Sunday, November 23, 2014

Stage Three for the Euro Crisis?

BERKELEY – The first two components of the euro crisis – a banking crisis that resulted from excessive leverage in both the public and private sectors, followed by a sharp fall in confidence in eurozone governments – have been addressed successfully, or at least partly so. But that leaves the third, longest-term, and most dangerous factor underlying the crisis: the structural imbalance between the eurozone’s north and south.

First, the good news: The fear that Europe’s banks could collapse, with panicked investors’ flight to safety producing a European Great Depression, now seems to have passed. Likewise, the fear, fueled entirely by the European Union’s dysfunctional politics, that eurozone governments might default – thereby causing the same dire consequences – has begun to dissipate.

Whether Europe would avoid a deep depression hinged on whether it dealt properly with these two aspects of the crisis. But whether Europe as a whole avoids lost decades of economic growth still hangs in the balance, and depends on whether southern European governments can rapidly restore competitiveness.

The process by which southern Europe became uncompetitive in the first place was driven by market price signals – by the incentives those signals created for entrepreneurs, and by how entrepreneurs’ individually rational responses played out in macroeconomic terms. Northern Europeans with money to invest were willing to lend on extraordinarily easy terms to those in the south who wanted to spend, and ample pre-2007 spending made employers there willing to raise wages rapidly.

As a result, southern Europe adopted an economic configuration in which its wage, price, and productivity levels made sense only so long as it spent €13 for every €12 that it earned, with northern Europe financing the missing euro. Northern Europe, meanwhile, adopted wage and productivity levels that made sense only as long as it spent less than one euro for every euro that it earned.

Now, if, as appears to be the case, Europe does not want its south to spend more than it earns and its north to spend less, wages, prices, and productivity must shift. If we are not to look back in a generation and bemoan “lost” decades, southern European productivity levels need to rise relative to the north, and wage and price levels need to fall by roughly 30%, so that the south can pay its way with exports and northern Europe can spend its earnings on those products.

If the euro is to be preserved, and if stagnation is to be avoided, five policy measures could be attempted:

·         Northern Europe could tolerate higher inflation – an extra two percentage points for five years would take care of one-third of the total north-south adjustment;

·         Northern Europe could expand social democracy by making its welfare states more lavish;

·         Southern Europe could shrink its taxes and social services substantially;

·         Southern Europe could reconfigure its enterprises to become engines of productivity;

·         Southern Europe could enforce deflation.

The fifth option is perhaps the least wise, for it implies the lost decades and EU collapse that Europe is trying to avoid. The fourth option would be wonderful; but, if anyone knew how to bring southern Europe's enterprises up to the productivity levels of the north, it would have happened already.

So we are left with a combination of the first three options, also known as “policies to restore European growth” – a phrase that appears in every international communiqué. But the communiqués never get more specific. Europe’s technocrats understand what adoption of “policies to restore European growth” means. So do some of Europe’s politicians. But European voters do not, because politicians fear that spelling it out would be a career-limiting move.

But if Europe does not adopt some combination of the first three options as policy goals over the next five years, it will face a stark choice: either lost decades for southern Europe (and perhaps northern Europe as well), or continued north-south payment imbalances that will have to be financed through fiscal transfers – that is, by taxing the north.

Northern Europe’s politicians should become more explicit about what “policies to restore European growth” actually mean. Otherwise, ten years from now, they will be forced to confess that today’s dithering imposed enormous additional tax liabilities on northern Europe. That might turn out to be the ultimate career bummer.

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    1. Commentedpeter fairley

      1.Inflation as 1/3 cure? Usa is in better shape with money printing and growth but still has weak inflation.
      2. Expand welfare in north as cure? Possibly in France but not likely in Germany;others? Taxes and govt spending already very high in big northern states
      3. South EU could shrink taxes & services? Govt contractors & govt workers are strong in politics so I say this also is unlikely.

      Author admits options 4 & 5 impossible or bad. If these are only options I am more sold on Pimco's Tony Crescenzi's view in "Keynesian Endpoint" book. Govt's and citizens have spent stimulus in advance, &spent retirement funds in advance. Keynes himself warned that deficit spending in boom times worsens the business cycle.
      So, a lost decade or two seems likely.

