In recent months desperate Eurocrats have tried to talk up the European economy. They have predicted that austerity is over, that growth is returning and that hard-hit middle class families have seen the worst of it.
All along, I have pointed to the facts, which speak quite a different language. And lo and behold:
The EU economy will remain flat in 2013, EU economic affairs commissioner Olli Rehn said on Tuesday (5 November), as he downgraded the bloc’s growth forecasts for 2014 and 2015. Although the EU economy grew by 0.3 percent in the second quarter of 2013, offsetting an identical decline between January and March, the commission is not expecting any further growth in the remaining six months of the year.
That 0.3-percent growth number is incorrect, unless it is quarter-to-quarter. Eurostat’s latest quarterly GDP data tells us that measured year to year in the second quarter, the EU-27 economy did not grow at all, but contracted instead by 0.2 percent.
The euro area fared worse, contracting by 0.5 percent. Furthermore:
|GDP Growth in the EU, 2013Q2|
There are several important pieces of information in this table. To begin with, the only countries that exhibit any recovery-strength growth are small outlying states like Latvia, Lithuania and Malta, or a tiny, mono-industrial economy like Luxembourg. The engines of the European economy, namely Germany, the United Kingdom and France, are not even at one percent growth.
Seven EU states have a GDP growth rate above one percent, while nine states have a GDP that is shrinking by more than one percent. In the latter category we find the austerity-devastated states on the southern rim: Spain, Portugal, Italy, Greece and Cyprus.
The Greek GDP loss is currently at a rate of 3.8 percent per year, on top of the 25 percent they have lost since the crisis began. That country is nothing short of a macroeconomic horror story.
With these observations, let us get back to the EU Observer story:
Rehn said all 28 of the EU’s member states would achieve economic growth by 2015. He said the European economy had “reached a turning point” although he cautioned that “it is too early to declare victory: unemployment remains at unacceptably high levels.”
That is an understatement, especially when it comes to youth unemployment which is at or above 20 percent in 20 EU member states. Over the past year youth unemployment has grown in 14 EU states and remained constant or fallen in 14 others (including rookie member Croatia). The average change in the first group is an increase of 2.75 percent while the average reduction rate in the second group is 1.95 percent.
These numbers will not get better until the European economy is back in growth mode. Consider this figure and its clear message on the correlation between growth and youth unemployment:
The fact that the EU Commission is now downgrading its growth forecast for 2014 and 2015 is a big reason to worry what is coming ahead. If there will be no substantial trend change for the better in terms of youth unemployment, Europe is going to lose its young. Period. By 2015 this crisis will be seven years old, going on its eighth year. With just a little bit of bad luck it might outdo the 1930s as the economically most devastating period in modern history.
Two days ago I reported on France’s rising unemployment and the potential for a large-scale repetition of the Greek crisis. I concluded that so long as the French economy continues to lose up to one percent of its taxpayers to unemployment every year, the government does not stand a chance at balancing its budget. Any attempts at doing so will one way or the other set a downward macroeconomic spiral in motion that, as Greece has demonstrated, can continue to the next Big Bang.
Unlike its southern neighbor Spain, France still has time to save itself from the Greek tragedy. However, their room to take appropriate action is limited by three factors:
1. The mere size of government as it is today heavily stifles private entrepreneurship. Even if the French government did nothing from hereon to try to balance its budget, the French economy would have a long, slow and frail journey to growth, full employment and rising prosperity. This makes it very difficult to defend continuing EU-imposed budget-balancing measures.
2. The socialist ideology of President Hollande, the prime minister and his cabinet prevents the current French government from thinking clearly about alternatives to big-government intervention whenever there is a problem. Since the only sustainable path out of France’s crisis goes through reforms to reduce the size of government, the people that French voters elected to lead the country are ideologically predisposed to reject such a solution. Even if they tried to develop the right kind of solutions it is highly unlikely that they would get very far before their voters, party grassroots and left-leaning media would cry foul and call them ideological hypocrites. Unfortunately, that alone can be a strong deterrent against the right kind of reforms.
3. A rescue plan to have France evade the Greek dungeon would require that most of the rest of the euro-area economy is in reasonably good shape.
Even if lightning struck twice and the French socialists managed to get their act together, the third condition will stand in their way like a concrete road block. Made in Germany. Behold this report from the EU Observer:
In December 2012, leaders from 25 EU countries all signed up to a pact championed by German Chancellor Angela Merkel. The so-called fiscal compact is supposed to discipline countries into spending within their means and reducing their budget deficits and overall debt. In Germany, the “debt brake” will fully come into force in 2019, when the federal state and the regions (laender) are legally bound to stop making new debt.
This is a charade of royal proportions. The EU has had a ban on member-state debt beyond three percent of GDP since 1992, Effectively, the Stability and Growth Pact, which has been in place over two decades now, has made “excessive” debt illegal. As we all know, that has not prevented EU member states from building excessive debt. But that does not prevent the Eurocracy from making what is already illegal, really illegal.
Back to the EU Observer, which reports some worrying signs from inside the German government conglomerate:
Germany is in a much better position when it comes to deficits and debts than its southern neighbours. But still the federal government currently has a debt running at 75 percent of the gross domestic product – above the 60 percent threshold enshrined in EU rules. But in the multi-layered German state, cities fear it will be they who will ultimately foot the bill for Germany’s exemplary balance sheet.
This is crucial:
Ulrich Maly, the mayor of Nuremberg, told journalists in Berlin on Tueday (1 October) that more and more tasks are being moved from federal and regional to the local level, but without any extra funding. … As head of the association representing 3,400 German towns and cities, Maly tabled a series of requests to the upcoming German government, warning of the unfair burden being placed on townhalls in reducing the country’s budget deficit and debt.
Let’s take this in slow motion. The federal government creates a welfare state, then asks states and local governments to participate in the execution of the welfare state’s entitlement programs. To encourage full participation from lower jurisdictions the federal government sends them money. States and local governments get used to the cash and think nothing more of it. Until the day comes when the federal government has made more spending promises than its taxpayers can afford.
All of a sudden the federal government has to make choice:
a) Do they raise taxes? or
b) Do they reduce spending?
The German government tried alternative (a) but tax-paying voters put an end to that. That is in no way surprising, and incumbent prime minister Angela Merkel is trying hard to avoid tax hikes. But choosing alternative (b) is tougher than one might think. Merkel could just slash spending across the board, but if she did she would be accused of wanting to dismantle the German welfare state. That is a battle she does not want to take, probably because she – like most of today’s European “conservatives” – has embraced the welfare state and wants to keep it.
Merkel avoids a battle over the welfare state if she can come across as not cutting any entitlement programs. But since the entitlement programs are the cost drivers for the German government – just as they are for any welfare-state government – she cannot fend off the deficit wolves without somehow reducing the cost of those same entitlements.
Her solution: pass on more obligations to local governments, so the federal government does not have worry about them. But don’t increase spending – have the cities do more with the same or even less money. That way you look like you are protecting the welfare state while also balancing the federal budget.
