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…
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.
With crawling speed, awareness is spreading across Europe that something has gone wrong – terribly wrong – with their economy. The latest to raise his eyes above the mainstream horizon is Jonathan Portes, director of the British think tank National Institute of Economic and Social Research. In a recent interview with Euractiv.com, Portes explained that Europe’s leaders have completely misunderstood the nature of the current crisis:
The problem for Portes is that he lists among the challenges for Europe that it needs to find a way to fund its welfare state. But the welfare state is precisely the problem for Europe. The welfare state is what eventually tipped a regular recession over the edge into a permanent, structural crisis. Surely, the welfare state was aided in its amplification of the crisis by misguided, ill-designed austerity policies. But the European economy was suffering from a structural imbalance, forced upon it by the welfare state, long before the financial crisis began.
We should not glean too much from Portes’s short statement, but it is probably not an exaggeration to conclude that he is looking for a sustainable funding model for the European welfare state. The problem is that no such model exists. In order for the welfare state to be fiscally sustainable, neither its funding model nor its entitlements can have any effect on the tax base from which the welfare state gets its revenue. This “exogenous” view of the welfare state has been thoroughly refuted, both by reality and by a long tradition of research.
There is only one solution to the European crisis, and that is to phase out the welfare state – to privatize education and health care and to return income security to the individual taxpayer. No more, no less, will save Europe.
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.
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.
Yes, there is more bad economic news coming out of Europe. Industrial production fell by 1.9 percent in August compared to the same month last year. Germany, the largest European economy, saw a year-to-year decline of 2.8 percent, but what is even more worrying is that German industrial production fell by 4.3 percent from July 2014 to August, the second highest month-to-month drop in the EU.
Another worrying number comes out of Greece: a decline of six percent year-to-year. While the month-to-month decline is not dramatic i itself at -1.6 percent, the Greek economy has seen industrial production fall month-to-month in five of the past six months. Not a good sign at all.
Furthermore, Sweden, a country filled with large exporting manufacturers, has seen a month-to-month decline in four of the past six months, and five of the past six months on a year-to-year basis.
As far as industrial production goes, Europe is not recovering. At best, stagnation continues. And things don’t look much better on the inflation front, according to Eurostat:
Euro area annual inflation was 0.3% in September 2014, down from 0.4% in August. This is the lowest rate recorded since October 2009. In September 2013 the rate was 1.1%. Monthly inflation was 0.4% in September 2014. European Union annual inflation was 0.4% in September 2014, down from 0.5% in August. This is the lowest rate recorded since September 2009 In September 2013 the rate was 1.3%. Monthly inflation was 0.3% in September 2014.
Despite a frenzy of liquidity expansion, the European Central Bank has not been able to reverse course. Europe as a whole is still heading for deflation. Bulgaria, Greece, Hungary, Spain, Poland, Italy, Slovenia and Slovakia are already in deflation territory. Only five EU member states, Latvia, the U.K., Austria, Finland and Romania have an inflation rate between one and two percent, the highest being 1.8 percent in Romania. The rest of the EU is stuck with zero to 0.8 percent inflation.
No wonder there is a growing conversation about the ailing currency union:
The eurozone appears to have come back onto the markets’ radar amid low inflation, poor economic news from Germany, and Greece’s bailout exit plans. Greece’s long-term borrowing costs went above 8 percent on Thursday (16 October) – their highest for almost a year – as investors took fright at the fragile political situation in the country. The government in Athens has tried to shore up popular support by suggesting it will exit its bailout programme with the International Monetary fund more than a year early. But the recent announcement spooked investors, unconvinced that Greece can stand alone.
The unrelenting stagnation of the European economy is bad news in itself for the sustainability of the currency union. If Greece exits, it will de facto but not de jure abandon the currency union. Moreover, things do not get better when Germans cluster together and sue the ECB for its allegedly illegal expansionary monetary policy:
[Critics] which include Bundesbank president Jens Wiedmann, say that the programme goes beyond the ECB’s mandate of maintaining price stability across the 18-country eurozone. They also say that knowing the ECB will buy their debt could make EU chancelleries less prudent. The plaintiffs had filed their case to the German Constitutional court in Karlsruhe, which in February referred the case to the European Court of Justice. In court, Gauweiler’s lawyer, Dietrich Murswiek, described the ECB scheme as an “egregious extension of [the bank’s] powers” which was designed to “avert the insolvency of member states”.
