Monday, October 20, 2014

What is Italy Saying?

NEW YORK – The outcome of the Italian elections should send a clear message to Europe’s leaders: the austerity policies that they have pursued are being rejected by voters.

The European project, as idealistic as it was, was always a top-down endeavor. But it is another matter altogether to encourage technocrats to run countries, seemingly circumventing democratic processes, and foist upon them policies that lead to widespread public misery.

While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. 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%, and Spain’s is above 50%. 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. Indeed, it will take a decade or more to recover the losses incurred in this austerity process.

In short, it is neither populism nor shortsightedness that has led citizens to reject the policies that have been imposed on them. It is an understanding that these policies are deeply misguided.

Europe’s talents and resources – its physical, human, and natural capital – are the same today as they were before the crisis began. The problem is that the prescriptions being imposed are leading to massive underutilization of these resources. Whatever Europe’s problem, a response that entails waste on this scale cannot be the solution.

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.

An alternative set of well-discussed policies could work. 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).

A banking union, too, is needed. But it needs to be a real union, with common deposit insurance and common resolution procedures, as well as common supervision. There will also have to be Eurobonds, or an equivalent instrument.

European leaders recognize that, without growth, debt burdens will continue to grow, and that austerity by itself is an anti-growth strategy. Yet years have gone by, and no growth strategy is on the table, though its components are well known: policies that address Europe’s internal imbalances and Germany’s huge external surplus, which now is on par with China’s (and more than twice as high relative to GDP). Concretely, that means wage increases in Germany and industrial policies that promote exports and productivity in Europe’s peripheral economies.

What will not work, at least for most eurozone countries, is internal devaluation – that is, forcing down wages and prices – as this would increase the debt burden for households, firms, and governments (which overwhelmingly hold euro-denominated debts). And, with adjustments in different sectors occurring at different speeds, deflation would fuel massive distortions in the economy.

If internal devaluation were the solution, the gold standard would not have been a problem in the Great Depression. Internal devaluation, combined with austerity and the single-market principle (which facilitates capital flight and the hemorrhaging of banking systems) is a toxic combination.

The European project was, and is, a great political idea. It has the potential to promote both prosperity and peace. But, rather than enhancing solidarity within Europe, it is sowing seeds of discord within and between countries.

Europe’s leaders repeatedly vow to do everything necessary to save the euro. European Central Bank President Mario Draghi’s promise to do “whatever it takes” has succeeded in providing a temporary calm. But Germany has consistently rejected every policy that would provide a long-term solution. The Germans, it seems, will do everything except what is needed.

Of course, the Germans have reluctantly come to accept the necessity of a banking union that includes common deposit insurance. But the pace with which they accede to such reforms is out of kilter with the markets. Banking systems in several countries are already on life support. How many more will be in intensive care before a banking union becomes a reality?

Yes, Europe needs structural reform, as austerity advocates insist. But it is structural reform of the eurozone’s institutional arrangements, not reforms within individual countries, that will have the greatest impact. Unless Europe is willing to make those reforms, it may have to let the euro die to save itself.

The EU’s Economic and Monetary Union was a means to an end, not an end in itself. The European electorate seems to have recognized that, under current arrangements, the euro is undermining the very purposes for which it was supposedly created. That is the simple truth that Europe’s leaders have yet to grasp.

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  1. CommentedHarlan Green

    See my latest Popular Economics column on why austerity doesn't work:

  2. CommentedGrzegorz Lindenberg

    Of course, German business is going to give huge wage icreases to its workers so that German exports become less competitive and they go bankrupt so as Italian, Spanish and Greek businesses can prosper. It happens all the time in Europe, as its business is known for its altruism.
    Any other useless advice, Professor?

  3. Commentedsande cohen

    It is astonishing to me that two concepts--austerity and government spending--are dominant in framing the discussion and analysis. Neither concept works any longer to explain the processes, in particular, the stranglehold in the U.S. by the professional classes on labor. Why is the U.S. so short of doctors? Why does a b.f.a. in drumming cost 160k in tuition (only) as the "top" schools? Why are colleges at 75% part-time instructors? Social rebellion has to be re-imagined...among other things.

  4. CommentedChristopher Thiem

    Even though I agree with him on one or two arguments, for the vast majority of his points it is quite hard to derive similar conclusions. Or, to speak more frankly, I think that Joseph Stiglitz is wrong about most of what he is saying with regard to the European debt crisis.