Does this seem cynical? Understandable. After all, it is cynical. But this is the way politics works when our elected officials set up policy goals that are entirely incompatible, and where the pursuit of one goal, such as the welfare state, hampers the pursuit of another goal, in this case the balanced budget.
This does not stop Merkel’s political opponents from exploiting the apparent inconsistency in her policies. The EU Observer again:
With social expenditure – such as for the integration of disabled people or kindergardens [sic] – taking up over half of cities’ budgets, the question will be “what kind of country do we want,” the Social Democrat said. ”The debt brake will put political choices in the spotlight. It will be a question of what we can still afford if we’re supposed to make no new debt. Do we want inclusion of disabled people – which will cost several billion euros – or do we abandon this human right?”
This would be the perfect point to explain to the German people that not even their economy can carry the welfare state any farther. The addition of new entitlements on the top of already existing ones, while people expect existing entitlements to grow, is a formidably bad idea. It goes to show that to the statist there is no such thing as a government big enough.
But it also goes to show how illiterate the backers of the welfare state actually are when it comes to basic macroeconomics. They choose to believe whatever they need to believe in order to motivate a sustained, even growing, welfare state.
And just to show how desperate the situation is getting in Germany, the EU Observer introduces us to…
Eva Lohse, a member of Merkel’s Christian Democratic Union and mayor of Ludwigshafen, … [Lohse] warned that the townhall has virtually no money left for infrastructure projects. ”Reducing deficits and debt actually means that somebody else is doing it, not that the task is gone. So whoever does it also needs to have the proper funding for it. We have bridges crumbling down in the middle of our towns – this is unacceptable,” Lohse said.
In effect, there is a glaring lack of understanding of basic macroeconomics on both sides of the ideological aisle in German politics. This lack of insight will delay or entirely rule out appropriate policy solutions. Both the “conservatives” and the social-democrats in Germany will continue to try and preserve the welfare state while balancing the budget in the midst of zero or negative GDP growth. This is a recipe for decline, putting Germany in the same category of struggling welfare states as France, namely one step behind Spain and two steps behind Greece.
Germany still enjoys a lot of economic strength, but with the country’s fiscal policy makers focused on the unworkable combination of the welfare state and a balanced budget that strength can evaporate quickly. Right now, the case for German economic decline is actually stronger than the case for Germany economic recovery. And with German economic decline other euro-zone countries are in grave danger. Greece and Spain won’t get more bailouts, and France and other less-disaster-stricken economies will not have the same strong support anymore from trade with Germany as they have had historically.
Inevitably, our conclusion from this must be that Europe is continuing its slide into the cold, dark dungeon of industrial poverty.
As I have reported recently, the European crisis is still cooking. Despite five years of austerity, deficits have not gone away. They are so persistent, in fact, that the European Central Bank has been forced to create an unlimited bond buyback program for troubled welfare states: whatever amounts of Greek, Italian, Spanish, Portuguese or any other euro-denominated Treasury bond anyone wants to sell, the ECB promises to buy them without the buyer losing any money.
This program is not making the welfare-state debt crisis easier, but worsening it. Its ultimate consequence could be high and persistent inflation; in order to see why, let us begin with acknowledging another consequence, namely that you can now buy 100,000 euros worth of ten-year Greek Treasury bonds, get 10,290 euros in interest over a year and then be guaranteed to get your money back as if you had bought a Swiss Treasury bond at 1.09 percent. Two weeks ago I explained the potential consequences of this bond buyback program:
In short: there will come a point when the international bond market will test the ECB’s cash-for-bonds promise. Just to give an idea of how much money the ECB could be forced to print, here is a list of government debt by the most troubled euro zone countries: Government debt 2012
Italy 1,988 bn
Ireland 192 bn
France 1,833 bn
Spain 884 bn
Portugal 204 bn
TOTAL 5,101 bn
Greece, notably, does not report its government debt to Eurostat. Nevertheless, here alone we are talking about five trillion euros worth of government debt. If the ECB had to execute on its bonds buyback program for only ten percent of that, it would have to rapidly print 500 billion euros. To put this in perspective, according to the latest monetary statistical report from the ECB, M-1 money supply in the euro zone is 5.3 trillion euros. Of this, 884 billion euros is currency in circulation while the rest is overnight deposits. If the ECB had to print money to meet a run on the bonds in the countries listed above, it would find itself having to expand the M-1 money supply by up to ten percent in a very short time window (theoretically over night). This is to be compared to the 7.7 average annual growth rate of M-1 in May, June and July of 2013.
For all you statists out there, this means increasing growth in M-1 money supply from 7.7 percent to 17.7 percent. By comparison, the Federal Reserve has increased the U.S. M-1 money supply by an average of 11.5 percent per year over the past 12 months (measured month past year to month current year). The growth rate has dropped in recent months, though, falling to 9.1 percent in August.
A temporary boost in euro money supply to stave off a run-on-the-Treasury wave of bond sales would hurl the euro boat into very rocky waters for some time, but if the buyback program really works as intended, the relentless cash pumping by the ECB will eventually calm things down. The problem for the ECB – just as for the Federal Reserve – is that it is a lot harder to reduce money supply than to increase it. Basically, once the cash is out there in private hands, people are not voluntarily going to give it back to the government.
That is, if the buyback program works as intended. It is a very risky program, especially if it would be extended to other euro-zone countries as well. France alone has 1.8 trillion euros in debt, and even though they are technically not covered by the bond buyback program at this time, they could be the next link in the euro chain to come under stress. Their ridiculous tax policies of late will guarantee very weak GDP performance in the next couple of years. I would be very surprised, frankly, if the French economy manages to grow, on average, in 2013 and 2014.
With zero GDP growth, or worse, tax revenues will not grow as the French government intended. They are still wrestling with a deficit – their taxpayers simply cannot keep up with the cost of the welfare state – and with the new, socialist-imposed extra tax burden that deficit is going to be even more persistent.
Since president Hollande and his socialst cohorts in the French National Assembly have pledged to end austerity, they have opened the door for more government spending. This obviously adds insult to injury for an economy already under great stress. It is therefore increasingly likely that the ECB will have to extend its bond buyback program to cover frog-issued bonds as well.
Given the size of the French economy, and debt, this would put the buyback program to the test. Not immediately, but eventually. Today France is paying lower interest rates on its national debt than the United States, but the trend is upward. After almost two years of declining interest rate costs, early this year the trend shifted direction. Interest rates have been going up since February of this year, and the ten-year French Treasury bond now pays almost a half a percent more than it did this past spring.
When the Spanish government started having problems with selling its bonds, it had to increase the interest rate from four to six percent in less than a year. That is a 50-percent spike in the yield demanded by investors, and at the time back in 2011 it took both the ECB and the Spanish government by surprise. Let’s hope no one is surprised if France finds itself in a similar situation 12-18 months from now.
