The truth about the European economic crisis is spreading. The latest evidence of this growing awareness is in an annual report by the European Commission. Called “Report on Public Finances”, the report expresses grave concerns about the present state as well as the economic future of the European Union. It is a long and detailed report, worthy of a detailed analysis. This article takes a very first look, with focus on the main conclusions of the report.
Those conclusions reveal how frustrated the Commission has become over Europe’s persistent economic stagnation:
The challenging economic times are not yet over. The economic recovery has not lived up to the expectations that existed earlier on the year and growth projections have been revised downwards in most EU Member States. Today, the risk of persistent low growth, close to zero inflation and high unemployment has become a primary concern. Six years on from the onset of the crisis, it is urgent to revitalise growth across the EU and to generate a new momentum for the economic recovery.
Yet only two paragraphs down, the Commission reveals that they have not left the old fiscal paradigm that caused the crisis in the first place:
The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past. … this has allowed Member States to slow the pace of adjustment. The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.
If Europe is ever to recover; if they will ever avoid decades upon decades of economic stagnation and industrial poverty; the government of the EU must understand the macroeconomic mechanics behind this persistent crisis. To see where they go wrong, let us go through their argument in two steps.
a) “The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past.” There are two analytical errors in this sentence. The first is the definition of “fiscal picture” which obviously is limited to government finances. But this is precisely the same error in the thought process that led to today’s bad macroeconomic situation in Europe: government finances are not isolated from the rest of the economy, and any changes to spending and taxes will affect the rest of the economy over a considerable period of time. The belief that government finances are in some separate silo in the economy led to the devastating wave of ill-designed attempts at saving Europe’s welfare states in 2012.
Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.
b) “The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.” Here the Commission says that if a government runs a deficit, it causes a “drag” on macroeconomic activity. This is yet another major misunderstanding of how a modern, monetary economy works.
Erstwhile theory prescribed that a government borrowing money pushes interest rates up, thus crowding out private businesses from the credit market. But that prescription rested on the notion that money supply was entirely controlled by the central bank; in a modern monetary economy money supply is controlled by the financial industry, with the central bank as one of many players. Its role is to indicate interest rate levels, but neither to set the interest rate nor to exercise monopolistic control on the supply of liquidity.
A modern monetary economy thus provides enough liquidity to allow governments to borrow, while still having enough liquidity available for private investments. In fact, it is rather simple to prove that the antiquated crowding-out theory is wrong. All you need to do is look at the trend in interest rates before, during and after the opening of the Great Recession, and compare those time periods to government borrowing. In a nutshell: as soon as the crisis opened in 2008 interest rates plummeted, at the same time as government borrowing exploded.
This clearly indicates that the decline in macroeconomic activity was not caused by government deficits; it was the ill-advised attempt at closing budget gaps and restore the fiscal soundness of Europe’s welfare states that caused the drag. And still causes the drag.
In other words, there is nothing new under the European sun. That is unfortunate, not to say troubling, but on one front things have gotten better: the awareness of the depth of the problems in Europe is beginning to sink in among key decision makers. What matters now is to educate them on the right path out of the crisis.
There is a lot more to be said about the Commission’s public finance report. Let’s return to it on Saturday.
In a few articles recently I have pointed to some evidence of an emerging economic recovery in Spain and Greece. This is not a return to anything like normal macroeconomic conditions, but more a stagnation at a depressed level of economic activity. To call it a “recovery” is a stretch, but given the desperate circumstances of the past few years, an end to the depression is almost like a recovery.
The transition from a depression with plunging GDP, vanishing jobs and overall an economy in tailspin, to stagnation where nothing gets neither better nor worse, is in fact a verification of my long-standing theory. Europe has entered a new era of permanent stagnation – an era best described as industrial poverty – and is slowly but steadily becoming a second-tier economy on the global stage. The path into that dull future is paved with decisions made by political leaders, both at the EU level and in national governments. While they do have the power to actually return Europe to global prosperity leadership, they choose not to use that power. Instead, their economic policies continue to destroy the opportunities for growth, prosperity and full employment.
In fact, Europe’s leaders have the opportunity on a daily basis to choose which way to go. The difference is made in their responses to the economic situation in individual EU member states. Let us look at two examples.
First out is an article from Euractiv a month ago:
Greece is “highly unlikely” to end its eurozone bailout programme without some new form of assistance that will require it to meet targets, a senior EU official said on Monday (3 November). “A completely clean exit is highly unlikely,” the official told reporters, on condition of anonymity. “We will have to explore what other options there are. Whatever options we may be adopting, it will be a contractual relationship between the euro area institutions and the Greek authorities,” the official said.
