far more interest is Balcerowicz’s “fiscal-to-financial” argument. Chronically overspending governments pull banks down with them, especially as the credit ratings of the welfare states start tumbling. I pointed to this in two articles last year, one in April and one in December. I also explain the role of the welfare state behind the crisis in my book Industrial Poverty.
The one point where Balcerowicz stumbles is when to explain why governments chronically overspend. He approaches the problem as a question:
What are the root causes of the tendency of modern political systems to systematically overspend, which results in fiscal-to-financial crises or in chronically ill public finances that act as a brake on economic growth?
He then suggests that the answer to this question “belongs to public choice”. This is an analytical mistake: public choice lacks the methodological power to penetrate the complexity of the welfare state.
Clearly, there is a need for libertarians and other friends of economic and individual freedom to learn how to understand, analyze and politically and legislatively dismantle the welfare state. Without such knowledge they will continue to make near-miss contributions such as the ones by Brooks and Balcerowicz.
But fear not. I have another book coming. Stay tuned.
The answer to the question whether or not Greece will stay in the euro will probably be given this week. New socialist prime minister Tsipras is not giving the EU what it wants, jeopardizing his country’s future inside the currency union:
Talks between Greece and eurozone finance ministers broke down on Monday with an ultimatum that Athens by Friday should ask for an extension of the current bailout programme which runs out next week. Greek finance minister Yanis Varoufakis said he would have been willing to sign off on a proposal made by the EU commission, which was more accommodating to Greek demands, but that the Eurogroup offer – to extend the bailout programme by six months – was unacceptable. The battle is about more than just semantics. EU officials say Greece cannot cherrypick only the money-part of a bailout and ignore the structural measures that have to be implemented to get the cash. “If they ask for an extension, the question is, do they really mean it. If it’s a loans extension only, with no commitments on reforms, there is an over 50 percent chance the Eurogroup will say no,” one EU official said. Failure to agree by Friday would leave very little time for national parliaments in four countries – notably Germany – to approve the bailout extension. It would mean Greece would run out of money and be pushed towards a euro-exit. … As for the prospect of letting Greece face bankruptcy to really understand what’s at stake, an EU official said “there is no willingness, but there is readiness to do it”.
The mere fact that there is now official talk about a possible Greek exit from the euro is a clear sign of how serious the situation is. It is also an indication that the EU, the ECB and the governments of the big EU member states have a contingency plan in place, should Greece leave the euro.
My bet is that Tsipras is gambling: he wants out of the euro, but with a majority of Greeks against a reintroduction of the drachma he cannot go at it straightforwardly. He has to create a situation where his country is given “no choice” but to leave. This is why he is negotiating with the EU in a way that he knows is antithetical to a productive solution.
The reason why Tsipras wants out is simple: he is a Chavista socialist and wants to follow in the footsteps of now-defunct Venezuelan president Hugo Chavez. That means socialism in one country. (A slight rephrasing of the somewhat tarnished term “national socialism”.) In order to create a Venezuelan-style island of reckless socialism in Europe, Tsipras needs to get out of the euro zone.
Should he succeed, it is likely that other countries will follow his example, though for different ideological reasons. However, there is more at stake in the Greek crisis than just the future of the euro zone. Tsipras is riding a new wave of radical socialism, a wave that began moving through Europe at the very depth of the Great Recession. Statist austerity was falsely perceived as an attempt by “big capitalism” to dismantle the welfare state. It was not – quite the contrary: statist austerity was a way for friends of big government to preserve as much as possible of the welfare state.
However, socialists have never allowed facts to get in the way of their agenda. And they certainly won’t let facts and good analysis get in the way of their rising momentum. What started mildly with a socialist victory in the French elections in 2012 has now borne Tsipras to power in Greece and is carrying complete political newcomers into the center stage of Spanish politics. But this new and very troublesome wave of socialism is not stopping at member-state capitals. It is reaching into the hallways of EU politics as well. As an example, consider these words on the Euractiv opinion page by Maria João Rodrigues MEP, Vice-Chair of the Socialists and Democrats Group in the European Parliament, and spokesperson on economic and social policies:
The Greek people have told us in January’s elections that they no longer accept their fate as it has been decided by the European Union. For those who know the state of economic and social devastation Greece has reached, this is only a confirmation of a survival instinct common to any people. The Greek issue has become a European issue, and we are all feeling its effects.
This is a frontal attack on EU-imposed austerity, but it is also a thinly veiled threat: unless Europe moves left, the left will move Europe.