    2. Portrait of Christopher T. Mahoney

      CommentedChristopher T. Mahoney

      The absence of a growth or employment mandate for the ECB has resulted in zero growth for indebted economies that cannot survive without growth. Europe is experiencing a classic Fisherian debt-deflation spiral. Only inflation can prevent another great depression (already being experienced in Greece, Ireland and Portgual). Because the South has been too timid to demand inflation, the ECB can continue to congratulate itself on its price-stability "success". Draghi knows this, but he doesn't want to look too "Italian", as if being Italian were some sort of character defect. Ditto Monti, who lacks the guts to speak truth to Merkel.

    3. CommentedMoritz G€d1g

      Like it matters what politicians did two years ago.
      Economists like Heiner Flassbeck had been warning for years, now the damage is done, now it is mostly a distribution and timescale deal.
      I have no hope that "the south" will ever become like "the north", their state is synonymous with their geographic position.

    4. CommentedG. A. Pakela

      How about a counterintuitive suggestion: southern Europe could simultaneosly cut both its VAT taxes on consumption and it marginal tax rates on investment income, while at the same time reducing the growth in government spending to roughly the rate of inflation or less!

      Too many economists ignore the fact that taxes are part of the very fabric of the price system. Except that unlike businesses and individuals who actively buy and sell, governement lacks the ability to engage in price discovery. That is, governments have never attempted to adjust tax rates to discover the revenue maximizing rates that should apply to income and consumption based taxes.

      Love or hate his policies, Ronald Reagan "proved" that governement can run high deficits at extremely high, even painful interest rates as long as economic growth is on the upswing.

    5. CommentedEric West

      That sounds all very sensible until you realize that a large percentage of Spanish and Portuguese families take home around €1,000 a month. A 30% decrease would plunge most of these people into poverty unless it was accompanied by a 30% decrease in the cost of living. That could only be achieve if these countries had their own currency. This articles ignores the other disincentives to investment in these countries, including a very high degree of corruption, patchy infrastructure, political and social instability, and a very high level of domestic leverage that implies necessarily high taxation for the foreseeable future. Making Spain cheaper won't necessarily attract investment.

    6. CommentedAndré Rebentisch

      The point is that the Germans joined a deal where price stability was central to the currency, and they won't accept forced inflation.

        CommentedMoritz G€d1g

        "Where was the price stability concern of Germany when the ECB was busy subsidizing the critically over-leveraged, irresponsible German financial system back in 2009 and 2010?"
        you make it sound as if that was exclusive to German banks. The ECB targets an average inflation, that means that Germany gets weighted heavier than the few Greeks that managed to cause over proportional trouble.

        CommentedAndré Rebentisch

        Dear Mr. Gomes,

        the concept of an independent central bank with a strict focus on price stability is an economic model, where the central bank is mostly on autopilot, and politics left to push the remaining buttons. That makes governance less risky and rules other governance concepts out. Your nationalistic pattern completely misses the point. It was a social contract with the German people on the model to be chosen for a EU central bank. A model which served them very well in the past. A conditio sine qua non. Germans won't accept other models, no inflation based policies, no price instability.

        CommentedDaniel Gomes

        Andre, price stability to who?

        Where was the price stability concern of Germany when the ECB was busy subsidizing the critically over-leveraged, irresponsible German financial system back in 2009 and 2010???

        Germans have convinced themselves that the Euro exists to serve them and are not even able to conceive otherwise.

        They got used to see Duisenberg and Trichet not giving a rat's ass about the price stability or economy in periphery countries inclusively raising interest rates while southern Europe was already in recession.

        This hypocrisy and arrogance was shamelessly publicized in the very own Deutsch bank official website with the statements of its head claiming Germany was more important than other euro members and therefore should have the last word.

        Well, if Germany is looking for a financial IV Reich it should think again, it bully behavior has already created so much distrust and division in Europe that very few still believe in a united Europe.

        As someone said, if Germany wants full control its currency with disregard for all those others sharing it, then it should leave the euro.

    7. CommentedElizabeth Pula

      Here's a great link to read that is a whole lot more informative in answering "Stage 3 for the Euro Crisis?".
      Pay attention to that "#6" as noted in the link.

        CommentedDaniel Gomes

        Any serious person who looks at the economy without a right or left wing bias, quickly realises that the lower and middle classes of all developed countries have suffered losses since they opened to Asia trade in the 70s and to China in particular in the last 2 decades.

        The problem is simple, most politicians and economists refuse to accept that the free trade religion which defines them was basically a horrendous deal for the western middle class and subsequently for the respective government's finances.