How will the EU, the European Central Bank and the International Monetary Fund respond to this? Will they continue to impose the same austerity mandates that they began forcing upon Greece four years ago? Back to Euractiv:
The eurozone and IMF bailout support of €240 billion began in May 2010. Greece is in negotiation with EU institutions and the International Monetary Fund ahead of the expiry of its bailout package with the European Union on 31 December. Athens has said it wants its bailout to finish when EU funding stops, though the IMF is scheduled to stay through to early 2016. The EU official said he expected eurozone ministers and Greece to decide on how best to help Athens at a meeting of finance ministers in Brussels on 8 December.
If the EU decides to continue with the same type of bailout program, thus continuing to demand government spending cuts and tax hikes, then their response to this particular situation will continue the economic policies that keep Europe on its current path into perpetual industrial poverty.
The second example, France, also presents Europe’s political leadership with a fork-in-the-road kind of choice. From the EU Observer:
France’s finance minister cut the country’s deficit forecast for 2015 on Wednesday (3 November) adding that Paris will be well within the EU’s 3 percent limit by 2017. Michel Sapin told a press conference that he had revised France’s expected deficit down to 4.1 percent from the 4.3 percent previously forecast, as a consequence of extra savings worth €3.6 billion announced by Sapin in October.
That sounds good, but what is the reason for this improved forecast – and, as always with optimistic outlooks in Europe, can we trust it?
The extra money does not come from additional spending cuts but instead from lower interest expenses from servicing France’s debts, a reduction in its contributions to the EU budget, and extra tax revenues from a clampdown on tax evasion and a new tax on second homes. “We have revised the 2015 deficit … without touching the fundamentals of French economic policy,” Sapin told reporters.
This also means they have done their debt revision without seeing a change for the better in “the fundamentals” of the French economy. In other words, no stronger growth outlook, no sustainable improvement in business investments or job creation. As a matter of fact, a closer look at the measures that Mr. Sapin refers to reveals a frail, temporary improvement that will not put France on the right side in any meaningful macroeconomic category:
- A lower interest rate on French government debt is almost entirely the work of the European Central Bank and its irresponsible money-printing; the French are paying lower interest rates on ten-year treasury bonds than we do here in the United States, but that will last only for as long as investors remain confident in the ECB’s version of Quantitative Easing; interest rates will quickly start rising again once that confidence is shattered – and it will be shattered as soon as investors realize that, unlike in the United States, the European economy will not start growing again;
- Reduced French EU contributions come at the expense of other countries and likely won’t last very long; as soon as other countries have grown impatient with the French, they will force Paris to increase its contributions again; besides, this “reduced EU contributions” thing is basically just an accounting trick – effectively it means that the EU has reduced their demands on how much France needs to cut its deficit to be “compliant”;
- A new second-home tax is a tax increase to which taxpayers will make the necessary adjustments; they will move from owning a home to renting one or to extended-stay vacations at luxury hotels; once that adjustment reaches a critical point the French government will have lost the new revenue and their hopes of being “compliant” with the EU deficit requirement will fade away.
If the French government spent all the political and legislative efforts that went into these measures, on structural reforms to the French government, then France would be en route to a major improvement in growth, jobs creation, business investments and the standard of living of their citizens. But that is not going to happen. All they do is try to comply with the same old statist rules that have forced them to balance their budget – and save their welfare state – instead of promoting the prosperity of their people.
There is a painful shortsightedness in European fiscal policy, one that almost entirely prevents the political leadership of that continent to look beyond the next fiscal year. It is time for them to stop, raise their eyes to the horizon and think about where they want their continent to be ten years from now.
If they don’t, I can surely say where they are going to be: in an era of industrial poverty, colored by three shades of grey, where children are destined to – at best – live a life no better than what their parents could accomplish. Think Argentina since the decline and fall of their 15 years of global economic fame.
Think Eastern Europe under Soviet rule.
Whenever government creates an entitlement, it makes a promise to its citizens. The promise is defined in terms of a cash value, or an in-kind service of a certain quality; in terms of duration and of who is, or can become, eligible.
Over time, people adjust their lives to these promises. They come to rely on government being there for them when it really matters, and therefore stop – or never start – saving for contingencies such as unemployment or major health care expenses. Their incentives to stop providing for unforeseen events are reinforced by the taxes that go toward paying for government’s promises.
There you have it, in a nutshell: the welfare state.
In the early years of its existence, the welfare state provided for people with relative ease. Many adults still lived by the old creed of keeping current expenses moderate in order to have enough in the bank for most of what life could throw at them. Taxes were also relatively moderate, allowing people the cash margins to do the saving they still thought they needed.
Over time, though, it became harder and harder for government to keep its welfare-state promises. The incentives structure that government had created began sinking in to the fabric of the economy. Not only did people cut down on their savings, thus relying more on the welfare state, but they also responded to the higher taxes by working less.
Dependency on government increased while independence decreased. This created a trend where the ability of government to pay for its promises was slowly but inevitably eroded. The cost of its promises crept upward, beyond what the creators of the welfare state had originally imagined; work disincentives eroded tax revenues, also beyond what the architects of the welfare state had pictured.