The ECB is not going to reverse course. They are stalwartly convinced that if money supply just keeps expanding, then eventually they can cause a shift from deflation to inflation. So long as they keep expanding money supply, interest rates will trend to zero. So long as interest rates dwell in that territory, more and more investors will turn to stock markets and real estate for profitable investments. This increases the volatility of those markets, without any gain in the real sector of the economy.
GDP at zero growth, double-digit unemployment, prices deflating, money supply exploding. Yep. This can’t go wrong.
But the budget deficit, folks – the budget deficit is now under control. Aren’t you happy?
When young, third-generation unemployed Europeans are getting tired walking up and down the streets looking for the jobs that aren’t there; when struggling former middle-class families have mopped up the scraps of what used to be a promising future; when the patients in austerity-ravaged hospitals are caught between untreated pain and calling the nurse in vain; when they all want to catch a break in their struggle to make ends meet in their new lives in industrial poverty; all they have to do is look up in the sky and see the shining budget balance spreading its glory over the economic wasteland.
Yankees baseball legend Yogi Berra coined the proverbial phrase “It ain’t over ’til it’s over”. That is certainly true about the European economic crisis. This past week saw a crop of bad news from the Old World. Nothing very dramatic – and certainly nothing that should surprise regular readers of this blog – but nevertheless bad news. In this first of two parts, let’s look at a report from the EU Observer:
The eurozone appears to have come back onto the markets’ radar amid low inflation, poor economic news from Germany, and Greece’s bailout exit plans. Greece’s long-term borrowing costs went above 8 percent on Thursday (16 October) – their highest for almost a year – as investors took fright at the fragile political situation in the country. The government in Athens has tried to shore up popular support by suggesting it will exit its bailout programme with the International Monetary fund more than a year early.
There is an important background here. The bailout program had three components:
1. The Greek government will do everything in its power to combine a balanced budget with protecting as much as possible of its welfare state against the economic depression;
2. In return for the Greek government’s tax increases and spending cuts, the International Monetary Fund, the European Union and the European Central Bank provided loans that kept the Greek government afloat cash-wise;
3. The only metric used to measure the success of bailout policies is the stability of a balanced government budget.
If GDP did not grow, if unemployment was at 30 percent, if more than half the young in Greece had no job to go to… none of that mattered. As a result, there has been no structural improvement of the Greek economy; government has not reduced its burden on the private sector – quite the contrary, in fact. Welfare systems have been reduced, but higher taxes have prevented welfare recipients from transitioning into self sufficiency.
As a result, the social situation in Greece is almost unbearable. The political reaction has come in the form of a surge for parties on the extreme flanks of the political spectrum. In my book Industrial Poverty I explain in detail what happened in Greece, what brought the country down from the heights of European prosperity to permanent stagnation. Today, sadly, the country is little more than a macroeconomic wasteland.
It is with this in mind that one should approach the news that Greece is considering leaving the bailout program. The coalition government is under enormous pressure to save the nation itself, to keep parliamentary democracy in place and to inject some sort of life into the economy. If they fail either of two extreme political movements will take over – the Chavista communists in Syriza or the Nazis in Golden Dawn.
International investors know this and are understandably scared. In their mind the bailout is the least of available evils; in reality, as I explain in my book, the attempts at balancing the budget and saving the welfare state in the midst of the crisis are the very policies that keep Greece from recovering; weak signs of a minor recovery earlier this year have yet to materialize into anything other than the “beaten dog” syndrome often following protracted periods of austertiy.
This is the very reason why Greece is now considering leaving the bailout program. They cannot continue forever to try to muddle through with an economy deadlocked in depression and a democracy so fragile that it has brought the first Nazis into a parliament in Europe for the first time since World War II.
