Mario Draghi, in an interview to the Journal du Dimanche, offers an interesting snapshot of his mindset. He (correctly in my opinion) dismisses euro exit and competitive devaluations as a viable policy choices:
The populist argument that, by leaving the euro, a national economy will instantly benefit from a competitive devaluation, as it did in the good old days, does not hold water. If everybody tries to devalue their currency, nobody benefits.
But in the same (short) interview, he also argues that
We remain just as determined today to ensure price stability and safeguard the integrity of the euro. But the ECB cannot do it all alone. We will not do governments’ work for them. It is up to them to undertake fundamental reforms, support innovation and manage public spending – in short, to come up with new models for growth. [...] Taking the example of German growth, that has not come from the reduction of our interest rates (although that will have helped), but rather from the reforms of previous years.
I find it fascinating: Draghi manages to omit that German increased competitiveness mostly came from wage restraint and domestic demand compression, as showed by a current account that went from a deficit to a large surplus over the past decade. Compression of domestic demand and export-led growth, in the current non-cooperative framework, would mean taking market shares from EMU partners. This is in fact what Germany did so far, and is precisely the same mechanism we saw at work in the 1930s. Wages and prices would today take the place of exchange rates then, but the mechanism, and the likely outcome are the same. Unless…
Draghi probably has in mind a process by which all EMU countries embrace the German export-led model, and export towards the rest of the world. I have already said (here, here, and here) what I think of that. We are not a small open economy. If we depress our economy there is only so much the rest of the world can do to lift it through exports. And it remains that the second largest economy in the world deserves better than being a parasite on the shoulders of others…
As long as German economists are like the guy I met on TV last week, there is little to be optimist about…
Last Thursday the ECB cut rates, somewhat unexpectedly. This shows that it takes the risk of deflation very seriously. Good news, I’d say. But unfortunately, press conferences follow ECB Council meetings. And I say unfortunately, because Mr Draghi words often fail to match his actions. Here is what he said on Thursday (I could not resist adding some bold here and there):
If you look at the euro area from a distance, you see that the fundamentals in this area are probably the strongest in the world. This is the area that has the lowest budget deficit in the world. Our aggregate public deficit is actually a small surplus. We have a small primary surplus of 0.7%, compared with, I think, a deficit of 6 or 7% deficit in US, – 6 I think – and 8 % in Japan. This is the area with the highest current account surplus. And it is also the area, as we said before, with one of the lowest – if not the lowest – inflation rate.
Fascinating. Truly fascinating. I will pass on the fact that one of the strong “fundamentals” Mr Draghi quotes, low inflation, is actually the main source of worry for economists and policymakers worldwide, including the ECB, that had to rush into a rate cut that was not planned at least until December! I will also pass on his praise of high current account surpluses while the Commission itself is considering opening an infraction procedure against Germany, for perpetuating an important source of imbalances within the eurozone and worldwide.
No, what I find more shocking is the list of fundamentals Draghi gives: public debt and deficit; inflation; current account balance. Now, it dates back a little, but I remember all of those, in Econ 101, to be defined as instruments of economic policy, supposed to serve the final objectives of growth and employment. It is true that we do rather well in what Draghi calls fundamentals, but I continue preferring to call instruments. Look at this table:
I have reported, for ease of comparison, data from the IMF World Economic Outlook (October 2013), therefore they are not the latest (quarterly or monthly) data. Also, I have highlighted in red the worst performer, and in green the best. And boy, Draghi is right! (Notice incidentally that eurozone inflation was 2.5 percent on average in 2012. With the latest data at 0.7 percent, this suggests that we are running, not walking, towards deflation.)
But if we look at the supposed objectives of economic policy (how would Draghi call these?), the picture changes, quite a bit:
No other major advanced economy is doing nearly as badly as the eurozone in terms of unemployment and GDP. But according to the ECB President we have “the strongest fundamentals in the world”. Does this means that Draghi did not take Econ 101? No, I know for sure that he did take it, and he actually had excellent mentors. To understand Draghi’s claim, it may be useful to read his whole sentence. After arguing that the eurozone has strong fundamentals he goes on:
This does not translate automatically into a galloping recovery. But, actually, it gives you the fundamentals upon which you can pursue the right economic policies. Structural reforms are the necessary and sufficient condition for this to happen. In the absence of that, unfortunately, we are going to stay here for quite a long time.
Here is the answer. The only and one answer. Focusing on instruments instead of targets is the strategy of those who do not believe that a role exists for active economic policies. It is a pity that one of these guys is heading the second most important central bank of the world. And it is paradoxically reassuring that the situation is currently so bad that he is forced to abandon his creed and implement active monetary policies.
Advice for the next episodes: praise Mario Draghi actions, and avoid reading the transcripts of his press conferences.
Sebastian Dullien has a very interesting Policy Brief on the “German Model”, that is worth reading. Analyzing the Schroeder reforms of 2003-2005, it shows that it fundamentally boiled down to encouraging part-time contracts, but it did not touch the core of German labour market regulation:
Note, however, what the Schröder reforms did not do. They did not touch the German system of collective wage bargaining. They did not change the rules on working time. They did not make hiring and firing fundamentally easier. They also did not introduce the famous working-time accounts and the compensation for short working hours, which helped Germany through the crisis of 2008–9.
