In the past weeks I have argued at length that the eurozone is in recession because of a strong contraction of aggregate demand; and that in spite of this fact the overall fiscal stance is restrictive.
I also argued that in the current situation the best that can be hoped for peripheral countries is a more gradual consolidation (ideally a neutral stance, but this is too much to ask). I do believe that a fiscal expansion, even in the periphery, would be sustainable and growth-enhancing. But at this stage this is just daydreaming. It won’t happen.
The fiscal stance of the eurozone will not become expansionary (as is sorely needed), if the core (and in particular Germany) does not implement robustly expansionary fiscal policies.
If their fiscal space is limited or non-existent, what can peripheral countries do, besides waiting for an improbable fiscal stimulus in Germany? A lot, actually. If public demand cannot be significantly increased (and will actually be further compressed, albeit at a slower pace), it is all the more important that the governments of Italy, Greece, Spain and so on, find ways to restart private demand.
There is a lot of discussion about structural reforms. They are not the answer. First, because they have an impact mostly on supply (and the problem, let me repeat it, is demand); second, because their benefits, if any, won’t materialize before a few years. And there is no time. The cumulate effect of five years of crisis is now threatening social cohesion in most peripheral countries.
A more straightforward policy, that could be implemented in the next few months with immediate effects, is a strong redistribution of the tax burden towards higher incomes. The increasing inequality of income of the past three decades is in my opinion one of the deep causes of the crisis; inequality has further increased since 2008. The squeeze of revenues for low incomes, coming from the combination of high unemployment and fiscal adjustment, is depressing both the capacity to spend and the morale of households. Increased inequality contributed to global imbalances in the past, and is recessionary in the current crisis.
In September, when the season of budget laws begins, governments in the periphery should propose to their parliaments revenue-neutral tax adjustments, lowering taxes on low income households and increasing them on the rich and very rich. This would be fair, and more importantly, effective to boost morale and consumption. I am talking about a substantial shift of the burden, large enough for its macroeconomic impact to be significant. This is all the more necessary if standard Keynesian deficit spending can not be implemented.
Update: just a link to Wolfgang Munchau, who seems to make a similar argument.
Austerity partisans had a couple of rough weeks, with highlights such as the Reinhart and Rogoff blunder, and Mr Barroso’s acknowledgement that the European periphery suffers from austerity fatigue.
In spite of the media trumpeting it all over the place, and proclaiming the end of the austerity war, it is hard to believe that eurozone austerity will be softened. Sure, peripheral countries will obtain some (much needed) breathing space. But this is neither a necessary nor a sufficient condition for a significant policy reversal in the EMU.
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.
I just published an editorial on the Italian daily il Corriere Della Sera (in Italian), that summarizes my views on the causes of the crisis and of global imbalances. It is a reprise of one of my first posts, written with Jean-Paul Fitoussi. It is useful to summarize and refresh the argument:
A picture of Germany somewhat different from the recent past emerges from two articles in the Financial Times of March 30:
- The first shows that, in a framework of decreasing unemployment, Germany’s domestic demand shows signs of vitality. Investment, and more remarkably consumption, increased moderately in 2011 and are forecasted to continue this year. Contrary to what happened in 2009-2011, most of growth for 2012 should come from domestic demand. This goes with (finally!) increasing wages, and some signs of price increases.
- The second article reports discussions on the ratification of the fiscal compact, with some parties in the Bundestag calling for a stop to austerity and for more solidarity towards troubled countries.
This does not mean that the overall stance of Germany will become openly expansionary, as would be sorely needed. But it is at least an indicator that the German domestic context is less monolithic than it used to be. This cannot be bad…