In the early 1970s most of Europe’s welfare states hit a point where the cost of the welfare state began rising above what the private sector of the economy could afford. Various accommodating measures were taken, varying from higher taxes and benefits cuts – as in Denmark – to supply-side tax cuts aimed at accelerating growth in tax revenue – as in Sweden. (Notably, the Reagan tax cuts were coupled with seven-percent-per-year federal spending growth, a clear indication that the supply-side policies were there to fund government, not part of a strategy to reduce the size of government.) But these were merely stopgap measures; inevitably, the welfare state overwhelmed the private sector with its entitlement costs, its high taxes, its incentives toward a lifestyle of government dependency.
The crisis of 2008 was the straw that broke the camel’s back. Europe’s welfare states plunged into the dungeon of economic stagnation and began their march into a new era of industrial poverty.
For more on that part of the story, see my book on the European crisis. For now, though, there is another aspect of the crisis of the welfare state that deserves attention. In response to the overwhelming cost of the welfare state, most of Europe’s countries have resorted to a kind of austerity not yet known to Americans. They cut government spending and raise taxes not to reduce the size of government, but to resize their welfare states to slim-fit them into a smaller economy (make them more “affordable” as Michael Tanner so aptly put it in his foreword to my book). The metrics for whether or not austerity has succeeded have nothing to do with how the private sector is doing – they are all focused on whether or not the welfare state will survive.
The primary measurement of survivability is whether or not the budget deficit has been reduced.
In order to get there, though, most European governments have had to cut deeply into their welfare state programs. That would be fine under the right circumstances – if people were given tax cuts corresponding to the spending cuts and thus a chance to buy the same services on a private market. But in the European, statist version of austerity, reduced spending means cutting the size of government without giving more room to the private sector. As much as this sounds like a contradiction in terms, consider the fact that while spending is reduced, taxes remain high or go up even higher.
As a direct result of this statist version of austerity, government breaks its promises to its citizens, and does it on many fronts at the same time. This is now statistically visible.
Broadly speaking, welfare-state spending consists of two parts: cash benefits and in-kind benefits. The latter is health care, elderly care, child care and similar services. Both these two categories can then be subdivided into means-tested and non-means tested benefits.
When a government is faced with the need to cut spending, and its motive for cutting spending is to save as much as possible of the welfare state, it will make its cuts based on two criteria:
- what cuts will give the most bang for the political and legislative effort; and
- what cuts will stir up the least political protests among voters.
These two criteria do not always work in tandem, and it varies from country to country, from government to government, which one weighs more heavily. However, as a general rule it is easier to cut in-kind benefits than cash benefits: while people see the reduction in cash benefits immediately, it takes a while for them to experience the reduced quality or availability of services such as health and child care.
We can see this rule at work in Europe. In countries that have been hit hard by statist austerity, there were tough cuts to in-kind benefits spending (Eurostat data; changes to annual total spending; current prices):
By contrast, countries that have not suffered as hard statist austerity measures:
Now compare the cuts to in-kind benefits in “austerity countries” to what they did with cash benefits:
What is the lesson from all this? There is, again, the broader, long-term lesson of a future in economic stagnation and a life in industrial poverty. But already today there are tangible consequences felt by citizens whom welfare statists often refer to as “vulnerable”. They have first been lured into dependency on government, then – when austerity strikes – they are left without access to services monopolized by government.
When the welfare state breaks its promises, having the right to health care is one thing; getting health care when needed is a totally different matter.
The European economic stagnation is now becoming a concern for the rest of the world. The OECD – Organization for Economic Cooperation and Development – is sounding the alarm in their latest Economic Outlook. From their news release:
The Economic Outlook draws attention to a global economy stuck in low gear, with growth in trade and investment under-performing historic averages and diverging demand patterns across countries and regions, both in advanced and emerging economies.
Put bluntly, the EU with its 500 million residents and supposedly first-world standard of living is spreading its stagnation to other countries and continents. An economy that is not growing is not growing its imports; it offers fewer, and less profitable, investment opportunities than a growing economy.
Many emerging economies have their own problems to deal with, from a heavy-handed government in India and clumsy deregulation in China to dangerous political corruption and violence in South Africa. But there is no doubt that entrepreneurs in those countries who can participate in global trade would be much more able to make a difference for the better if they had a growing global market on which to sell their products. While the U.S. economy sticks to its lazy recovery – the latest job numbers are moderately good but not exciting – the Japanese upturn is still fledgling. But the big drag on the global economy is, no doubt, Europe.
The OECD notes this…
“We are far from being on the road to a healthy recovery. There is a growing risk of stagnation in the euro zone that could have impacts worldwide, while Japan has fallen into a technical recession,” OECD Secretary-General Angel Gurria said.