If the ECB thus finds itself saddled with the responsibility to – at least in theory – have cash ready for almost seven trillion euros worth of government debt, it will have to abandon its prime goal, namely price stability. While the United States has proven that you can increase money supply five, six even eight times faster than GDP without causing high inflation, this does not mean that there is no inflation threat attached to money printing. However,
- if the freshly printed money goes out to the private sector in the form of reckless lending – as in China – then there is an inflation price to pay (the Chinese are looking at six or more percent inflation this year); or
- if the fresh new cash goes into the hands of entitlement recipients, thus feeding private consumption without a corresponding increase in private productive activity,
then high, persistent inflation is knocking on the door.
If the ECB starts buying back Treasury bonds en masse, the latter effect could kick in:
1. Troubled governments know that the ECB will guarantee their bonds, thus significantly reducing their incentives to shrink their deficits;
2. The ECB has attached austerity demands to the buyback program, but those demands have proven totally ineffective against government deficits, thus practically voiding those austerity demands of meaning;
3. Persistent, high and socially stressful unemployment has shifted the fiscal balance in troubled welfare states on a permanent basis, with fewer taxpayers and more entitlement takers; in order to maintain political and social stability national politicians will avoid more cuts in the welfare state;
4. As the welfare state’s spending programs remain and more people join them as a result of the economic crisis, government spending will rise while tax revenues are stalled or even decline.
By allowing an increasing share of the population to live on entitlements, Europe’s troubled welfare-state governments will create an imbalance between productive and improductive economic activity strong enough to drive up inflation.
Add to this the imported inflation that inevitably comes in from other countries when the ECB’s new, massive money supply eventually weakens the currency.
The involvement of the ECB in trying to keep Europe’s welfare states afloat is troubling for many reasons. The prospect of the bond buyback program bringing about inflation is not a very healthy one. But for every year that goes by without the EU doing anything to reform away its welfare states, the scenario outline here, which is somewhat speculative today, moves closer and closer to becoming reality.
I have been warning for a long time that Europe is in long-term decline, losing its position alongside North America, Australia and North East Asia as the world’s most prosperous regions. I have warned that Europe is turning into an economic wasteland and explained that nothing is going to change so long as the governments of Europe’s welfare states continue to use austerity to defend their big, redistributive entitlement systems.
This trend of stagnation and decline is not new to the current economic crisis – in some countries it began showing itself as early as the 1980s – but the last five years have put enough nails in Europe’s prosperity coffin to transform the continent into a new South America.
I have been pointing to this serious, structural decline for almost two years now. So far, my warnings have not been heard very widely, but now some people are beginning to see the same pattern. One example is Dan Steinbock, research director at the India, China and America Institute, who just published an opinion piece in the EU Observer. He starts out with a somewhat hopeful observation:
The second quarter GDP figures for the Euro-area economies indicated growth, for the first time in 18 months. Some fund managers and market observers argue that positive new developments could unleash a long-term rally for the continent.
And those fund managers are wrong. Taxes have gone up and government spending has gone down. The private sector has to replace what government is no longer spending money on, with higher-taxed incomes, while still maintaining all its other spending. How is that a recipe for a “long-term rally”?
Steinbock seems to want to agree, at least in part, with the fund managers:
While there are some signs of possible recovery, Europe’s debt crisis has not gone away. … The US economy may soon be ready for a gradual, multi-year exit from QE. Southern Europe certainly is not. And yet, current forecasts portray 2013 as the magical year when everything will turn for the better.
Go back and look at forecasts over the past 3-4 years. Eurostat, OECD and others have consistently been over-optimistic as to where the European economy was heading. The main reason is that they think austerity is good for the economy. So long as they believe that they are going to continue to portray every “next year” as the one where the flowers start blooming again in Europe.
The reason why economists continue to miss the forecasting mark is that they have not done their theoretical homework. They know how to run all kinds of regressions, up and down, sideways, inside out, even in zero gravity, but they treat the economic system as mechanical pieces in hydraulic interaction, not the complex social, cultural and moral system it really is.
In the past year or so, the backlash against austerity in Southern Europe has resulted in policy shifts, which, in turn, have supported greater stability, less severe contractions and an improved sentiment across the region. None of these gains indicate a major turnaround, but alleviation of single-minded austerity measures that have added to European challenges.
Again, he is too optimistic. The Greeks are still pushing more austerity measures, and Portugal is in political turmoil over more austerity. Not to mention France – which Steinbock does:
Despite the shift from the conservative Sarkozy to the socialist François Hollande, the competitiveness of France continues to erode. While Paris is slowly moving toward reforms, it is lingering in contraction and can hope for weak growth in 2014, at best.
May I recommend this article, which I published two days ago.
Back to Steinbock, who continues his somewhat optimistic review before eventually turning pessimistic:
Italy has been ridden by contraction for nine consecutive quarters. Enrico Letta’s government has been strong enough to stay in power, but too weak to achieve major changes. The more flexible approach to austerity across the Eurozone has benefited Italy and may allow Rome’s exit from the excessive deficit procedure (EDP) in 2014. But Italy suffers from structural challenges, which translate to continued decline of industrial production and the end of the Letta government by 2014. After half a decade of recession, Spanish conditions are now bad but not devastating, as the austerity obsession has given way to more realistic policies. … In Portugal, the recession will continue until 2014, which means that unemployment will remain close to 20 percent. In July, the resignation of two ministers led to a new cabinet. Greater flexibility in austerity measures and rising sentiment are softening the contraction impact.
Let’s not get ahead of ourselves here. The prime fiscal policy directive in Europe, and especially in Spain, Portugal, Italy, France and Greece, is still to balance that pesky government budget. This means that all other policy goals, such as growth in GDP, reduced unemployment or increased private consumption, are ranked below that goal. Every policy measure is evaluated first and foremost on its potential for bringing down the deficit, and only secondarily on whether or not it can help the economy grow.
Whatever leniency Steinbock is detecting in terms of austerity is more political trickery than signs of a real change in fiscal policy. This means that the economies in Southern Europe will still be under great pressure.
Steinbock then turns to Greece, which, he says…
will be in recession well over the mid-2010s, despite additional funding by Brussels. Unemployment is over 26 percent. Political turmoil is likely to increase toward 2013/2014. A government collapse could pave way to the radical left coalition Syriza, as the leading political party.
Probably. But don’t disregard the possibility that Golden Dawn will team up with the Greek military and force an equally radical political change onto the country.
And now for the more pessimistic, bigger view of the Lost Continent:
[The] Eurozone is suffering a lost decade, which could have been avoided with more sensible policies. During the past half a decade, prosperity levels, as measured by per capita incomes, have stagnated or fallen across Southern Europe. In this way, they have amplified the historical trend line. … By the end of the 2010s, a new hierarchy will prevail in Southern Europe. In France, per capita income is likely to be slightly behind that of Germany. In turn, income per capita in Italy (80% of French GDP per capita) and Spain (70%) will fall behind. Before the global recession, prosperity levels in Greece and Spain were not that different. However, the past half a decade has been devastating in Greece. By the end of the 2010s, Greek per capita income will be close to that in Portugal. In these two countries, prosperity will be barely half of that in France.