    Read more on my blog:

  5. Portrait of Pingfan Hong

    CommentedPingfan Hong

    "Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis": that is true, but the surpluses in these countries before the crisis were the result, or integral part, of the housing and financial bubbles.

  6. CommentedMichael Hennigan - Finfacts

    It's foolish to claim that the result of Italy's general election is a clear message on austerity.

    Austerity has a lot of opponents including the very wealthy, in countries with large shadow economies.

    Monti's aggressive anti-tax evasion campaign against the well-off/ family businesses under-declaring income would not have benefited Berlusconi?

    Given the level of support for the discredited Berlusconi and the disenchantment with the existing parties, the message isn't as clear-cut as claimed.

    In the past decade, Italy’s GDP increased by less than 3%; that of France, with about the same population, by 12%. The gap perfectly reflects the difference in hourly productivity - - stationary in Italy, up by 9% in France. Italy’s performance applied to North and South alike.

    In the course of a decade, Italy received foreign direct investment inflows equal to 11% of GDP, compared with 27% in France.

    The real earnings of employees in Italy have been virtually stationary over the past decade, compared with a gain of 9% in France; real household consumption, which has risen by 18% in France, has grown by less than 5% in Italy and only by eroding the propensity to save.

    The World Bank's ease of doing business/ starting a business etc ranking of 185 countries gives Italy a 73rd ranking - - 3 steps above Mongolia, a communist state until 1990. Greece has improved to 78 from 100 in 2012.

    It should be clarified that the under 25 jobless rates while too high, exclude those in full-time education.

    In 2012, Germany's trade with the other 16 countries of the EMU was almost in balance. Most of the surplus is ex-27.

    The European Commission has estimated that a 1% increase in German domestic spending would improve Italy’s trade balance by just over 0.02% while it would have a greater impact on economies such as the Czech Republic and Poland.

    Besides, surpluses are not as large as they seem. According to the OECD-WTO, in 2009, Germany exported 25% more than the United States in gross terms but only 5% more in value added terms. China gains a few dollars from each Apple iPhone assembled but its trade deficit with the US rises per unit shipped.

    Italy's current unemployment rate is at the same level it was in 1996; Spain had a jobless rate of 21% in 1997, just before the start of its property boom. Youth unemployment has been a problem for decades as they are lined up to be the shock-absorbers.

    Germany had deficits with Spain, Italy and Greece, 20 years before the launch of the euro.

    The internal failures that have stunted growth for decades should not be downplayed.

    Ireland would be closer to Albania now than to Germany but for American FDI.

    It would help if economists such as Prof Stiglitz supported claims with data as otherwise, what is self-evident to him, will only continue convincing the converted.

  7. CommentedJohn Zani

    "The European project, as idealistic as it was, was always a top-down endeavor. But it is another matter altogether to encourage technocrats to run countries, seemingly circumventing democratic processes, and foist upon them policies that lead to widespread public misery."

    The techoncrats, supposed to be economists (and I wonder which kind of economists they were...) turned out to be more politicans than expected.
    And I am surprised that Mr. Stiglitz is in favour of more coordination at EU level given that all the parliament in the EU can do is simply to spend.
    That's perhaps how the new EUSSR has come to life, where talent, contrary to Stiglitz's opinion, is going away and Italy is one of the countries that suffer the most of this outflow.
    But again green and socialist politicians are simply happy to get votes by influx of unskilled workers from former communist countries and Northern Africa.

    And as someone already pointed out the Italian elections were not as much a vote on austerity measure as they were for the discontent towards the same politicians that have been riding the scene for years.

    I haven't looked through the figures for the exact public expenditure during the period of Monti but much of the austerity was driven by tax increases. VAT (21% with an increase in next months) and IMU (tax on housing) are the two main examples.
    That's exactly the opposite of what he should have done in order to liberalise an economy strangled by bureaucracy and taxes.

  8. CommentedMark Manger

    If German wages were to rise, the imbalances within Europe would probably correct to some extent, but the Eurozone as a whole would swing into a massive current account deficit with China. Real interest rates would be artificially depressed and asset bubbles would reemerge on an even larger scale than before. I fail to see how that would be a long-term solution.

  9. CommentedCarol Maczinsky

    A people as the Italians is fully responsible. Responsible for its finances and for its political class. They are free to object "austerity" and blame their failure on other nations. But then they also have to sufffer the consequences.