…but when it comes to prescriptions for what to do about this, the OECD falls short. Before we get there, though, it is important to note one aspect of the OECD report that hints of what kind of solutions they may be prescribing:
The euro area is projected to grow by 0.8% in 2014, before slight acceleration to a 1.1% rate in 2015 and a 1.7% rate in 2016. A prolonged stagnation in the euro area could drag down global growth and have knock-on effects on other economies through trade and financial links. A scenario in the Outlook shows how a negative shock could lead an extended period of very low growth and very low euro inflation, resulting in unemployment remaining at its current unacceptably high level.
I have lost count of all forecasts over the past two years that predict a rising GDP growth rate for the euro zone or the EU as a whole. The reason why so many economists make these predictions is that they base their modeling on the standard notion that every economy eventually, long term, gravitates back toward full-employment equilibrium. They are no doubt mystified by the protracted nature of the current European crisis, but instead of rethinking the fundamentals of their forecasting they stick to their default, which is a long-term full-employment equilibrium.
This is, however, not a regular crisis that allows itself to be analyzed in terms of standard macroeconomic models. It is a structural crisis, systemic in nature and by default perennial in duration. Its cause is a permanent imbalance between government-promised entitlements and the ability of the private sector to pay for those entitlements. This imbalance will remain forever unless Europe’s legislators actively reform away entitlements and alleviate the burden of the welfare state on the shoulders of the private sector.
In short: it does not take another negative shock to keep there European economy depressed forever. All it takes is absence of drastic structural reform.
That, however, is not what the OECD is prescribing:
“With the euro zone outlook weak and vulnerable to further bad news, a stronger policy response is needed, particularly to boost demand,” said OECD Chief Economist Catherine L Mann. “That will mean more action by the European Central Bank and more supportive fiscal policy, so that there is space for deeper structural reforms to take hold. A Europe that is doing poorly is bad news for everyone.”
More action from the ECB? Let’s look at some recent annual growth rates in euro-zone M1 money supply, courtesy of the European Central Bank, and current-price GDP growth, courtesy of Eurostat:
Current-price GDP growth represents growth in money demand. The liquidity pumped out by the ECB in excess of that goes straight into the financial system where, to be a bit crude, it will slush around in search of profitable investment opportunities.
For example, in 2013 the ECB printed €7.36 for every €1.00 in increased current-price GDP. Technically this adds €245 billion of liquidity into the financial system. The result of this monetary policy, zero to negative interest rates, has not made a bit of a difference to the euro-zone economy.
As for the fiscal-policy part of the OECD recommendations, this would take a complete abandonment of welfare-state saving austerity. Are the Europeans ready to do that? And more importantly: are they ready to use active fiscal policy to roll back government and provide more growth room to the private sector?
So far, neither the EU Commission nor key member-state governments have showed any inclination in that direction. But I am not even sure the OECD actually would recommend the right kind of fiscal policy; the farthest they would go is probably a traditional mainstream-Keynesian fiscal stimulus. That would only serve to preserve status quo.
With all this in mind, though, it is good that the OECD is now waking up to the European crisis. Next step is to lead them to the right conclusion as to the nature of that crisis…
Europe’s perennial recession is depriving the welfare state of revenue. This in turn is causing frustration, especially among those who still defend the welfare state and the big, redistributive government it represents. And the welfare statists are getting vocal, as shown by a contribution from Klaus Heeger, Secretary General of the European Confederation of Independent Trade Unions. Heeger does his best to blame the welfare state’s revenue starvation on corporate tax planning:
What the recent tax scandals in Luxembourg have shown is that governments are stripping back public services, while at the same time encouraging companies to engage in complex tax schemes. The promotion of tax evasion has deprived public services of crucial resources at a critical time.
No, it is not tax planning that “deprives” government of “crucial resources”. It is the recession. A government spending program is a promise, or a bundle of promises, to a designated segment of the population. Government defines that segment as “entitled” to a cash or in-kind government service, specifies the quality and quantity of that entitlement and then starts pouring out the money. There is almost never a funding source tied to the entitlement – funding comes out of general revenue – and on the rare occasions when there is a dedicated funding source, the entitlement is not conditioned on available tax revenue.
This is, in essence, like me promising my children a flat screen TV each for Christmas without first looking at my bank account. (And never mind the risk of spoiling them to the point where they won’t work for what they want…) But somehow this aspect of the welfare state is lost on its fervent proponents, Klaus Heeger being one of them.
He does, however, make one interesting point:
This public financing has been critical for the banking sector in the past 5 years and is now critical for citizens and workers. Lost revenue means less means of financing public services used by citizens and companies alike, and less redistribution towards a fairer and more sustainable society.
If we forget about the programmatic rhetoric about “fairer and more sustainable”, the argument about the banks is not without merit. But the problem, again, is that elected officials think that it is perfectly fine to use government – and thereby tax revenue – for everything and anything. But corporate welfare is not a government function in a free society.