This is a bit vague, as Steinbock does not explicitly define the term “prosperity”. It appears to be per-capita GDP, in which case it makes a great deal of sense to compare countries. However, even more important than the relative growth in GDP is the performance of each country: the Greek loss of 25 percent of its GDP in a matter of a few years is completely devastating and unheard of in the Post-World War II industrialized world. It is examples like Greece that can teach us something about what we should and should not try to do to fix an economic crisis.
Steinbock’s main point, again, is that economists are overly optimistic in forecasting Europe’s future. This is a point worth repeating, and the consequences of erroneous forecasts definitely deserve a mention:
At Brussels, the current forecasts – including projections of per capita income, debt, unemployment – are predicated on the idea that 2013 is the year of the great turnaround, when debt will start to decline, recovery will broaden, per capita incomes will climb and high unemployment rates are expected to decrease by some 20 percent by 2018. These gains are anticipated, even despite the impact of aging populations on productivity and growth, and thus on prosperity. In reality, Southern Europe is coping with long-term erosion, which has been compounded by excessive reliance on austerity, at the expense of fiscal support, pro-growth policies and structural reforms. There is no easy way out anymore.
That is entirely correct. The solution lies in those “structural reforms”, the most important of which means dismantling the welfare state – it is the only way out of the prosperity shadow-realm where Europe now finds itself.
The latest economic data out of Greece spell more trouble for the country. The Greek news site Ekathimerini reports:
Greece’s economy shrank by 4.6 percent of gross domestic product in the second quarter of 2013, the Hellenic Statistical Authority (ELSTAT) said on Monday. This was the 20th consecutive quarter of negative growth for Greece. The economy had contracted by 5.6 percent in the first quarter.
Technically this means that economic activity grew in the second quarter. But all that is needed for an upswing is increased tourism during the summer season. There is nothing wrong with that, especially in a country like Greece where tourism is a big industry. But it is very difficult for a country to pull itself out of a deep recession – or on this case a depression – by relying on foreign visitors. There has to be domestic economic activity as well; as a sign of how unlikely that is to happen, the Greek statistics agency ELSTAT reports that construction has fallen by 50 percent – in one year.
More likely, the depression of the Greek economy will continue. A major reason is that the government is still using austerity measures to try to close the budget gap. As always, the immediate result of new austerity is indeed an improved budget balance, which Ekathimerini reports that Greece is enjoying right now:
Earlier, there was more encouraging news for the government on the fiscal front. Alternate Finance Minister Christos Staikouras said Greece’s central government achieved a primary budget surplus of 2.6 billion euros, or 1.4 percent of GDP, in the first seven months of 2013 against a target for a primary deficit of 3.1 billion euros, The reading for January to July excludes interest payments and the budgets of local government and social security funds.
In other words, it is a statistically convenient figure to present. It is a safe bet that the social security funds are running big deficits. If they are, there is yet more trouble coming down the pike for Greek taxpayers.
As a hint of that, enjoy this little story from Euractiv:
German opposition parties accused Chancellor Angela Merkel yesterday (11 August) of lying before elections next month about the risks of a new bailout for Greece, after a magazine reported the Bundesbank expects it will need more European aid in early 2014. Der Spiegel quoted an internal document prepared by the German central bank as saying that Europe “will certainly agree a new aid programme for Greece” by early next year at the latest.
How about that! Another truck load of taxpayers’ money dipped into the black hole known as the Greek welfare state.
This means two things. First, Bundesbank already has the architecture in place for another effort to plug the hole in the Titanic with chewing gum. Secondly, knowing as they do what is happening behind the scenes in the Greek economy, the Bundesbank is convinced that the trend from the last few years will continue on a steady downward trajectory. Any attempt by some media to spin today’s GDP and budget numbers in a positive direction will fall flat to the ground.
We have never before witnessed a modern, industrialized economy in macroeconomic free-fall like the situation Greece is in today. This makes it very difficult to predict when this process will end, and how. But we do know one thing: so long as Brussels forces the Greek government to continue with destructive austerity policies, there will always be enough fuel for yet another round of GDP contraction.
After years and years of bone-crushing austerity; after having lost 25 percent of its GDP; with six out of ten young and three out of ten of all workers unemployed; you’d think Greece would be out of its crisis, right? That is, if austerity was the right kind of medicine for their crisis.
That is a pretty big “if”, and it grows bigger for every year. As I have reported repeatedly, austerity is not the right medicine for the European crisis in general, and certainly not the right remedy for Greece. It has now been five years since the crisis broke out, and nowhere in Europe has a government been more devoted to spending cuts and tax hikes than in Greece (with the exception, perhaps, of Sweden in the ’90s). Alas, as the English-speaking Greek news site Ekathimerini reports, the result is a still-uncontrollable budget deficit:
Greece will not be able to return to bond markets next year to help plug an estimated 11-billion-euro financing gap that will start to open up, market sources said this week, contrary to earlier suggestions from the government and its European partners.
Greece has not been able to sell its treasury bonds on the open market for a long time. Its bonds were tossed on the financial junk yard more than a year ago when the country de facto – though not formally – went into bankruptcy. The EU-IMF-ECB troika rescued the Greek government with cash loans and demanded a continuation of austerity. They believed that such measures would reassure the bond market enough to let Greece return as a credible borrower.
The problem is that Greece has not accomplished any of the objectives sought by means of austerity:
- GDP growth forecast, adjusted for inflation, for 2013 and 3014 is -1.2 percent and -0.4 percent, respectively;
- Private consumption is expected to decline by the same numbers;
- From 2009 to 2012, government revenue increased as share of GDP from 38 to 45 percent of GDP, yet during the same time government spending has remained at 54-55 percent of GDP;
- In 2012 the Greek budget deficit was at ten percent of GDP for the third year in a row.
The fact that Greece has not seen a decline in government spending as share of GDP is sometimes taken as an indicator that they have not made any serious efforts at cutting spending. But they have, as data for government consumption shows. Here are the changes in percent, adjusted for inflation, in government consumption from 2010, including forecasts for 2013 and 2014:
There are two reasons why, despite these numbers, government spending does not fall as a share of GDP. The first is plain macroeconomics: even though government spending is the most inefficient way to get anything done in our economy, it is an indisputable fact that government-funded hospitals, schools and other services do produce some services. When we cut those services we also cut the number of people on payroll, the purchases of inputs (think medical instruments for hospitals and food for school cafeterias) and spending on other, related items. These cuts are felt, especially by local economies, where small businesses lose some demand and thus have to shrink their activities.
The second and more important reason is that the other part of government spending, namely financial transactions (welfare, unemployment benefits and similar income-security items), actually increases when the economy is in a decline phase. As people lose their jobs they go from being paid for work to being paid not to work. People who are paid for work, whether private or public employees, spend money in their local communities, pay taxes on their consumption and property, etc. Unemployed people spend a lot less (unless unemployment benefits cover 100 percent of your previous income which I don’t think is the case anywhere in the free world) and typically pay no income taxes on the benefits they receive.