However, as the EU Observer explains, the Greek government is caught between a rock and a hard place – as are other hard-hit euro zone economies:
But the recent announcement spooked investors, unconvinced that Greece can stand alone. Long-term borrowing costs also jumped in the weak periphery states, Spain, Italy, and Portugal. The market jitters – while not comparable to the height of the eurozone crisis in 2011 and 2012 – come as the eurozone’s main economies are once again at odds over policy responses.
France also belongs on that list, primarily for its typically European attempt at leaving the bailout program. Its government tried to leave the bailout path for a left turn into the quagmire of government expansionism. Thinking that more government spending, on top of the largest government spending in the world, could in fact bring about a recovery, the French socialists who won the 2012 elections scoffed at the EU balanced-budget rules and went full speed ahead with their government-expansionist agenda.
Two years later that agenda has hit a brick wall. Massive tax increases, supposed to pay for some of the new government spending, have only resulted in an exodus of brain power and entrepreneurship. The French GDP is standing more still than the Eiffel Tower.
In fact, the EU Observer notes,
France and Italy are fighting a rearguard action for more flexibility saying budget slashing will condemn them to further low growth. Paris is on collision course with both Berlin and the European Commission after having indicated that it wants an extra two years to bring its budget deficit to below 3 percent of GDP. Italy, meanwhile, has submitted a national budget for 2015 which brings the country to the edge of breaking the rules.
The French challenge to the budget-balance rules compounds the uncertainty emanating from the talks in Athens about a Greek bailout exit. It is more than a theoretical possibility that at least one of these countries leaves the euro zone in the next two years, and does so for a combination of political and economic reasons. That would be an institutional change to the European economy – and really the global economy – of such proportions that no traditional quantitative analysis can render justice to a forecast of its effects. It is therefore entirely logical that global investors are growing more uncertain and as a result demand higher risk premiums.
As the icing on the uncertainty cake, informed investors know that Marine Le Pen may very well become France’s next president. If she wins in 2017 her first order of business is in all likelihood going to be to exit the euro zone and reintroduce the franc. On the one hand that could be an “orderly” exit; on the other hand it would have ripple effects throughout the southern rim of the euro zone to the point where the very future of the common currency is in grave danger.
In summary: mounting uncertainty about the future of the euro is being mixed with growing uncertainty about the macroeconomic performance of the member states of the currency union.
Stay tuned for the second part about the bad news out of Europe.
At the beginning of this year there were lots of forecasts that the European economy was going to recover. I never believed them, primarily because government was a bigger burden on the economy than ever. So far I have been proven right, which is not something I would want to celebrate. But I also want to make clear that once government pulls back from its efforts at balancing its budget with higher taxes and spending cuts, the private sector will eventually start to recover.
There is a lot of research to show this. I review the public policy part of that research in chapter 5 in my new book Industrial Poverty. My conclusion is that this kind of austerity can work – the private sector emerges growing from even the most protracted periods of austerity. However, this is not a reason to use austerity as it has been applied through most of recent history, namely as a means to save government. Instead, austerity must be redesigned to reform away government. Otherwise the private-sector recovery that follows will suffer from two ailments:
1. It will look fast in the beginning, as consumers catch up with the standard of living they lost during the austerity period; and
2. Because of the recalibration of the welfare state – permanently higher taxes and permanently lower spending – the economy will hit its full employment level at a higher rate of unemployment than before the austerity episode.
It is also important to keep a watchful eye on whether or not a recovery is external or internal. In too many European countries over the past quarter century, a recovery has come from a rise in exports, i.e., been external. The consequence of this is that the domestic economy lags behind.
To make matters worse, much of modern manufacturing in Europe consists of bringing in parts produced in low-cost countries, assembling them at a highly efficient plant in a European country and then shipping them on to their final destination. This new kind of industrial production is increasingly isolated from the rest of the economy, which means that its multiplier effects on private consumption and business investments is relatively weak. It is, in other words, no longer possible for a small, exports-oriented European country to enter a lasting growth period merely on a rise in exports.