Heeger’s little jab about businesses taking tax money is of course aimed at getting them to give back in the form of higher taxes:
Concrete measures need to be implemented now in order to put the spotlight on tax justice across Europe. The [recent] G20 summit shows that solutions exist; there is just a lack of political will in Europe to put them in place. While Europe is still hesitating on how to approach the sensitive issue of tax rulings, the G20 have underlined the need to fight these “harmful tax practices”.
There is a sense of desperation in calling tax planning “harmful”. Businesses that create jobs, provide people with products that improve their standard of living; businesses that produce medicine and high-quality food, that build safe and comfortable ways for us to travel; businesses that produce power to we can warm our homes; those businesses need to make sure they can make their ends meet and have enough money for future investments. They need to be able to compete, to improve their products, to pay their workers more.
When they take steps to reduce an already onerous tax burden, they are not engaging in “harmful” activities. They are trying to avoid harm to their own operations, their employees and their customers.
The harm is done by over-reaching governments extending their taxation beyond what is economically sustainable.
Unfortunately, union leader Klaus Heeger does not see this side of the issue. On the contrary, he wants the EU and its member states to further tighten the tax noose around the corporate neck. The goal, says Heeger, is “a common tax base”:
Starting with more transparency on tax ruling, Europe then needs to push ahead with legislation on a directive on a common tax base with binding harmonisation at the heart of the proposals. A single tax base will ensure profits are taxed once and redistributed amongst countries hosting the company.
Today, companies in Europe can choose a country of residence where they file their taxes. What Heeger and other proponents of a perpetually large government are pushing for is, simply, the elimination of that ability. Exactly how this would happen is not clear at this point, but there are two options: either the EU takes over the taxation of corporations, eliminating the member-state corporate income tax; or the EU dictates to member states what tax rate – or bracket of rates – they can tax at.
Either solution is frankly a bit brutal. Today the member states of the EU and the two remaining countries within the former EES system, Switzerland and Norway, compete for corporate headquarters with competitive taxes; in a future Europe where all tax competition is eliminated it will be the continent that competes against the rest of the world.
It is a safe bet to predict that a “tax harmonized” Europe will maximize its “common tax base”, thus making itself uncompetitive against a resilient United States, a steadily improving Canada, an increasingly industrialized Africa and, of course, the entire pack of Asian Tigers.
Heeger suggests a slew of other measures to squeeze more taxes out of corporations. While motivating his rhetoric with fairness and transparency, the real goal is to eliminate tax competition and to monopolize fiscal policy aimed at paying for the welfare state. That can only deprive Europe’s workers of yet more jobs and opportunities. It will most certainly drive yet another generation of Europeans into perennial dependency on government and destroy yet more of the prosperity generators in what was once a world-leading economy.
European third-quarter GDP growth data is beginning to make its way out in the public. What we have seen so far is just more of the same new normal – the same new stagnated way of life in industrial poverty.
Starting from the aggregate level, Eurostat’s third-quarter growth report says that the EU-28 grew at 1.3 percent per year in Q3 of 2014 over the same quarter 2013. The euro zone’s growth rate was half-a-percentage point lower at 0.8. This difference is the same as over the past few years: the last quarter where the euro zone grew faster than the entire EU was in Q1 of 2011. It shows that austerity is still taking a tougher toll on Europe’s core countries than its non-euro members on the outer rim.
Or, to make the same argument from the other side: if you are a European welfare state, it pays to keep your own currency.
The growth numbers for the EU and the euro zone are poor in and by themselves. By not even coming close to two percent per year, Europe is not even able to reproduce its own standard of living. But even worse is the fact that the U.S. economy grew by more than two percent annually for the second quarter in a row: 2.3 percent in Q3 of 2014, compared to 2.6 percent in Q2 of 2014. This growth disparity is slowly becoming a self-reinforcing phenomenon: when global investors see that the U.S. economy is growing while the Europeans are standing still, they choose to reallocate their investments to the United States. That way investments and new jobs go to where investments and new jobs are already going.
But does not that mean that the U.S. economy will run into inflation problems that, in turn, will even out the differences between the United States and Europe? No, not necessarily. In fact, that is a very unlikely scenario. We are now rising to become the global leader in producing energy, with costs far below those of European countries. Right-to-work states offer a union-free manufacturing environment, something that, e.g., Volkswagen successfully took advantage of when they opened their new plant in Tennessee. The large US-only Passat they build there is a runaway sales success, $7,000 cheaper and selling ten times more (100K units per year) than its German-built predecessor.
Long-term, it looks like manufacturing is making its way back to the United States. This does not bode well for Europe, whose exporting manufacturing industry has, basically, been the only part of the economy that has not sunken into the three shades of gray that is industrial poverty. That European manufacturing is in trouble is well proven by the Eurostat report, according to which Germany has seen a decline in growth for two quarters in a row: now down to 1.2 percent on an annual basis.