Back to Rodrigues:
European integration can only have a future if European decisions are accepted as legitimated by the various peoples who constitute Europe. Decisions at European level require compromises, as they have their origins in a wide variety of interests. But these compromises must be perceived as mutual and globally advantageous for all Member States involved, despite the commitments and efforts they entail. The key question now is whether it will be possible to forge a new compromise, enabling not only to give hope to the Greek people, but also to improve certain rules of today’s European Union and its Economic and Monetary Union.
This should not be misinterpreted as a call for return of power to the member states. The reason why is revealed next:
We need a European Union capable of taking more democratic decisions and an Economic and Monetary Union which generates economic, social and political convergence, not ever-widening divergence. If Europe is unable to forge this compromise, and if the rope between lenders and borrowers stretches further, the risks are multiple: financial pressures for Greece to leave the euro; economic and social risks of continued stagnation or recession, high unemployment and poverty in many other countries; and, above all, political risks, namely further strengthening of anti-European or Eurosceptic parties in their aspiration to lead national governments, worsening Europe’s fragmentation.
The fine print in this seemingly generic message is: more entitlement spending to reduce income differences – called “economic and social convergence” in modern Eurocratic lingo – and a central bank the policies of which are tuned to be a support function for fiscal expansion. The hint of this is in the words “If the rope between lenders and borrowers stretches further”: member states should be allowed to spend on entitlements to reduce income differences, and if this means deficit-spending, the ECB should step in and monetize the deficits.
Rodrigues offers yet another example of the same argument:
[Many of] Greece’s problems were aggravated by the behaviour of the European Union: Firstly, it let Greece exposed to speculative market pressures in 2010, which exacerbated its debt burden. Secondly, when the EU finally managed to build the necessary financial stabilisation mechanisms, it imposed on Greece a programme focused on the reduction of the budget deficit in such an abrupt way that the country was pushed into an economic and social disaster. Moreover, the austerity measures resulted in a further increase of Greece’s debt compared to its GDP.
It is apparently easy for the left to look away from such obvious facts as the long Greek tradition of welfare-state spending. But that goes with the leftist territory, so it should not surprise anyone. More important is the fact that we once again have an example of how socialists use failed statist austerity to advocate for even more of what originally caused the crisis, namely the big entitlement state. They want to turn the EU and the ECB into instruments for deficit-spending ad infinitum to expand the welfare state at their discretion.
To further drive home the point that what matters is the welfare state, Rodrigues moves on to her analysis of Greece:
What Greece needs now is a joint plan for reform and reconstruction, agreed with the European institutions. This plan should replace the Troika programme, while incorporating some of its useful elements. Crucially, it should foresee a relatively low primary surplus and eased conditions of financial assistance from other eurozone countries, in order to provide at least some fiscal room for manoeuvre for the country. In return, the plan should set out strategic reforms to improve the functioning of the Greek economy and the public sector, including tax collection, education, employment and SMEs services as well as ensuring a sustainable and universal social protection system.
There is no such thing as a “sustainable and universal social protection system”. When Europe’s new generation of socialist leaders get their hands on the right policy instruments they will turn all government-spending faucets wide open. Deficits will be monetized and imbalances toward the rest of the world handled by artificial exchange-rate measures (most likely of the kind used by now-defunct Hugo Chavez).
If this new wave of socialism will define Europe’s future, then the continent is in very serious trouble.
A short-term measure of the strength of the momentum will come later this week when we will know whether or not Greece will remain in the currency union. Beyond that, things are too uncertain to predict at this moment.
After a delay with its national accounts publications, Eurostat has now caught up. Fourth-quarter numbers are beginning to sip out, with the following press release last Friday:
Seasonally adjusted GDP rose by 0.3% in the euro area (EA18) and by 0.4% in the EU28 during the fourth quarter of 2014, compared with the previous quarter, according to flash estimates published by Eurostat, the statistical office of the European Union. In the third quarter of 2014, GDP grew by 0.2% in the euro area and by 0.3% in the EU28.
More important, though, is the annual growth rate:
Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 0.9% in the euro area and by 1.3% in the EU28 in the fourth quarter of 2014, after +0.8% and +1.3% respectively in the previous quarter. During the fourth quarter of 2014, GDP in the United States increased by … 2.5% (after +2.7% in the previous quarter).
The U.S. economy is still way ahead of Europe, and there are no signs of this parity shrinking. For the three countries where Eurostat has reported individual 2014 GDP numbers, inflation-adjusted growth rates are far from impressive:
- Germany: 1.61 percent;
- France: 0.38 percent;
- Greece: 0.87 percent.