Earlier this year I pointed to Germany as an example of the feeble macroeconomic role of exports. You can get a temporary boost in GDP growth from a rise in exports, but once that boom goes away, it will have left very few lasting “growth footprints” in the economy. It looks like the same thing is now happening in Spain, which is in a recovery, according to the ECB:
The economic recovery has gathered momentum during 2014, with GDP growing at a faster pace than the euro area average.
Going by the latest national accounts numbers from Eurostat, which for obvious reasons covers only the first two quarters of 2014, it was not until Q2 this year that Spanish GDP outpaced the euro zone: 1.1 percent real growth over the same quarter previous year, compared to 0.5 percent for the euro zone.
Before that, Spain was doing worse than the euro zone by a handsome margin.
The ECB again:
Growth has been supported by a rise in domestic demand, while the external balance has weakened substantially as a result of a slowdown in export market growth and higher imports. Domestic consumption and investment in equipment are benefitting from growing confidence, employment creation, easier financing conditions and low inflation.
Over the past year there has been a slow but steady decline in Spanish unemployment, from 26.1 percent in August 2013 to 24.4 percent in August 2014. That is very good for a people hit very hard by disastrously ill designed fiscal policies over the past three years.
At the same time, there are clear signs that this is an “export bubble”. Consider these growth numbers for the country’s GDP (quarterly over same quarter previous year):
There is no doubt that GDP growth is improving. While 1.1 percent is absolutely nothing to write home about, as mentioned earlier it exceeds the euro-zone average. The big question is whether or not this improvement will last. The biggest concern is the exports numbers: good growth for two quarters, then a major leap up to 6.4 percent, only to fall back to 1.5 percent. (While these are not seasonally adjusted numbers, they are quarterly growth on an annual basis which neutralizes seasonal effects.) If exports fall back to tepid growth numbers below two percent, GDP growth will most likely slide back into zero territory.
However, there are a couple of other mildly encouraging factoids in these numbers. To begin with, government spending, while on the growth side, is expanding slowly at no more than one percent per year. This number does not account for financial payments, such as unemployment benefits and other income security entitlements, but they do account for government activities that involve government employees. Alas, restraint in government spending means very little effort from government to expand its payrolls to do away with unemployment.
The apparently stable growth in private consumption is in all likelihood attributable to the post-austerity effect I pointed to above. This means that we will not see 2+ percent growth for much longer; for that to happen there has to be a sustained and substantial addition of consumers to the economy who are capable of spending more than what is required for pure subsistence. This, in turn, will not happen until unemployment comes down more than marginally.
Another mildly encouraging sign is that business investments have stopped declining. The turnaround over the past four quarters is in all likelihood an attempt by exporters to expand their capacity. If the exports boom is coming to an end, so will probably investments.
To turn this fledgling recovery into a lasting trend, the Spanish government needs to address the underlying problem in its economy: the welfare state. Otherwise it will just experience spurts of growth here and there as anomalies to a permanent state of stagnation – and industrial poverty.
Almost everywhere you look in Europe there is unrelenting support for a continuation of policies that preserve big government. Hell-bent on saving their welfare state, the leaders of both the EU and the member states stubbornly push for either more government-saving austerity or more government-saving spending. In both cases the end result is the same: fiscal policy puts government above the private sector and leads the entire continent into industrial poverty.
Monetary policy is also designed for the same purpose, which has now placed Europe in the liquidity trap and a potentially lethal deflation spiral. The European Central Bank is fearful of a future with declining prices, thus pumping out new money supply to somehow re-ignite inflation. In doing so they are copying a tried-and-failed Japanese strategy, on which Forbes magazine commented in April after news came out that prices had turned a corner in the Land of the Rising Sun:
Japan’s government and central bank are likely to get much more inflation than they bargained for. This risks a sharp spike in interest rates and a bond market rout, with investors fleeing amid concerns about the government’s ability to repay its enormous debt load. In the ultimate irony, it may not be the deflationary bogey man which finally kills the Japanese economy. Rather, it could be the inflation so beloved by central bankers and economists that does it.