Another supposedly big manufacturing economy, France, barely finished the third quarter with growth at all: 0.4 percent over Q3 of 2013. Austria’s growth is also dwindling, with 0.3 percent this quarter compared to 0.5 in Q2 and 0.9 in Q1.
The only real positive news is that the Greek economy showed annual growth for the second quarter in a row – at 1.4 percent this quarter – with growth numbers improving steadily for a year now. Spain also shows positive growth, 1.6 percent, with a similar upward long-term trend.
Neither the Greek nor the Spanish number is anything to write home about, but it looks like the two countries are slowly recovering from the bad austerity beating they took in 2012 and 2013. It is an extremely hard journey back for both of them, though, especially for Greece which lost one quarter of its economy to destructive austerity policies. The welfare states of both Spain and Greece have now been recalibrated, so that government budgets paying for the welfare states will balance at a much lower employment level than before. This means, effectively, that government will begin to net-tax the economy and thereby cool off a growth trend long before full employment is restored.
This structural problem is entirely unknown to Europe’s lawmakers – and, frankly, to almost every economist on the planet. I defined the problem in my book Industrial Poverty; if unsolved, this problem will guarantee permanent economic stagnation in Europe for, well, ever.
That said, I don’t want to spoil the fun for Greek and Spanish families who are now seeing the first glimpse of daylight after a long, horrible nightmare. Let them celebrate today; tomorrow they will still be living in industrial poverty.
Retail trade is one of the better indicators of how an economy is doing. It is an immediate “gauge” of both confidence and private finances of consumers. Therefore, given the overall stagnant nature of the European economy, the latest report on retail trade from Eurostat has some valuable information in it:
The 1.3% decrease in the volume of retail trade in the euro area in September 2014, compared with August 2014, is due to falls of 2.2% for the non-food sector and 0.1% for “Food, drinks and tobacco”, while automotive fuel rose by 0.9%. In the EU28, the 1.2% decrease in retail trade is due to a fall of 2.1% for the non-food sector, while “Food, drinks and tobacco” remained stable and automotive fuel increased by 0.4%. The highest increases in total retail trade were registered in Malta (+1.0%), Luxembourg (+0.9%), Hungary and Slovakia (both +0.7%), and the largest decreases in Germany (-3.2%), Portugal (-2.5%) and Poland (-2.4%).
Month-to-month changes are not that important. The one detail here to note, though, is the big contraction in Germany. It is a small but noteworthy sign that the German economy, as this blog has reported before, is leaving a period of exports-driven growth and returning to the new European normal, namely stagnation.
The Eurostat memo also reported annual data:
The 0.6% increase in the volume of retail trade in the euro area in September 2014, compared with September 2013, is due to rises of 0.9% for “Food, drinks and tobacco”, of 0.6% for the non-food sector and of 0.5% for automotive fuel. In the EU28, the 1.0% increase in retail trade is due to rises of 1.5% for the non-food sector and 1.2% for “Food, drinks and tobacco”, while automotive fuel fell by 0.2%. The highest increases in total retail trade were observed in Luxembourg (+12.3%), Estonia (+9.1%) and Bulgaria (+5.6%), while decreases were recorded in Finland (-3.2%), Poland (-1.8%), Denmark and Germany (both -0.8%).
Again Germany shows up on the negative side, reinforcing the impression that the largest economy in Europe is no longer its locomotive.
On the upside, there is one interesting detail worth noting. Greece has experienced three months in a row of annual, inflation-adjusted retail sales increases: four percent in June, 4.6 percent in July and 7.4 percent in August.
Is this an early sign that the Greek depression is coming to an end? Let’s hope so.
Back in college I had a friend who blamed a cut in Swedish government-provided student loans on Moammar Ghadaffi. It was a tongue-in-cheek exercise, of course, designed to prove that if you want to, you can make any argument credible so long as you can make people believe your chain of cause and effect.
For some reason, that idea is widespread in politics, only there it is taken with the utmost seriousness. Political leaders can make the most remarkable connections between otherwise totally unrelated events. This is particularly true in economics and policy. The latest example is the stubborn European recession and what it is blamed on. Reports the EU Observer:
The European Commission lowered its growth forecasts for the EU and the eurozone area, blaming the wars in Ukraine and the Middle East, and urging governments to do more to spur investments. According to the Autumn forecast growth in the EU is now expected to be 1.3 percent of GDP this year, compared to 1.6 percent projected in spring, while the eurozone economy is to grow by only 0.8 percent, compared to the earlier projection of 1.2 percent.
I have lost count of how many times that European forecasters have had to adjust their forecasts downward. Not to brag (actually, yes, to brag…) I have not changed my forecast at all since I formulated Europe’s current problem more than two years ago. That problem is a structurally unaffordable welfare state combined with policies that try to preserve the welfare state inside a tax base that is structurally incapable of paying for it. This structural imbalance keeps the economy in a state of stagnation for an indefinite future.