For the two largest economies in the euro zone, Germany and France, the combined growth rate is 1.08 percent. That is a minuscule uptick over the second and third quarter annual growth rates of 0.99 and 1.02 percent, respectively. Furthermore, while the combined growth rate for Germany and France is slowly increasing, the individual growth rates for the two countries are going in different directions. Again, annual inflation-adjusted growth rates reported by quarter:
Frustrating comments are already pouring out over the internet. EUbusiness.co. says that the numbers are “too weak to convincingly signal a full-blown recovery”. They are absolutely right. Analysts quoted by EUbusiness.com attribute the slight uptick in growth to falling oil prices and a weaker euro. Both of these are external factors, which means that Europe still has no core growth power. It is also important to remember that the weak euro partly is attributable to concerns about the future of the currency. With Greece basically in open defiance of payment obligations and EU-imposed austerity programs, and with countries like Portugal and Italy likely to join Greece should Athens decide to secede from the currency union, there are complicated, long-term reasons for a weak euro.
One analyst suggests to EUbusiness.com that the fact that the ECB has basically eliminated interest rates is adding so much to the picture that it is time to talk about a European recovery:
The ECB’s version of so-called quantitative easing has already decreased government borrowing prices across most of the currency bloc and weakened the euro, which should help to boost exports in Europe. “For the first time in two years, we can say that the region is going for solid growth,” Anna Maria Grimaldi, an economist at Intesa Sanpaolo SpA in Milan, told Bloomberg News. “The euro area is supported by the very strong tailwinds of the fall of the euro, the fall of oil prices and the fall of interest rates sparked by ECB QE.”
However, as I explained last week, the zeroing of interest rates has at best led to a temporary boost in business investments. There are no signs of a permanent recovery.
I will repeat this ad nauseam: unlike the American economy, the European economy has no reason to recover.
Sweden has joined the club of runaway monetary policy. From Reuters:
Sweden shocked markets on Thursday by introducing negative interest rates, launching bond purchases and saying it could take further steps to battle falling prices. The central bank joins a list of those including the European Central Bank, the U.S. Federal Reserve and the Bank of England, to resort to unconventional monetary policy steps to confront an unusual combination of economic problems.
No. The Federal Reserve has reversed course. And together with The Bank of England the Fed has been helped by the fact that it is operating in an economy with moderate taxes and relatively relaxed fiscal policy. The ECB has opened the monetary flood gates in an economy that is plagued by statist austerity and more or less zero growth.
In fact, the slight uptick in economic activity in the third quarter of 2014 that I reported on earlier this week is closely correlated to the all-out liquidity bombardment that the ECB began early summer last year. On the margin there are those who will take advantage of declining interest rates. According to data from the ECB, euro-denominated loans to non-financial corporations declined noticeably in 2014. In the group of loans with a 5-10 year rate fixation, the interest on loans above 1 million euros fell by more than one percentage point, from 2.9 percent to 1.73 percent. Other collateral loan categories saw smaller declines, but the downward trend is unmistakable.
It is likely that the same thing will happen in Sweden; the question is what effect lower interest rates will have on economic activity. In the EU, gross fixed capital formation – a.k.a., business investments – did actually increase in 2014. However, broken down by quarter, the annual growth rate (i.e., over the same quarter the previous year) looks much different:
- Q1 2014 up 3.78 percent;
- Q2 2014 up 2.35 percent;
- Q3 2014 up 1.86 percent.
In other words, the largest annual increase was recorded before the ECB declared a negative interest rate. It remains to be seen what happened in the fourth quarter, but even if there was an increase somewhere in the same territory as earlier in 2014, the big question is what the lasting impact is going to be on GDP growth and employment. One indicator of this is private consumption, which seems to have benefited a bit more from the ECB’s desperate interest rate cuts. Again measured as annual increases by quarter:
- Q1 2014 up 0.68 percent;
- Q2 2014 up 1.27 percent;
- Q3 2014 up 1.4 percent.
For the two years Q3 2012 to Q3 2014 the annual increase was, on average, 0.3 percent. Nothing to be jubilant about, but the modestly accelerating trend during 2014 indicates a stabilization (rather than some sort of genuine recovery).
What does this mean for Sweden? The problem with that particular country is that its private-consumption increase is inflated by recklessly high household debt levels. These levels, in turn, are held up by mortgage loans with absolutely irresponsible terms, such as interest-only payments or basically life-long maturity periods. As I explained in my book Industrial Poverty, if Swedish household debt had remained a constant share of disposable income from 2000 and on, its private-consumption growth rate would almost have stalled.
