Saturday, November 22, 2014

Private Wealth and European Solidarity

COLOGNE – A little-discussed but crucial factor in the debate over wealth transfers from Europe’s more economically sound north to its troubled south is the relationship between public debt, GDP, and private wealth (households’ financial and non-financial assets, minus their financial liabilities) – in particular, the ratio of private wealth to GDP in the eurozone countries.

While the European Central Bank’s bond-purchasing scheme has calmed financial markets to a considerable extent, some European economies – including Italy, Spain, Greece, and Portugal – are still at risk, because they are not growing fast enough to narrow their deficits and stem the growth of their national debts. The grim irony here is that the ratio of private wealth to GDP in some of the countries that are in need of support from the ECB and northern eurozone members is equal to or higher than that in more solvent countries.

Consider Italy, which has the highest ratio of private wealth to public debt of any G-7 country, and is some 30% to 40% higher than in Germany. Likewise, Italy and France share a private wealth/GDP ratio of five to one, while Spain’s – at least before the crisis hit the country in full – was six to one. By contrast, the ratio in Germany, Europe’s largest creditor, is only 3.5 to one.

This discrepancy is at the heart of the question with which European policymakers are now grappling: Should taxpayers in debtor countries expect “solidarity” – or, more bluntly, money – from taxpayers in creditor countries? Why should taxpayers in creditor countries have to take responsibility for financing the euro crisis, especially given that high private wealth/GDP ratios may result from low tax revenues over time, while lower ratios may reflect higher tax revenues?

Before seeking or accepting help from the rest of Europe, countries should employ all available domestic resources. Debtor governments should call upon their own taxpayers to fund some of the national debt in order to avoid higher interest rates in credit markets. They could, for example, offer an incentive in the form of a 3-4% interest rate on bonds, and even make them tax-free eventually. This would allow Italy, Spain, and even Greece to finance their national debts at a more reasonable, sustainable cost.

Citizens’ voluntary financing of their countries’ national debt would be the most effective means of reducing strain on Europe’s financial resources, while simultaneously serving as a powerful symbol of solidarity. By contrast, turning creditor-country citizens’ tax payments into forced subsidies of other countries’ debts would undermine European cohesion. Nordic countries, for example, cannot be expected to fund other countries’ debts in the long term – especially if those countries have not made full use of their own resources.

In fact, while concerns over the eurozone’s survival tend to focus on its indebted members, Europe’s monetary union is at risk of losing one of the few members that still enjoys a triple-A credit rating: Finland. Given Finland’s difficult domestic political situation, its citizens may look to Denmark and Sweden – which boast rapid growth and low national debt, and do not pay into the European Financial Stability Facility or the European Stability Mechanism – and decide that eurozone membership costs too much and is no longer worthwhile.

Italy and Spain have enough resources to rescue themselves, and to secure the time needed to restructure their economies. Indeed, even after taking on the entire national debt, their private wealth/GDP ratios would still be higher than they are in some northern European countries.

Escaping the euro crisis is less a matter of economics than of political will. By calling upon citizens to finance their own countries’ national debts, southern Europe’s leaders can fix their own economies and strengthen the European principles of solidarity and subsidiarity.

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    1. CommentedNathan Coppedge

      It is an interesting kinetic relationship you seem to propose, that a mere shift of balance could solve many problems. I suspect that is only one dimension of economics, and the table is not as flat as some people suppose. If that is true, there should be some way to serve advantages economically, but the result may be to serve the upper classes unless there is a strong element of trickle-down industries or public austerity. And of course it shouldn't be merely a trick of words to make something operate. But I think ultimately there is a trend towards stable conceptual currency. If we ever encounter an alien race, they may think thoughts are money or conversely that economics is a simple engineering problem always solved in broad daylight.

    2. CommentedMarco Fortis

      The topic is interesting but the data are not correct. At the end of 2011, according to Eurostat, among Mediterranean countries only Italy (168 pct) had a household net financial assets ratio to GDP significately higher than Germany (122) and also France (135). On the contrary, the so called PIGS had lower ratios: Greece (only 47!), Spain (73), Ireland (75), Portugal (123). These data demonstrate two things. First: Greece, Spain and Ireland can't utilize private wealth to reduce public debt. Second, it's time to utilize not only the public debt-GDP ratio to evaluate the financial sustainability of a nation, but also the public debt-private wealth ratio or a combination of the two. In these case, analysts and also financial market will discover that the public debt/private wealth of Italy is quite similar to Germany's and France'. In other words the Italian public debt is actually sustainable if it would not penalized by irrealistic interest rates. In 2011 Italy had a problem of political credibility that professor Monti helped to resolve. But Italy never lost their good economic fundamentals. The Italian economy has 5 pillars: 1) a structural trade surplus in manufactured product (in 2012 it will be around 75 billion euro); and Italy is one of the only five G20 countries in surplus together with China, Japan, Germany and South Korea; 2) the lowest household liabilities to GDP ratio among advanced economies; 3) an high and well distributed household net financial wealth; 4) an high non financial private wealth (see for both these aspects the last Global Wealth Databook 2012 published by Credit Suisse); 5) a net international investment position to GDP ratio absolutely under control, similar to UK's and lower than US's. It's time that Nordic European countries and investors rebuild a little faith in Italy.

    3. CommentedJan Smith

      Look carefully: this column is only about Italy.

      It focuses three "southern" countries--France, Spain, and Italy.

      France is not asking for help. Even the American credit raters (lackeys of the big banks) couldn't succeed in driving up the the bankers' rents from French debt.

      To make Spain fit the argument, the column uses a pre-crisis ratio, before Spanish private housing wealth crashed.

      Why is Greece neglected? Because even a pre-crisis ratio wouldn't make Greece fit the argument.

      So we are left with Italy. We learn that Italy has a higher debt/GDP ratio than Germany.

      That's all, folks!

    4. CommentedTony Li

      The high private wealth to GDP ratio in PIIGS is ironic. This indicates the root of the sovereign debt crisis - structural problem in economies.

      Greece have been a heaven for riches, with millionaires having yachts and ferrari in Athens while they have a better-than-average welfare system. However, the productivity of the general public is not that high, compared to its neighbors like Germany.

      Countries like Spain, suffer the same problem. They have the best corporations in the world like Zara, but they still suffer from massive unemployment.

      The wealthy will certainly decline to help their countries by their private wealth. They will just leave given they are "penalized" by the higher tax rate. This is particularly true to Eurozone members.

      So it's not practical to expect the people in the troubled countries to help.

    5. Commentedradek tanski

      Maybe High private wealth to debt ratios are to be expected in desperate countries? After all, it would stand to reason that they would be more afraid to alienate their assets than richer countries.

      If they tried to force the issue, and all of a sudden their private wealth to public debt ratios would decrease, for all the wrong reason.

      I suppose its the ago old question. How do the poor force the rich to give them handouts. How do the rich keep the poor at bay?