In other words, as unemployment goes up government has to spend more money through its cash entitlement programs. This is one big reason why the Greek government is unable to close its budget deficit. It is also a major reason why there is again, as Ekathimerini reports, rising desperation in Europe over the black hole also known as the Greek government budget:
With pressure mounting on eurozone officials to find a solution to the 4.4-billion-euro shortfall the International Monetary Fund projects will kick in from August 2014, and widen by a further 6.5 billion euros in 2015, more debt relief now seems all but inevitable for Athens. “The troika will not likely be able to avoid new bailout discussions before the end of 2014 in order to plug the gaps, and is very likely to decide on an extension,” said Barclays in a research note. “We do not see how Greece could possibly return to the markets next year, even if recent developments have been very positive.”
Again: the troika has failed in achieving any of the objectives behind its relentless austerity policies.
As if to highlight the desperation mounting over the Greek economy:
European Union officials – who believe the size of the gap next year is somewhat smaller at 3.8 billion euros – see the issuance of short-term bonds as an option to make up the shortfall, alongside utilizing unused funds earmarked for the country’s bank recapitalizations and/or new loans. Bankers, however, say the country will struggle to convince investors to buy its bonds, especially given that further restructurings are not out of the question.
By “restructuring” they mean debt write-downs. Or, in plain English: the borrower unilaterally declares that today he owes his creditors less than he did yesterday.
But the threat of a new debt write-down is not the only problem in the way of utilizing the bank recapitalization funds. Many Greek banks are not in a shape to absorb the loss of recapitalization funds, and the reason has to do with the country’s terrible real-estate market. Behold another article at Ekathimerini:
Government and opposition MPs have reacted to suggestions that the coalition is considering lifting the restrictions on the repossession and auctioning of people’s main residence if they are not able to keep up mortgage repayments. Repossessions have been suspended in Greece since 2008. It is thought that the sale of some 200,000 homes has been prevented so far.
That is 200,000 homes that banks have invested money in – money that they in turn borrowed from someone. While the banks have to pay their loans back, mortgage defaulters are not paying them, and when the banks are prevented from selling the defaulters’ houses they lose big money. The banks, which lost enormous amounts on the government debt write-down, are slowly but steadily bleeding to death. Without recapitalization and without access to its assets on the real estate market they will inevitably go the way Titanic did.
As Ekathimerini explains, there seems to be little understanding of the exceptional consequences of a full-scale bank collapse in Greece:
Deputy Development Minister Thanasis Skordas suggested on Thursday that there could be a partial lifting on the ban from next year … New Democracy MP Sofia Voultepsi said there was no way she would discuss the auctioning of reposed [sic] homes. [Social Democrat party] PASOK deputy Paris Koukoulopous said Parliament would never accept such a measure. Opposition parties also raised concerns about the possibility of such a measure being introduced.
Long story short, the situation in Greece is as bad as it has ever been during the current economic crisis. The EU has failed to provide adequate help, the Greek governmetn is on i ts last straw of popular credibility and the banking sector is destined for collapse.
So long as Greece remains in the EU and the euro zone its government will be forced to continue to depress the economy with the same kind of measures that have turned the country into an economic wasteland. So long it continues with its austerity policies, the Greek government is undermining the last few pillars of support among the Greek people for the parliamentary system of government. Last year four in ten voters supported more or less totalitarian parties, which opens a frightening perspective on what may very well happen if the country does not very soon regain its fiscal and monetary freedom.
A quick note today on the systemic design errors in Europe’s fiscal and monetary policies.
The new narrative in Brussels is that the common currency of the euro zone needs more support from GDP growth in order to remain a strong, credible player in the global economy. The implication is that the recent drop in support for the euro is due to the deep recession. If this is indeed what the Eurocrats really believe, then they have woken up very late to smell the coffee: they themselves are responsible for turning a regular economic recession into a depression-style crisis. Without the austerity madness that Brussels has added to the mix the economic downturn that began in 2008 would have been over by 2011.
But we will never see a full mea culpa from the Eurocracy. All they can muster is to turn down the austerity volume a little bit. British Daily Express reports:
Some EU member states were urged to ease the pace of their spending cuts in a fresh attempt at boosting the struggling single currency. Spain, Portugal, Poland, Slovenia and the Netherlands were all given more time to complete their austerity drives by the European Commission. Strong fears about the continuing recession in France were also raised. The French government was given an extra two years to bring down its budget deficit.
GDP growth is a necessary condition for the elimination of a budget deficit. Austerity stifles growth, because it increases the net cost of government to the private sector. Businesses and families have less money to spend which means they will do whatever they can to reduce their economic activity. The goal is to survive until times get better and they can start improving their lives again.
The problem is that with austerity, times never get better. That long run over which things are supposed to get better never comes to an end. There are numerous examples in Europe of countries that have seen GDP growth disappear because of austerity, but there is no example of a country where austerity has done its intended work and growth has returned.
Therefore, if this is what the leaders of the European Union and the European Central Bank are looking for in order to strengthen the euro, they won’t find it and they won’t strengthen the euro. On the contrary, there is an inherent inconsistency between the euro and the EU constitution that is supposed to support it. One feature of the constitution is the so called Stability and Growth Pact, a series of fiscal-policy rules that impose tight restrictions on the budgets of all EU member states. The Pact is the legislative vehicle that the EU Commission rides on when it imposes austerity policies on member states, policies that are supposed to support and strengthen the euro. But the euro is not strengthened by austerity – it is weakened.
Europe’s economy won’t get better so long as they keep the euro, but a recovery is also prevented by the Stability and Growth Pact. The Pact, in turn, enforces anti-growth fiscal policies that have already cost the European economy tens of millions of jobs.
If this looks like a gigantic systemic error, that is because it is a gigantic systemic error. I am working on an article to elaborate on it, which I hope to have finished in a couple of weeks. Stay tuned.
On April 24 I reported that the chairman of the European Commission, Jose Manuel Barroso, was going out and about telling Europe and the world that years of crippling austerity policies were coming to an end. I warned against believing him, especially because the EU was unrelenting in its demands on member states with budget problems to stick to austerity programs.
My warning still stands, for a number of reasons I will outline below. There is growing evidence, though, that the Commission is trying to divest itself of austerity, and the reason is ostensibly that they have come to realize that austerity has become politically toxic. But this does not mean they have abandoned the economic thinking behind austerity, only that they have decided to dress it in new political attire.
A report from Euractiv explains what the Commission now wants for Europe:
The European Commission will further shift the EU’s policy focus from austerity to structural reforms to revive growth when it presents economic recommendations for each member state tomorrow (29 May), officials said. In its annual assessment as guardian of the EU’s budget rules, the Commission will say that while fiscal consolidation should continue, its pace can be slower now that a degree of investor confidence in the euro has been restored.