        The fact that the relation between politicians, banksters and multinationals is extremely promiscuous results in political leaders continuing to protect the status quo by shoveling further tax payers money into these globalized gangsters in order to sustain them and keep the current bankrupt system afloat at the expenses of the blood and sweat of the western middle class.

        Until people wake up and start demanding that their governments impose barriers against the unfair competition of countries like China with its devalued currency and exploited migrant laborers, and demand that free trade only be accepted if countries abide by the same rules, until then we continue heading into the abyss for the sake of western multinationals profit.

    8. CommentedElizabeth Pula

      A very lengthy rehash of rehashes to reach this final paragraph.

      How about starting to mention real policy options to combat results that are revealed in these BBC graphs:

      I definitely have to agree with one of the other comments on this page that I am really tired of all the verbiage, and "no guts" to actually present any real ideas especially by leading economists. Yes, this is another well written article , and reaches a reasonable, logical conclusion. But MG, all it does is repeat what everyone already knows, and has known for years now. It's already ten years beyond any past for forced confessions. The tax liabilities are already being dumped on the majority of citizens that don't have any incomes left to assume additional tax burdens.

      With the unemployment trends that are indicated from the BBC graphs, I doubt very much that word games will prove any kind of win-win situation for the majority of people in either the North or South EU regions.

      How about some "explicit" alternatives by leading economists with some guts to reveal and discuss alternatives? Economics is meaningless without addressing political issues.

      So, I am more than implying that I think that the majority of writers of economic articles really have no guts to jeopardize their own income positions so there is never any revealing publicly of any kind of comments that could have a remote possibility to "rock any boat" anywhere.

      Are you just waiting to write a review about a scenario of economic chaos to pick up the slack?

    9. CommentedZsolt Hermann

      We will not solve the crisis until we find a positive, common motivator for each country and individual to relate to each other and the common whole with mutual responsibility and concern.
      We need a global, integral education program to explain to people all over Europe and the globe in a transparent, factual, scientific way that we live in a global, interconnected and interdependent human network, where the success and prosperity of any individual, any nation is dependent and directly related to the success and prosperity of the whole.
      A change, adjustment at one end of the network immediately directly affects all the other parts of the network, there cannot be any partial, or local adjustments, changes without taking the whole system into consideration.
      Only when everybody clearly understands and accepts this then it is possible to revise the current system to succeed, and only then will we be able to build a sustainable future.

        CommentedEdward Ponderer

        "United we stand, divided we fall." Never have the words been truer in history. For it is no longer about the bonds of individuals as individuals, but rather the sinews, blood vessels, and nerves connecting the cells, tissues, and organs of a single body. And bodily organs better coordinate and care.

    10. CommentedPaul A. Myers

      There needs to be credible plans to put millions of people back to work across Europe, in particular southern Europe.
      Only additional employment can generate the income to sustain on-going financing.

      If there is not employment expansion, then the citizens of Europe are going to start voting for breakup because in the extremity departure from the euro and devaluation will create a situation where employment can expand.

      I suspect "elite" solutions have a lot less time to prove themselves than many people think.

    11. CommentedDaniel Gomes

      Tired of these biased pseudo-economists.
      Why is that no one bothers to look at the numbers anymore?

      Take a very good look at the per capita GDP growth adjusted to inflation in all European countries until the ratings agencies started to downgrade the credit rating of periphery countries and do tell me what do you see.

      With few exceptions like Sweden, there are absolutely no facts to substantiate this argument of northern economical superiority.

      By the way, is Ireland a northern country? They just prospered since they adopted the Asia model of low taxation and attracting foreign investment

      What about Iceland? Also a southern country? They unilaterally defaulted on their debt unlike southern European countries.

      What about UK, also southern Europe?
      Every single statistic shows that UK even after multiple QE and currency devaluation is still in a worse situation than most southern European countries, and if you consider private debt and foreign reserves, it is actually in a worse situation than Greece.

      What about the absolutely extreme over leveraging of German financial sector mostly on US subprime assets which was cleaned up by the ECB and FED through massive amounts of subsidization from 2008 to 2010?

      Stop the ridiculous bias.. it was this same bias that led us to this situation.

    12. CommentedMarcello Casalena

      That's only true for productivity-adjusted wage increase, but in reality the difference between north and south Europe is a difference of productivity, not of wages.
      The wages in Italy has growth slower than the inflation, resulting in a decrease of the purchase power of the population. Still the productivity -after taxes- has grown at an even slower peace.