This is a good point. Monetary inflation is an entirely different phenomenon than real-sector inflation. The latter is anchored in actual economic activity, i.e., production, consumption, trade and investment. It emerges because basic, universally understood free-market mechanisms go to work: demand is bigger than supply. This classic situation keeps inflation under control because prices will only rise so long as producers and sellers can turn a profit; if they raise prices too much they attract new supply and profit margins shrink or vanish.
Monetary inflation is a different phenomenon, based not in real-sector activity but in artificially created spending power. I am not going to go into detail on how that works; for an elaborate explanation of monetary inflation, please see my articles on Venezuela. However, it is important to remember what kind of inflation European central bankers seem to be dreaming of. As they see it, monetary inflation is the last line of defense against a deflation death spiral, regardless of what is happening in Japan.
They may be right. Again, there is almost unanimous support among Europe’s political elite that whatever policies they choose, the overarching goal is to preserve the welfare state. However, there is a very remote chance that something is about to happen on that front. And it is coming from an unlikely corner of the continent – consider this story from France, reported by the EU Observer:
France has put itself on a collision course with its EU partners after rejecting calls for it to adopt further austerity measures to bring its budget deficit in line with EU rules. Outlining plans for 2015 on Wednesday (1 October), President Francois Hollande’s government said that “no further effort will be demanded of the French, because the government — while taking the fiscal responsibility needed to put the country on the right track — rejects austerity.” The budget sets out a programme of spending cuts worth €50 billion over the next three years, but will result in France not hitting the EU’s target of a budget deficit of 3 percent or less until 2017, four years later than initially forecast.
In the beginning, Holland stuck to his socialist guns, trying to grow government spending and raise taxes. However, he soon changed his mind and combined tax hikes with cuts in government spending, as per demands from the EU Commission. Now he is taking yet another step away from established fiscal policy norms by combining spending cuts, albeit limited ones, with tax cuts – yes, tax cuts:
The savings will offset tax cuts for businesses worth €40 billion in a bid to incentivise firms to hire more workers and reduce the unemployment rate. In a statement on Wednesday, finance minister Michel Sapin said the government had decided to “adapt the pace of deficit reduction to the economic situation of the country.”
The “adaptation” rhetoric is the same as the French socialists had when they took office two years ago. What has changed is the purpose: back then their fiscal strategy was entirely to grow government – because according to socialist doctrine government and only government can get anything done in this world. Now they are actually a bit concerned with the economic conditions of the private sector.
This goes to show how desperate Europe’s policy makers are becoming. In the French case it is entirely possible that Hollande is willing to become a born-again capitalist in order to keep Marine Le Pen out of the Elysee Palace. After all, the next presidential election is only three years out. But it really does not matter what Hollande’s motives are, so long as he gets his fiscal policy right.
The EU Observer again:
Last year, France was given a two-year extension by the European Commission to bring its deficit in line by 2015, but abandoned the target earlier this summer. It now forecasts that its deficit will be 4.3 percent next year. The country’s debt pile has also risen to 95 percent of GDP, well above the 60 percent limit set out in the EU’s stability and growth pact. Meanwhile, Paris has revised down its growth forecast from 1 percent to 0.4 percent over the whole of 2014, and cut its projection for 2015 to 1 percent from 1.7 percent. It does not expect to reach a 2 percent growth rate until 2019.
This is serious stuff but hardly surprising. I predict this perennial stagnation in my new book Industrial Poverty. And, as I point out in my book, a growth rate at two percent per year only keeps people’s standard of living from declining- it maintains a state of economic stagnation. There will be no new jobs created, welfare rolls won’t shrink and standard of living will not improve. For that it takes a lot more than two percent GDP growth per year.
Hollande’s new openness to – albeit minuscule – tax cuts should be viewed against the backdrop of this very serious outlook. He will probably not succeed, as the tax cuts are so small compared to the total tax burden, and the tax-cut package is not combined with labor-market deregulation. But the mere fact that he is willing to try this shows that there is at least a faint glimpse of hope for a thought revolution among Europe’s political leaders. Maybe, just maybe, they may come around and realize that their welfare statism is taking them deeper and deeper into eternal industrial poverty.