Thus, Dullien concludes, the standard Berlin View narrative, i.e. the success of the German Economy is due to fiscal consolidation and structural reforms in particular in labour markets, needs to be reassessed to say the very least. But there is more than this.
Dani Rodrik has an excellent piece on Project Syndicate. I strongly advise reading and sharing it. Rodrik points out that structural reforms (if well designed, I’d add) tend to destroy jobs in low productivity sectors, and to create them in high productivity ones. He then argues that for the second effect to happen, the high productivity sectors need to face strong demand. This is not happening right now, so that structural reforms, where implemented, are only contributing to depressing employment and growth. He concludes that the very success of structural reforms depends on fixing the short run aggregate demand deficiency problem, through standard Keynesian policies. The zest of the paper is in the last two paragraphs:
Ultimately, a workable European economic union does require greater structural homogeneity and institutional convergence (especially in labor markets) among its members. So the German argument contains a kernel of validity: In the long run, EU countries need to look more like one another if they want to inhabit the same house.
But the eurozone faces a short-term problem that is much more Keynesian in nature, and for which longer-term structural remedies are ineffective at best and harmful at worst. Too much focus on structural problems, at the expense of Keynesian policies, will make the long run unachievable – and hence irrelevant.
Rodrik states something rather obvious: Read more
I wrote this piece with my friend Jean-Luc Gaffard. It is part of our ongoing thinking on the early steps of the new French administration. But I think it applies beyond France.
The French government faces a double challenge. The short run effects of the euro crisis compound a long-standing problem of competitiveness: from 1997 to 2012, the French market share fell from 5.3% to 3.3% of world exports. France is therefore suffering more than its neighbors, notably Germany, for the current slowdown.
In response to these challenges, François Hollande designed a two-arms strategy. First, he embraced austerity. To reduce public deficit to 3% next year, the French government presented a shocking 36 billion euros budget law for 2013. That will be mostly composed of tax increases. The second arm of the government strategy, a “competitiveness pact”, was, initially, aimed at shifting an important part of the burden of social security (20 billions euros) from firm contributions to the general taxation. Read more
I started by highlighting the French weakness in this particular moment:
- France suffers, like all other eurozone countries, from a protracted period of slow growth; it is the effect of the global crisis, and its vicious evolution into a local sovereign debt crisis.
- This problem is compounded by the structural weakness of France, witnessed by its deteriorating external position in the past 15 years. A loss of competitiveness that contrasts with the increasing strength of Germany.
The commonsensical solution seems therefore to “do like Germany”: structural reforms aimed at lower wages and lower taxes on firms, in order to improve competitiveness (I did not say it, but this of course goes together with a reduced role of the government and a leaner welfare state). Nevertheless, i pointed out that there are a lot of “buts“, that make the solution less commonsensical than it would appear at first sight: Read more
Thanks to the Financial Times of a couple of weeks ago, I have read an interesting paper on tax evasion in Greece. Interesting because it quantifies what everybody already knew: the Greek government is structurally incapable to collect taxes. The study estimates a lower bound of 28 billion euros of unreported income for Greece. As a consequence, the foregone government revenues amount to 31 percent of the deficit for 2009. We are talking about lower bounds here, so both figures could be substantially higher.
The excessive weight of the informal economy, and the inefficiency in tax collection had already been pointed out repeatedly, for example in the last OECD Economic Survey of Greece before the crisis hit (2009). A sentence of the accompanying Policy Brief best summarizes what we already knew before the crisis
The April data on Italian unemployment are out, and they look no good. Not at all. The overall rate (10.2%) is at its maximum since the beginning of monthly data series (2004), and youth unemployment is above 35%. The rest of Europe is not doing any better, with more than 17 millions people looking for a job in the eurozone alone.
We already knew. The latest data just add to the bleak picture. We also know (I discussed it) what the consensus diagnosis is: Too many rigidities, excessively high labour costs, both because of wages and of taxes on labour (the so-called tax wedge). Therefore, let’s have lower wages, and all will be well! Unemployment will disappear, growth will resume. Mario Draghi said it rather nicely:
Policies aimed at enhancing competition in product markets and increasing the wage and employment adjustment capacity of firms will foster innovation, promote job creation and boost longer-term growth prospects. Reforms in these areas are particularly important for countries which have suffered significant losses in cost competitiveness and need to stimulate productivity and improve trade performance.
Last week a number of European public figures joined the ranks of those calling for renewed emphasis on growth. The most remarked was Mario Draghi during his audition before the European Parliament; but equally important was the joint statement of Mario Monti and Manuel Barroso. “Growth” seems to be the word of the month, a must in any European leader’s speech.
I will certainly not complain, about this, because both the reduction of unemployment and the sustainability of public finances in the eurozone simply cannot happen in stagnant economies. Nevertheless, once more, there are some reasons for being worried. At a close look, it seems as if the word were an empty box, simple lip service paid to public opinion in order to keep doing business as usual.