First of all, investors are more pessimistic about Europe now than they were before the austerity campaign began. This means, among other things, that they believe that either will austerity continue or its effects will linger on in the European economy for a long time to come.
Secondly, the only reason why there seems to be restored confidence in the euro is that the ECB has artificially propped up the value of the treasury bonds of troubled states. The ECB has de facto pledged to buy up every single treasury bond from Greece, Spain, Italy and Portugal. In other words, the confidence is not in the currency but in the short-term soundness of owning Greek, Spanish and Portuguese treasury bonds.
It is really very simple. Normally, investors who lose confidence in, e.g., a treasury bond would demand a very high interest rate to even consider buying it. This drove the interest rate on Spanish treasury bonds up north of seven percent, a rate that means the bond is teetering on the edge of the financial junk yard. At that point, only the boldest investors put any substantial money into it.
Then came the ECB and its guarantee to buy back bonds – in theory an unlimited amount – from anyone who owns Spanish, Italian, Portuguese or Greek bonds. (Technically the guarantee was more limited than that, but the expectation quickly spread that it would apply to all troubled euro countries.) Needless to say, investors suddenly saw a practically unprecedented opportunity to make some really big money: seven percent return on treasury bonds with a 100-percent buyback guarantee.
In order to avail themselves of this unique opportunity, investors had to buy euros. The rise in demand for the money give-away party hosted by governments in southern Europe meant that more people needed more euros. The decline in the euro’s exchange rate stopped and the currency suddenly looked stable.
That is, in a nutshell, what happened in 2012 and early 2013. It is a sordid story, and the political cynicism in it is only reinforced by the fact that the European Commission is using it as an excuse to try to get out of its commitment to austerity. But as we shall see, it is wise not to believe them.
Because highly indebted governments cannot afford to kickstart growth through public spending, they must reform the way their economies are run – by making labour markets more flexible or by opening up product and services markets. ”The main message will be that the emphasis is shifting to structural reforms from austerity,” one senior EU official said. The recommendations, once approved by EU leaders at a summit in late June, will become binding and are expected to influence how national budgets are drafted for 2014 and onwards.
Let us put aside for a moment the ridiculous notion that government spending is a good kick-starter of economic growth. When the EU Commission talks about structural reforms it means deregulation of markets. This may sound like a big leap in the direction of economic freedom, but it really isn’t. Deregulation is always good, but it cannot do the trick on its own. Deregulation of the labor market is Euro-speak for loosening up hire-and-fire laws, thus making it easier for employers to take on workers without a life-long commitment.
This would make a difference for the better, if employers were screaming for more workers. But the reason why there is not more job creation in Europe is not that hire-and-fire laws are in the way of job creation – the reason is that private employers do not see their sales go up. On the contrary, in many countries the private sector is stagnant; the entire economy for the euro area is expected to grow by a microscopic 0.1 percent this year. This translates directly into stand-still sales for millions of businesses, large and small, across Europe.
Why take on more employers when there is no new business for them to take care of?
The other deregulation effort mentioned above is to increase competition on regular consumer-product markets. The idea is to drive prices down, thus give people’s real wages a boost and thereby encourage more consumer spending.
This structural reform could have substantial effects. I remember reading a study back in graduate school (about 1998 or ’99) that showed that disposable income of Danish households was 20 percent higher than otherwise thanks to deregulation efforts a decade earlier. I am not going to vouch for the results of this study as I don’t have it available, but economic theory rather clearly supports the notion that a high degree of competition on consumer markets is good for the economy.
However, once again we run into the problem of a stagnant economy. The Danish economy was thriving back in the ’90s, which made it easy to reap the harvests of deregulation. This does not mean you should not deregulate in a deep recession, but I would caution against believing in this as the sword that will solve the Gordian knot. It takes longer for competition to affect prices in a stagnant market than in a growing market: a stagnant market does not invite nearly as many new sellers as a market characterized by growing sales. It takes longer to recover the costs of investing in sales infrastructure and in establishing a market brand on a stagnant market, compared to one that is booming.
It is therefore safe to conclude that deregulation, while welcome, will have little positive effect on the European economy.
Which brings us back to the austerity issue. I suspect that the EU Commission is basing its deregulation proposals on some glossy forecast of growth. That growth in turn will, they think, grow the tax base and boost government revenues, which in turn will eliminate budget deficits and make austerity redundant.
The ten-thousand euro question, then, is: what will the EU Commission do when they discover that their deregulation efforts have not had nearly the effect they were hoping for? Let us not forget that they are still very much committed to balanced budgets in all euro-area member states (and theoretically in all other EU states as well, though not as adamantly since they have their own currencies). If tax revenues fall short of what the EU Commission needs to declare austerity cease-fire, it is as certain as Amen in church on Sunday that they will return to austerity.
Another piece of evidence to the same conclusion is the fact that they have not even abandoned austerity, just slowed down the pace at which it is being implemented. Euractiv again:
The 17 countries that share the euro will have halved the pace of budget consolidation in 2013 compared to 2012, as the overall budget deficit of the eurozone fell by 1.5% of GDP in 2012 but will only shrink a further 0.75% this year, the European Commission forecast this month. … Unless policies change the overall eurozone consolidation will be only 0.1% of GDP in 2014, the Commission said … The Commission has already indicated that it will give France, the eurozone’s second biggest economy, and Spain, the fourth largest, two extra years to bring their budget deficits below the EU ceiling of 3% of GDP, and other countries are also expected to get a year’s extension.
The flattening-out effect is probably under-estimated. The reduction in deficit-to-GDP in 2012 is the accounting-style effect of a slew of austerity programs in Spain, Greece, Italy, Portugal, the Netherlands and France. Once these programs have gone into effect – which they now have – they will start spreading their venom into the economy. Governments take more money from the private sector and give less back. Private sector activity is depressed, resulting in lower GDP growth. The tax base shrinks compared to the forecast that the EU Commission had in mind, and the deficit-to-GDP ratio starts rising again no later than 2014.
Bottom line is that the EU Commission has not given any country a pass on austerity, only some leeway to take a couple of extra years to shove the bitter pill down the throats of their voters. Austerity remains the top item on their agenda.
And just to reinforce this point, Euractiv explains that in exchange for more leeway on austerity…
both France and Spain will have to commit to broad structural and labour-market reforms intended to make their economies more competitive and help create jobs.
In other words: austerity first, then maybe some reforms to boost the tax base. If the reforms don’t work, the governments of both France and Spain will be forced back into the fiscal torture chambers again.
One final note. Nowhere in this does the EU Commission speak of structural reforms that actually reduce government spending on a permanent basis. Which makes the welfare state the elephant in the room that no one is talking about.
Except, of course, The Liberty Bullhorn. Here, on the other hand, we already have a plan for doing away with the welfare state.