    What caused the crisis was softy regulation and risk taking. May I remind you of the European Treaties? Do you think a technocrat as Mario Draghi may ignore and overrule the law and break the Treaties? I don't think so. I expect a central bank to rather let the economy die when it deserves death than undermine the fundamental trust.

    "the primary objective of the European System of Central Banks (hereinafter referred to as the ESCB) shall be to maintain price stability."

    If someone launches a coup d'etat it is for noble citizens to defend their freedom and restore law and order. You know the history, when you launch a succesful cavallery charge without autorisation and win the battle, you deserve to be hanged!

    In the case of Italy, the state can solve its financial crisis any time by selling South Tyrol, its dishourable acquisition from WWI, back to Austria.

  10. CommentedMarco Ceccagnoli

    If the Euro dies there will a successor, the "EURO 2", as it has always been. One where the union is stronger than before. The European union has always progressed, from commercial to monetary. Now in Europe we need fiscal union, then political union. This is the big bet, the only one that will save Europe from progressive marginalization from the world economy.

  11. CommentedJoshua Ioji Konov

    Dear Mr. Stiglitz, the EU needs not just monetary and regulatory changes and enhancements as much macro economic such..., whereas the big business and investors are not subsidized in expense of the small and medium businesses and investors, whereas the austerity measures would change nothing..., the trickle-down economics so inclined in the EU ideology is not performing on any level..., I believe the EU is doomed if not quickly fixed...

  12. CommentedFrank O'Callaghan

    Almost all discussion takes place from inside the 'box'. Objectivity suggests that we should change perspective. Some positions are debunked even from inside the paradigm. The suggestion that austerity and lower wages can work has been tried and it has failed. Repeating the experiment is nonsense.

    What has not been tried? Large taxes on the very wealthy are an option. They have the virtues of making sense (the wealthy have wealth), they cause virtually no deprivation (the wealthy by definition are not materially deprived) and -most importantly- they are the direct opposite of the policies that created the crisis.

  13. CommentedProcyon Mukherjee

    The debate is moving more towards building of political capacity, as the top down approach must maintain distance (autonomy) and collaboration (embeddedness) with private capital and should not fall prey to the bond vigilante; the compromise among the elite, no matter how subtle its manifestation, there is still have a large gap in terms of building of a consensus. The apparent lack of policy continuity to be able to drive development raises the question whether politics could be developmentally driven or is it development that can to be politically driven.

  14. CommentedEdward Ponderer

    "The European project, as idealistic as it was, was always a top-down endeavor. ... It is an understanding that these policies are deeply misguided."

    Indeed, what is really missing here is nature's entrance into successful systematization. The failure of both the Communist and Capitalist systems was not that they didn't try to mimic Nature. Indeed, complete annulment of the individual in the presence of the "state," as well as dominance hierarchy are both formally present in Nature. But the development of these was, so to speak, the "will of the people."

    Now, of course there is no "will" in the human sense of the word, among animals. However, in the chemical and other communicative sense of a group optimization within a given environment, "will" extends down to the vegetative, even to microorganisms, and the quantum mechanical sense, even to the atomic world.

    Now, democracy tries to follow this will of the people, but the only ones who sort of got it right were the Greeks -- basically everybody shouting out their opinions and votes from a mountain side. Their only real weakness was that in expanding inclusiveness (no slave, female, "barbarian," or other classes to be excluded), and complexity, the system was too unwieldy. The complexities of government and economics were well beyond the ken of the average individual, and as well, how to have the people express its will without it, in mutual contradiction, it turning into the random, destructive noise of the mob. Thus a hierarchical representative system developed, to allow experts to "understand" the will of the people -- as best it could be, and then be guided in that while using their real-world savvy. Unfortunately, that real world savvy, like the mobs noise, generally shifts to a focus upon personal self-interest. Then upon that, is a layer of extra-governmental forces, financial and media, which further knows where "their bread is buttered." In short its a mess -- the mess that we now live in.

    Now going back to the Greek idea, supposing we do this natural evolution:

    (1) pursue neither a top-down Capitalist or Communist economy, but rather a behavioral economics based upon interpersonal relationships. In this pursuing, through integral education and the natural evolution of societal values of mutual responsibility -- where social rewards and a special feeling of self-worth & happiness, become inculcated as drivers to leadership in place of money & power.