In the last quarter of the 20th century large parts of the world lifted themselves out of poverty. China and India are the best known but far from the only examples. Countries like Malaysia, Indonesia, Vietnam and Korea elevated themselves to a standard of living that for most of the population meant life in the global middle class. The Soviet sphere collapsed and allowed hundreds of millions of people from Saxony to Sakhalin to pursue happiness unhindered by government.
Now the prosperity train is slowly making its way through the African continent. Its effect is still marginal, but global corporations have discovered pockets of economic environments in Africa where they can actually set up operations with reasonable prospects of stability and profit.
While this is happening, the old industrialized parts of the world have mismanaged their prosperity. Latin America offers a split image with Argentina and Venezuela sinking into the holes of socialism while Chile and Brazil are examples of economic progress. The United States is still an economic superpower but has over the past 25 years allowed its government to grow irresponsibly large. It is still manageable and we are moving forward economically, but not at the pace we could.
Europe is the black sheep of the industrialized family, having squandered its prosperity for the sake of income redistribution. While Europe has not yet sunk into abject poverty, and probably never will, the continent has entered a stage of economic stagnation that it will take a very long time to get out of. In fact, the European economy is beginning to resemble some of the less oppressive countries in the Soviet sphere – not in terms of political oppression, but in terms of the destructive presence of government in the economy. Europe has, partially and unintentionally but nevertheless destructively, adopted the static statism that characterized countries like Poland, Czechoslovakia and Hungary before the Iron Curtain came down.
The stagnant nature of the European economy and the slower-than-capacity growth rates in the United States and Canada are all self inflicted. The fatally erroneous belief that government has a productive role to play in the economy inhibits the creation of prosperity in parts of the world where, fundamentally, the conditions for creating prosperity are better than anywhere else. This structural mismanagement of some of the world’s wealthiest economies have ramifications far beyond their own jurisdictions. By keeping their economies from growing, Europe’s political leaders hold back demand for products from countries on the verge of climbing out of poverty. By holding back the forces of prosperity, America’s political leaders prevent the creation of a surplus that otherwise could provide funds for development and investment projects in developing countries.
Instead of unleashing the prosperity machine we know as capitalism and economic freedom, governments in Europe and North America spend far too much time trying to preserve their welfare states. When their government-run entitlement programs promise more than taxpayers can pay for, they resort to growth-hampering austerity measures, aimed not at reducing the presence of government in the economy but at saving the very structure and philosophy of the welfare state. The result, again, is stagnation and industrial poverty.
The First World’s obsession with the welfare state thus prevents the proliferation of prosperity to parts of the world still struggling in poverty. By means of economic freedom, nationally and globally, the relatively wealthy can help the poor toward a better life. This cannot be stressed strongly enough; if accounts of the demerits of the welfare state are not enough to turn our political leaders in favor of economic freedom, then perhaps a new report on global poverty can help. Published by an organization called ATD Fourth World, Challenge 2015: Towards Sustainable Development that Leaves No One Behind provides a painfully direct account of abject poverty around the globe. The authors do not exhibit any deeper understanding of what causes poverty, but the parts of the report that tell the story of poverty from the “ground level” are definitely worth reading.
More than that, they provide a stark contrast to the destructive policies used in Europe and North America to preserve the welfare state. Instead of raising taxes and putting more of our own people on welfare, we owe it to the rest of the world to maximize our creation of prosperity. We can only do that by relieving our own population of the shackles of artificial redistribution. With more wealth, higher incomes and a growing standard of living we will have more money to trade with developing countries, as well as more surplus to donate to and invest in productive development projects in the poorest parts of the world.
Economic freedom has elevated billions of people from abject poverty to a respectable standard of living. It has elevated millions into true prosperity, and thousands upon thousands to almost unlimited wealth. It can do the same for those still in poverty. All it takes is that we in the most prosperous nations of the world sort out our priorities and responsibilities.