The EU’s adjusted outlook once again confirms that I am right. The EU Observer again:
For 2015, the outlook is also pessimistic: the EU economy is expected to grow by 1.5 percent (down from 2 percent predicted in spring) and the eurozone by 1.1 percent (compared to the spring forecast of 1.7 percent). EU “growth” commissioner Jyrki Katainen admitted that forecasts are difficult to trust, especially since all other international institutions publishing economic forecasts “have been more often wrong than right” because there are so many variables on growth, employment, and investments.
Oh dear, there is so much to factor in… Seriously – it is the job of the economist to separate what matters from what does not matter, and then make his forecasts for the former while not being distracted by the latter.
This kind of excuse would not pass for a serious contribution here in the United States. But the Europeans are also trying to blame their years-long, endless recession on new events. Another article in the EU Observer:
Germany is on the brink of recession after recording its weakest export levels for five years. Data published by the Federal Statistics Office on Thursday (9 October) indicated that exports slumped by 5.8 percent between July and August, the sharpest monthly fall since 2009, at the height of the financial crisis. Imports also fell by 1.3 percent, suggesting that German consumers are also losing faith in the country’s economy. In a statement, the statistics office blamed late-falling summer vacations in some German regions and the Ukraine crisis for the fall in exports and imports.
But of course, there is no problem with the high taxes in Germany, or the rising energy costs as they close their nuclear reactors and try to rely on windmills instead… As share of GDP, taxes in Germany have increased from 42.6 percent ten years ago to 44.5 percent in 2013. This places Germany 12th among the 28 EU member states, and just a hair below the 45.3-percent EU average. But being average does not cut it when times are tough, it is a buyer’s market and the consumers who can actually afford to buy things are far away from your own country’s borders.
And, as noted, exports no longer serve as the locomotive of the German economy. Berlin simply cannot continue to suppress domestic demand for budget-balancing and ill-conceived energy reform reasons.
Back to the story about Germany:
The dismal statistics are the latest sign that Germany is facing an economic slowdown. In August, the ZEW think-tank’s index of financial market confidence, a trusted indicator of German economic sentiment, hit its lowest level since December 2012. The fall was attributed to the weak eurozone and fears about the EU’s ongoing sanctions battle with Russia. According to Eurostat, the EU’s data office, Germany’s output fell by 0.2 percent between April and June, after expanding by 0.8 percent in the first three months of 2014.
So what is the prevailing advice for how to get out of this state of endless stagnation?
On Thursday, four of the country’s top economic institutes urged chancellor Angela Merkel to increase public spending in a bid to stoke the economic engine. “On the spending side, public spending should be increased in those areas which can potentially boost growth,” the IFO institute in Munich, DIW of Berlin, RWI of Essen and IWH of Halle said in a joint report.
How fortunate that four of Germany’s most prominent think tanks all agree with each other. One might wonder why they need four think tanks of they all agree on something so profoundly important as how to revive the economy. Not one of them expresses concern that Germany might need just a tiny bit more economic freedom. On that note, if they are going to expand government spending without running budget deficits – what is the point in taking money away from the private sector and dole it out again through government? Private-sector activity is going to be further depressed by higher taxes: either you take away from what they spend or you depress their cash-flow safety margins and force them to depress spending in order to restore those safety margins.
There are two reasons why Germany cannot grow without exports. The first is high taxes, which up until 2012 were higher than in Greece. The second is uncertainty about the future. German consumers and at least smaller entrepreneurs have adjusted their spending downward on a permanent basis, simply because they feel overall less confident and less optimistic about the future. As Keynes explained in Chapter 16 of his General Theory, a depression of economic confidence is not a temporary matter:
An act of individual saving means — so to speak — a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand, — it is a net diminution of such demand.
That downward adjustment in demand will become the new normal until consumers and entrepreneurs has a reason to become more optimistic about the future. Evidently, that is not happening in Germany.
Not in Greece either, by the way. From Euractiv:
Greece is “highly unlikely” to end its eurozone bailout programme without some new form of assistance that will require it to meet targets, a senior EU official said on Monday (3 November). “A completely clean exit is highly unlikely,” the official told reporters, on condition of anonymity. … The eurozone and IMF bailout support of €240 billion began in May 2010. Greece is in negotiation with EU institutions and the International Monetary Fund ahead of the expiry of its bailout package with the European Union on 31 December. … The official gave no details of what new aid might look like, but policymakers have said that the most likely tool is an Enhanced Conditions Credit Line, or ECCL, from the European Stability Mechanism. That means Greece would be under detailed surveillance from the European Commission, the EU executive, for the duration of the credit line. “There needs to be money available for drawing on,” the official said.
Money available for spending items that Greek taxpayers cannot afford. So long as those spending promises remain in place, Greece cannot regain its fiscal independence unless they massively raise taxes. That, in turn, would be like begging for an even deeper depression.