    (2) Pursue a dynamic representative government as a continuous round-table political structure, fractal as it were, round tables of round tables -- over the Internet (the present day human "chemicals" and "quantum mechanics" of communicative will). If (1) is successful, that rather than mobs of self-centered individuals and groups at the bottom, and exploiters at the top, one will have a continuous homeostatic sense mechanism from the bottom, and governing brain utilizing this information at the top, for the good of all in a manner far better than could be grabbed by the self, for the self.

  15. CommentedZsolt Hermann

    The article has many important points, but I do not think it penetrated the full depth of the problem.
    What the voters in Italy truly rejected, and what other countries will also reject is the complete disconnection between the "ruling elite" and the general public.
    The leaders in Europe, and in fact all over the world, simply stubbornly push on with their agenda, without even considering the collateral damage.
    The religious mantra of "return to growth", "austerity vs growth", bailouts and "solutions" are only aimed at the markets and the financial institutions, basically sacrificing the public.
    What I mainly do not understand is why people think that politicians, interest groups that are mostly interested in growth, increasing profits, buoyant markets would choose austerity if they could generate growth?!
    This article also tries to suggest that the European politicians should put such policies in place that helps the return of growth.
    They do not even want to consider that actually the "return to growth" is not possible any more.
    And this is not a European problem.
    True growth has stopped all over the world, since it was an illusion to start with, it was built on producing excessive, unnecessary and mostly harmful products in order to satisfy artificially generated desires.
    Such an unnatural system, where bubbles are built on bubbles without any natural foundation, where the human resources necessary to drive the system are gradually exhausted, is simply unsustainable, and now we reached the end.
    Even now only superficial "plastic surgery', virtual money injections cover up the much deeper abyss in Europe, in the US and everywhere else.
    The Italian election results again are only symptoms, they show the result of the split within the societies and the public protest against that split.
    But the main problem is the false, unnatural system we are trying to push on with all over the world.
    Until we ignore or fear to reveal the true disease we cannot cure the crisis, superficial, symptomatic reactions, treatments cannot help, only make things worse.

  16. CommentedG. A. Pakela

    To reverse the so-called "austerity" policies is simply to kick the can down the road. If governments continue to tax and spend in an unproductive manner the result will simply be stagnation instead of deflation and unemployment. But, since these countries have maxed out on the ability to continuously issue government debt, the attempt to maintain the overly generous welfare payments and public sector pensions will only hasten the next debt crisis. Utimately, austerity will be forced down Italy's throat as there will be no one left to tax or finance the government subsidized lifestyle.

    The real problem is just as much a microeconomic one: there is a lack of flexibility in the labor markets of these countries. Too many work rules, an inability to lay off, fire and close unproductive plants. But on the macro side, yes let's get rid of the austerity starting with dramatically cutting VAT taxes, taxes on capital income and the elimination of income taxes altogether on low income citizens. I'm willing to bet Mr. Stiglitz $10,000 that these tax cuts would end up increasing revenue within a couple of years. Why? Because taxes are a fundamental part of the price system and if firms cannot increase profitability by simply raising prices, why does the government think it can raise revenues by increasing taxes on those very same goods and services?

  17. CommentedMarco Cattaneo

    Austerity policies must be reversed, but this has to be made in conjunction with a reform of the European Monetary System to allow depressed countries to pursue monetary together with fiscal expansion, and to rebalance competitivity vis-a-vis Germany. Breaking the euro up is an avenue but it is not the only one. Here is an alternative, exploiting parallel monetary instruments.

  18. CommentedMark Pitts

    Professor Stiglitz is correct when he says austerity is not working well. But his proposed solutions, as always, boil down to income and wealth redistribution. That, too, would fail.

  19. CommentedShane Beck

    A fixed exchange rate is good for the northern European countries as their principle focus is upon manufactured goods. A fixed exchange rate is bad for the Southern European countries whose principle focus is upon tourism and shipping where a floating currency would be better. Whether the differing cultural, religious and social values come into play is anyone's guess but the core principle remains that Northern Europe and Southern Europe are fundamentally different and any attempt towards union is doomed to failure.

  20. CommentedVirgil Bierschwale

    Germany will eventually come to the realization that its own future is tied to America and Europe's ability to purchase the finished goods that America produces.

    As more and more Americans, and Europeans are unable to purchase these finished goods, Germany will be able to sell fewer and fewer of the components that make up the American finished goods.