Put bluntly: Sweden appears to be in reasonable economic shape only because households have increased their debt as share of disposable income from 90 percent 15 years ago to 180 percent today.
What this means is, plain and simple, that it is exceptionally irresponsible to make more credit available at even lower costs. But it also means that on the margin, the Swedish Riksbank will get less new economic activity out of every negative interest point than the ECB gets; the higher the household debt, the less inclined banks are to let people pile on new debt.
Unfortunately, the Riksbank president, Mr. Stefan Ingves, does not see this problem. Reuters again:
“Should this not be enough, we want to be very clear that we are ready to do more,” said Central bank governor Stefan Ingves. “If more is needed, we are ready to make monetary policy even more expansionary.” The central bank said this would mean further repo-rate cuts, pushing out future rate hikes and increasing the purchases of government bonds or loans to companies via banks.
As the Reuters story also explains, the Riksbank is ready to move into debt monetization – unthinkable only a year ago:
The Riksbank said it would “soon” make purchases of nominal government bonds with maturities from 1 year up to around 5 years for a sum of 10 billion Swedish crowns ($1.17 billion). But with the ECB printing 60 billion euros a month in new money the Riksbank’s much more limited program may have little effect on bond yields – already at record lows. “In terms of GDP, the mini-QE program amounts to about 0.25 percent,” banking group Morgan Stanley said in a note. “Therefore, this measure should be seen more as a signal that the Riksbank is ready to do more and remain dovish for the foreseeable time.”
In other words, here again the marginal payoff is going to be small. The only exception would be if the Swedish government decides to throw out its balanced-budget rules and start a major spending drive funded by the Riksbank. This seems unthinkable today – just like negative interest rates and a QE program seemed unthinkable a year ago.
Quantitative Easing is not a recession remedy. It is a defensive monetary strategy. So is the negative interest rate. Together, these two measures declare that a government and its central bank has reached the end of the road in trying to get their economy moving again. The big problem for Europe, Sweden included, is that they have come to this point almost seven years after the Great Recession started. With a recovery being half-a-decade overdue, with tapped-out monetary policy and fiscal policies restrained by ill-designed balanced-budget measures, Europe is firmly planted on the road straight into industrial poverty.
Sweden, with its imbalanced real estate market and very deeply indebted households, is on the same road, only with a more volatile ride.
With third-quarter GDP data available we can now get an updated view of the government debt situation across the economically stagnant European Union.
For the first time in years there is actually a little bit of good news on the horizon. But before we get there, let us look at member-state debt ratios as of third quarter last year:
|Third quarter 2014|
Debt ratios appear to be plateauing. From the third quarter of 2012 to Q3 2013, seven member states decreased their debt ratios; from Q3 2013 to Q3 2014 eight countries experienced a decline. The following table reports changes in percentage points; for example, in Austria the debt ratio increased from 82.4 percent in Q3 2012 to 84.1 percent in Q3 2013 – a difference of 1.7 percent:
|Debt ratio changes, third quarters|
|12 to 13||13 to 14|
For the EU-28 as a whole the debt ratio has increased from 83.4 percent in 2012 to 86.6 percent in 2014. Euro-18 has seen a similar upward trend.
However, if we review the data on a quarter-to-quarter basis, things look a bit more optimistic. For the EU-28 there is a small decrease, from 87 percent in Q2 2014 to 86.6 percent in Q3 2014. The same marginal decline is visible in 18 member states. In eleven of them the decline is only marginal, i.e., less than one percentage point, an fact that is important to keep in mind.
That said, it would make sense that the debt ratio is stabilizing across Europe. The statist austerity measures applied in several countries the past 2-4 years have cut spending and increased taxes – not to reduce the size of government, but to make the welfare state more affordable in a new era of economic stagnation. Those measures have now re-aligned the welfare state with a smaller, non-growing GDP.
Greece appears to have achieved this alignment. Their debt ratio fell, quarter to quarter, for the first time since before the Great Recession:
It is far too early to actually conclude that the debt ratios have stabilized. However, this first indication, embedded in third-quarter data, is encouraging in the sense that the crisis is over and an era of less-worse stagnation has begun.
What these numbers do not show, though, is any sign of a turnaround in the European economy. Less inflation, GDP growth remains in one-percent territory, which is actually worse than in 2011.
Lacking the economic and political willpower to recover, Europe has opted for the second-best alternative: economic stagnation and industrial poverty.