At least in the Greek case nobody is blaming the Klingon High Council for their bad economic situation. But unless the Europeans step up to the plate and take responsibility for their own economic failure, the entire continent will continue to dwell in the shadow realm between the economic wasteland and industrial poverty.
Today’s blog will be a short one, just a reminder of some vital statistics relating to the liquidity trap – an important topic now that Sweden, a non-euro member state of the EU, has joined the euro-zone in the trap.
The practical meaning of the trap is a situation where GDP is stalled – in other words the economy is stuck in a recession – and there is so much liquidity available in the economy that adding another euro (or krona) will not make any difference at all. Monetary policy is useless. That is where the euro zone is now, something that ECB leader Mario Draghi is well aware of, as he recently sent out a desperate call for help from Europe’s political leaders. He knows that monetary policy has reached the end of the road and that the only remaining options are within the realm of fiscal policy.
Despite this, Draghi continues to pump out M1 money supply into the euro zone like the recovery actually depended on it. Consider Figure 1:
Fig. 1: Quarterly growth rates. Sources: ECB and Eurostat
The blue line, depicting growth in euro-zone M1 money supply, deserves an explanation. The two growth peaks, one at the end of 2005 and one in late 2009, are largely related to the expansion of the euro zone, which went from 12 to 16 member states between 2006 and 2009. (Since then Estonia and Latvia have also joined.) If we adjust for the enlargement, money supply is fairly well in tune with GDP growth – until we get to 2012. That is when the ECB started making promises to buy any and all treasury bonds from “troubled” euro-zone countries, as well as to participate in the massive austerity programs that the EU and the IMF convinced the worst-off member states to adopt.
On top of that, the ECB decided this summer to take its interest rate to zero, and to punish banks – charge a negative interest rate – for depositing cash in overnight accounts with the ECB. This has flooded the euro zone with liquidity; if the theory behind this policy were right, we would see a major upturn in business investments and notable workforce expansion. However, we don’t see that; at best, year-over-year quarterly GDP growth rates show an economy barely struggling to stay afloat.
The inevitable – and from both a Keynesian and an Austrian viewpoint rather obvious – conclusion is that the theory behind the liquidity expansion is flawed. In fact, the ECB is playing with fire: sooner or later the massive supply of liquidity will go look for profitable investment opportunities. So long as the real sector of the economy remains essentially stagnant that search for profit will rapidly climb the speculative hills in the real estate and stock markets.
Again: welcome to life in the liquidity trap.
As awareness rises that Europe’s economy is going nowhere but down again, anxiety among the political leadership is beginning to catch up. The latest addition to the ranks of the worried is the president of the European Central Bank, Mario Draghi. At a summit with all the euro member states on October 24 he gave a speech that echoed of the panic from 2012:
European Central Bank chief Mario Draghi on Friday (24 October) gave a stark warning to eurozone leaders about the risk of a “relapse into recession” unless they agree on a “concrete timetable” of reforms and spur investments. “The eurozone is at a critical stage, the recovery has lost its momentum, confidence is declining, unemployment is high. Commitments were made but often words were not followed by deeds,” Draghi told the 18 leaders of eurozone countries who gathered for a special meeting at the end of a regular EU summit in Brussels.
He turned his presentation into a good, old show-and-tell by providing his audience with a slide show. The slides show the following:
- Quarter-on-quarter GDP growth for the euro zone is in an almost perfect state of stagnation since at least early 2012;
- Unemployment has fallen slightly in the last year, but that decline is in no way different from the decline in 2012; after that decline unemployment shot up significantly;
- Per-employee compensation growth is the lowest in ten years;
- Inflation is trending steadily downward, and will flip into economy-wide deflation within six months;
- While real GDP has remained stagnant since 2008 – with a growth index a hair below 100 – private investment has dropped to an index of 85 with no signs of growth;
- Government-sector investment has dropped even further, below growth index 80, and continues to decline.
Toward the end of Draghi’s show-and-tell session he inevitably points to euro-zone government debt and deficit ratios. Then, equally inevitably, he turned to the empty toolbox for macroeconomic solutions to the zone’s macroeconomic problems:
To get the economy growing again, Draghi said leaders should not count only on actions by the ECB, but also do their share: boost investments and implement reforms. He welcomed plans made by the new EU commission chief, Jean-Claude Juncker, to raise private and public money for €300 billion worth of investments for 2015-2017. Draghi alluded to Germany by saying that countries “with fiscal space” should boost internal demand in order to help out the rest of the eurozone.
On the one hand Draghi keeps bashing the member states for not complying with the Stability and Growth Pact debt and deficit rules; on the other hand he demands some sort of help from states in activating the economy again.
Evidently, the knowledge of macroeconomics is rather limited in the higher layers of the European political and economic leadership. That is one of the big reasons why I stand by the same forecast that I have put forward all year long: Europe is in a permanent state of economic stagnation – and there is only one way out of it.