Something is happening in Italy. There is a faint glimpse of hope that one of Europe’s largest countries may be seeing the end of its tyrannical austerity policies. From the EU Observer:
Italy is set to move off the EU ‘crisis list’ this week, as the European Commission acknowledges its efforts to reduce its budget deficit. EU sources indicated on Monday (27 May) that Italy will be among several countries to be taken out of an Excessive Deficit Procedure (EDP) when the European Commission delivers its verdict on national reform programmes (NRPs) and budget plans on Wednesday (29 May).
The reason for this has to do in part with the latest austerity measures, in part with policies to end those. This sounds contradictory, but bear with me.
Austerity measures have a positive effect on the budget deficit in their first year. In other words, an initial upswing for government finances is to be expected under austerity. It takes a year for people to fully adjust their economic behavior to the new austerity measures. However, once the private sector has adjusted to government’s increased net taking of its resources, it produces fewer jobs and a smaller tax base than what government calculated with when it put its austerity package to work.
The net effect is a downward adjustment of economic activity, a loss in revenue for government and increased demand for poverty-related entitlements. The budget deficit bounces up again.
However, if you shift policies from austerity to a strategy that is more friendly toward the private sector, growth in employment, consumer spending and investments will grow the tax base and continue the improvement of the government budget.
This may actually be what is happening in Italy. But first, back tot he EU Observer:
Economic affairs commissioner Olli Rehn will deliver “country-specific recommendations” for each of the 17 members of the eurozone. Italy’s budget deficit is predicted to fall to 2.9 percent in 2013 before falling to 2.5 percent in 2014 and the country once regarded as too big to fail in the eurozone is no longer top of the commission’s at risk list. However, it is expected to remain in recession in 2013 before recording a modest 0.7 percent growth rate in 2014.
In order for the budget deficit to fall by 0.4 percent of GDP from 2013 to 2014 the government budget has to run a surplus of that amount. The tax base, GDP, is expected to grow by 0.7 percent which means that spending cannot grow faster than 0.3 percent of GDP.
While it is very unlikely that spending will grow at such a small rate, it is possible for the tax base to grow faster. Italy’s new prime minister, Enrico Letta, wants to see a shift in policy from austerity, which increases the government’s net taking from the economy, to a more growth-friendly strategy:
The centrepiece of his tax pledge is the suspension of the hated property tax, known by its acronym IMU, that was imposed on primary residences by former leader Mario Monti and strenuously opposed by Mr. Berlusconi. He did not, however, vow to kill the tax. Some economists think it will ultimately be reduced or imposed only on residences above a certain value. He also said he hoped the planned hike in the value-added tax to 22 per cent from 21 per cent, another initiative of Mr. Monti, would not go ahead, and that taxes on employers – a “tax on jobs,” as he put it – would be cut. Mr. Letta is trying to gain European support for his anti-austerity, job-creation plans by visiting German Chancellor Angela Merkel and European Council President Herman Van Rompuy this week.
Not bad but not enough. Still, it is nice to see some European leaders ready to fight for common-sensical economic policies.
Then there is the mandatory short-sighted question:
How Italy will pay for these measures was left unsaid and Italy has virtually no flexibility, even though its sovereign funding costs are well below their crisis highs of 2011, when Mr. Berlusconi was effectively ousted and replaced by Mr. Monti. While Italy is not Greece, the country is in deep recession and is saddled with a ratio of debt to gross domestic product of 127 per cent, the second largest in Europe, after Greece.
It is precisely the wrong way forward to focus on how to pay for tax cuts. That notion presumes that the tax cuts will have no positive effects on the economy. If the pay-for-itself measure is about the government budget, there is little to fear. Tax cuts often pay for themselves, as was well proven in the U.S. economy during the ’80s.
If on the other hand the pay-for-itself question is related to jobs, GDP growth and a return to prosperity, there are reasons to not be as optimistic. The Italian recession is very deep and it will take a lot to put it back on a growth track again. Mr. Letta would have to pursue far bigger tax cuts than he is currently discussing.
That said, it is always better to cut taxes than to raise taxes. If the Italian government – and more importantly its buddies in the EU – can take their eyes off the government budget for a couple of years, then Italy might actually have a fighting chance to get back on track again. However, that chance would be much stronger if there was also a plan in place for structural spending-cut reforms. So far I don’t see any such plan on the horizon.
Bottom line: don’t count Italy out just yet, but don’t expect miracles from small spending cuts either.
Europe’s austerity disaster is not just a matter of reckless policy decisions by arrogant leaders in the EU, although that is ultimately where the buck stops. Many others have been involved in explicitly or implicitly, directly or indirectly, keeping the crisis going. Among them are assorted economists in various positions whose forecasts have reinforced the desires among political leaders: while the politicians want austerity to work, economists have predicted that it would work.
There is just one problem. Austerity does not work. While it has taken economists quite a while to begin to realize this, others have raised questions for some time now. Among them are business leaders: two years ago British corporate executives began expressing concern about the soundness of continuing EU-imposed austerity policies. The seeds of that doubt have grown, so much in fact that a few days ago Britain’s Chancellor of the Exchequer found it necessary to make a plea to business leaders to stay on board with Britain’s own austerity program. The Guardian reports:
George Osborne has asked business leaders to hold their nerve and continue backing the government’s austerity measures after the Bank of England gave the first signal since the financial crash of a sustained economic recovery. The chancellor told the CBI annual dinner on Wednesday night that the business community should ignore critics of his economic policy who advocate a stimulus package to spur growth and reduce unemployment. … His speech followed a series of forecasts from Threadneedle Street showing the UK recovery strengthening and inflation falling over the next three years. Sir Mervyn King said the outlook had improved, with growth likely to reach 0.5% in the second quarter of 2013, after the 0.3% registered in the first three months.
This is a good example of how the desires of politicians conspire with unrefined forecasts by economists. Anyone who reads a “strengthening recovery” into a 0.2 percent of GDP uptick in growth, from 0.3 to 0.5 percent, is either sloppy or desperate. Since the difference between 0.3 and 0.5 percent is little more than a margin-of-error change to GDP growth, I am inclined to conclude that at least some of the involved economists are sloppy.
One reason for this is that there have been forecasts of an improvement at the time of the announcement of every new austerity package in Europe over the past few years. I am planning a larger research paper to expose these errors; in the meantime, it is important to ask why economists think that the current austerity policies will have any other effect than the others that have been implemented since 2009.
More on that in a moment. It is important that we do not let the political leaders off the hook. I am firmly convinced that they are desperately looking for any sign that austerity is working – and that their desperation has reached such levels that they are inviting to a conspiracy of the desperate and the willing. It is interesting, namely, to see all the optimistic forecasts that are surfacing now. Politicians who should know better than most of us that austerity does not work, give a surprising amount of attention to those forecasts.
Their desperation is cynical yet understandable. Almost every political leader in Europe has invested his entire political career in supporting austerity. Now he is witnessing more and more critics lining up with The Liberty Bullhorn, pinning the unfolding social disaster on austerity advocates.
The obvious reaction should be to question austerity. After all, I cannot be the only one to ask how much farther the EU is willing to push its member states. For example, how much more can Greece take before the country explodes?
Europe’s leaders are no doubt aware of how close some parts of the continent are to social unrest. So long as austerity-minded politicians cannot provide people with an economic recovery, they know they are accountable for whatever happens.
As an alternative, they use forecasts of willing economists to convince people that the recovery is just about to happen, no matter how microscopic it might be. The Guardian again:
The modest improvement in output over recent months comes against a backdrop of rising unemployment, the lowest wage rises on record … According to the Office for National Statistics unemployment rose by 15,000 to 2.52m in the three months to the end of March. Wages were 0.8% higher in March than a year ago and only 0.4% better if bonuses are taken into consideration, which is the lowest rise in incomes since records began in 2001.
Again, calling this a “strengthening recovery” is clear signs of desperation. There were times when any growth under two percent set off alarm bells, among economists as well as politicians. Now, numbers a fraction as high are raised to the skies as signs of a “strengthening” recovery. From the Sydney Morning Herald:
The dogged recession across the eurozone has snared key economy France, with the latest EU figures released Wednesday [May 15] showing a full year-and-a-half of contraction as tens of millions languish in unemployment. In Brussels, French President Francois Hollande tipped ‘zero’ growth on the national level, blaming an EU-wide, German-led austerity trap — and hitting out at banks for holding back on lending as he and fellow leaders battle to unlock taxable assets hidden in offshore bank vaults or breathe life into training programmes for Europe’s disillusioned youth.
And his recipe is to take it all out in the form of higher taxes instead. Yep. That will really make things better… The fact of the matter is that France desperately needs a complete reversal of its economic policy, with long-term credibility to go with it. The same holds for the entire euro zone, which according to the Sydney Morning Herald is in deep trouble:
official figures showed a 0.2 per cent contraction between January and March, in the longest recession since the single currency bloc was established in 1999. EU data agency Eurostat said output across the 17 states that share the euro — which are home to 340 million people — fell by 1.0 per cent drop compared to the same quarter last year. France notably slid into recession with a 0.2 per cent quarter-on-quarter contraction, with unemployment already running at a 16-year high.
French president Hollande blamed the bad economic news…
on “the accumulation of austerity politics” and a “lack of liquidity” within the banking sector leading to a euro-wide loss of confidence. Fresh from winning France a two-year period of grace from the Commission to bring its public finances back within previously-understood EU targets, Hollande argued that nascent plans to divert state and private investment towards projects intended to get Europe’s youth working would make a difference.
In other words, more government programs on top of government programs that don’t work. If government was the answer, there would not be a crisis in Europe today.
Instead, as the Sydney Morning Herald reports, Europe is heading for yet more of the same, though some economists seem stubbornly unwilling to accept the permanent nature of the crisis:
Following a string of disappointing survey results in recent weeks, Ben May of London-based Capital Economics warned: “We doubt that the region is about to embark on a sustained recovery any time soon.” The latest official European Commission forecast for 2013 published earlier this month tipped a 0.4-per cent contraction, but May said that was way off course with “something closer to a two-per cent decline” likely. His firm’s pessimism was backed by Howard Archer of fellow London-based specialist analysts, IHS Global Insight. “We expect the eurozone to suffer gross domestic product (GDP) contraction of 0.7 per cent in 2013 with very gradual recovery only starting in the latter months of the year,” said Archer.
What reason does he have for expecting a recovery? This is the standard mistake that mainstream economists and econometricians make: they rely heavily on models that are inherently prone to draw the economy toward long-term full employment equilibrium. When they “inject” a change to economic activity, such as an austerity package, their model automatically makes the assumption that this sudden and uncharacteristic change – called a “shock” – will be absorbed and the economy will move on.
Every new austerity package is treated the same way, both by the econometricians who design the models and by the economists who provide the analytical framework. Their take on the European crisis is therefore a series of individual shocks, not a systemic re-shaping of the entire economy. As a result, they always predict a recovery and return to some long-term stable growth path.
To the best of my knowledge there is not a single macroeconomic model out there that has yet incorporated the systemic effects of austerity. Therefore, the economics profession will continue to make systemic forecasting mistakes – and advise politicians based on those mistakes.
Don’t get me wrong. I am not blaming economists for the errors that politicians end up making. But our profession must begin to recognize its almost chronic inability to deal with economic crises. Our forecasting methods can handle regular recessions but are frustratingly inept at dealing with situations that become inherently unstable, such as the current European disaster.
In fairness, I am not the only economist with an unequivocal criticism of austerity. On March 5, Joseph Stiglitz explained in Economywatch.com:
While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. Indeed, it will now take a decade or more to recover from the losses incurred by misguided austerity policies – a process that may eventually force Europe to let the euro die in order to save itself.
Strange conclusion. The euro is not the cause of the crisis. But Stiglitz is probably letting his ideological preferences get in the way of good economic judgment. Otherwise he would do the same analysis has I have and conclude that the crisis is caused by the welfare state.
That said, Stiglitz is eloquent in his criticism of austerity:
The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930’s. Greece’s youth unemployment rate now exceeds 60 percent, and Spain’s is above 50 percent. With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy. The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labeled as populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease.
Well said. But what alternative is Stiglitz proposing? Certainly not that the welfare state must go:
The simplistic diagnosis of Europe’s woes – that the crisis countries were living beyond their means – is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.
I don’t know where Stiglitz gets his data but here are the debt/GDP ratios for Ireland and Spain in 2003-2008:
In terms of actual euros, the general government debt in Ireland shot up by almost 84 percent from 2003 to 2008. In other words, it was only thanks to strong growth in current-price GDP that the Irish did not see their debt ratio grow faster than it did. They were expanding their government as fast as they could, and certainly more than was healthy for the economy: in 2010 the debt-to-GDP ratio had reached 87 percent, i.e., close to double what it was two short years earlier.
The Spanish situation followed a similar pattern, though with less dramatic numbers than the Irish. The lesson to be learned from this is not that these economies could afford their big governments, but that their big governments survived only because there was enough current-price GDP growth to pay for them. As soon as GDP slacked off, the cost of the welfare state quickly became completely unbearable.
Stiglitz refuses to see this. He goes on to advocate even more government, without a hint of explanation of how the world’s already highest-taxed nations would be able to pay for that:
Europe needs greater fiscal federalism, not just centralized oversight of national budgets. To be sure, Europe may not need the two-to-one ratio of federal to state spending found in the United States; but it clearly needs far more European-level expenditure, unlike the current miniscule EU budget (whittled down further by austerity advocates). … There will also have to be Eurobonds, or an equivalent instrument.
More welfare state spending, more government, more debt, more of the same that brought about the crisis in the first place.
Instead of wanting more of the same and providing politicians with rosy outlooks, practitioners of economics should re-examine the results of their own contributions over the past few years. The ability of hundreds of millions of people to maintain their current standard of living, even support their families, depends on it.