Last week’s publication of a Lancet article1 on the effect of austerity on Greek public health made a lot of noise (for those who know Italian, I suggest reading the excellent Barbara Spinelli, in La Repubblica).
The Lancet article sets the tone since the abstract, talking of “mounting evidence of a Greek public health tragedy”. It is indeed a tragedy, that highlights how fast social advances may be reversed, even in an advanced economy.
Some time ago (March 2012) I had titled a post “Greek Tragedies“. Mostly for my students, I had collected data on Greek macroeconomic variables. I concluded that austerity was self-defeating, and that at the same time it was imposing extreme hardship on Greek citizens. Of course one needed not be a good economist to know what was going on. It was enough not to work at the Commission or in Germany… But the Lancet article also allows to substantiate another claim I made at the time, i.e. that austerity would also have enormous impact in the long run. It is weird to quote myself, but here is my conclusion at the time:
Even more important, investment (pink line) was cut in half since 2007. This means that Greece is not only going through depressed growth today. But it is doing it in such a way that growth will not resume for years, as its productive capacity is being seriously dented.
What makes it sad, besides scary, is that behind these curves there are people’s lives. And that all this needed not to happen.
I think it is time for an update of the figure on the Greek tragedy. And here it is:
I said in 2012 that investment cut in half spelled future tragedy. Two years later it is down 14 more points, to 36% of 2007 levels. I am unsure the meaning of this is clear to everybody in Brussels and Berlin: when sooner or later growth will resume, the Greek will look at their productive capacity, to discover it melted. They will be unable to produce, even at the modest pre-crisis levels,without running into supply constraints and bottlenecks. I am ready to bet that at that time some very prestigious economist from Brussels will call for structural reforms to “free the Greek economy”. By the way, seven years into the crisis, the OECD keeps forecasting negative growth together with unsustainable (and growing) debt.
I also added unemployment to my personal “Greek Tragedy Watch”: Terrifying absolute numbers (almost 30% unemployment overall, youth unemployment around 60%, more than that for women!). And absolutely no trend reversal in sight. A final consideration, related to the melting of the capital stock. How much of this enormously high unemployment, is evolving into structural? How many of the unemployed will the economy be able to reabsorb, once it starts growing again? Not many, I am afraid, as there is no capital left.
Not bad as an assessment of austerity… And yet, just this morning the German government complained for a very limited softening of austerity demands. Errare umanum est, perseverare autem diabolicum…
1. Kentikelenis, Alexander, Marina Karanikolos, Aaron Reeves, Martin McKee, and David Stuckler. 2014. “Greece’s Health Crisis: From Austerity to Denialism.” The Lancet 383 (9918) (February): 748–753. Back
Today we learn from Daniel Gros, on Project Syndicate that the emphasis on German surplus is misplaced:
The discussion of the German surplus thus confuses the issues in two ways. First, though the German economy and its surplus loom large in the context of Europe, an adjustment by Germany alone would benefit the eurozone periphery rather little. Second, in the global context, adjustment by Germany alone would benefit many countries only a little, while other surplus countries would benefit disproportionally. Adjustment by all northern European countries would have double the impact of any expansion of demand by Germany alone, owing to the high degree of integration among the “Teutonic” countries.
Fascinating. The bulk of the argument is that Germany is a small player in the global economy, and therefore that its actions have no impact. I have two objections to Gros’ argument. Read More
Olli Rehn wrote a balanced piece on Germany’s current account surplus. To sum it up:
- He acknowledges that Germany’s surplus is a problem.
- He acknowledges (albeit indirectly) that the initial source of the problem were capital flows from Germany and the core to the periphery; flows that did not go into productive investment but fueled bubbles.
- He (correctly) argues that over the long run some excess savings from Germany is justified by the need to provide for an ageing population.
- He points out that investment has been too low and needs to increase (possible within the framework of an energy transition).
- He also mentions, without mentioning it, the problem of excessively low wages and pauperisation of the labour force, calling for increases in wages and reduction in taxes to boost domestic demand.
This seems to me a reasonable analysis, and I would welcome an official position of the Commission along these lines. Yet, I think that what is missing in Rehn’s piece, and in most of the current debate, is a clear articulation of between the long and the short run.
I would not object on the need for Germany to run modes surpluses on average over the next years, to pay for future pensions and welfare. It is after all a mature and ageing country. Even more, I would agree with the argument that low wages need to increase, and that bottlenecks that prevent domestic demand expansion should be removed. In other words, I would most likely agree on the Commission’s prescriptions for the medium-to-long run.
Nevertheless, there is a huge hole in Olli Rehn’s analysis, that worries me a bit. Rehn seems to overlook the need to do something here and now. Today, with the periphery of the eurozone stuck in recession, emerging economies sputtering, and continuing jobless growth in the US, the world desperately needs a boost from countries that can afford it. And unfortunately there are not many of these.
Germany is instead siphoning off global demand, making the rest of the world carry its economy when it should do the opposite. As a quick reversal of private demand is unlikely, (this, I repeat should be a medium run target), I see no other option in hte very short run than a substantial fiscal expansion.
A cooperative Germany should implement short run expansionary policies (the need for public investment is undeniable), while working to rebalance consumption, investment and savings in the medium run, with the objective of a small current account surplus in the medium run.
That, incidentally, would not make them Good Samaritans. Ending this endless recession in the eurozone (yes I know, it is technically over; but how happy can we be with growth rates in the zero-point range?) is in the best interest of Germany as much as of the rest of the eurozone (and of the world).
A clear articulation between the different priorities in the short and in the medium-long run would benefit the debate. The problem is that then Olli Rehn should acknowledge that in the short run there is no alternative to expansionary fiscal policies in the eurozone core. That would be asking too much…
Wolfgang Munchau has an excellent piece on today’s Financial Times, where he challenges the increasingly widespread (and unjustified) optimism about the end of the EMU crisis. The premise of the piece is that for the end of the crisis to be durable, it must pass through adjustment between core and periphery. He cites similar statements made in the latest IMF World Economic Outlook. This is good news per se, because nowadays, with the exception of Germany it became common knowledge that the EMU imbalances are structural and not simply the product of late night parties in the periphery. But what are Munchau’s reasons for pessimism? Read More
George Soros writes a piece on Project Syndicate, that is both pedagogical and very clear in outlining a possible answer to the current EMU crisis. He starts with a diagnosis of the EMU imbalances that rejects the “Berlin View”, and argues for the existence of structural imbalances
Normally, developed countries never default, because they can always print money. But, by ceding that authority to an independent central bank, the eurozone’s members put themselves in the position of a developing country that has borrowed in foreign currency. Neither the authorities nor the markets recognized this prior to the crisis, attesting to the fallibility of both. Read more
Just a quick note on yesterday’s announcement by the Commission that virtuous countries will be able, in 2013 and 2014, to run deficits and to implement public investment projects.
Faced with an excessive enthusiasm, Commissioner Rehn quickly framed this new approach within very precise limits, that are worth transcribing:
The Commission will consider allowing temporary deviations from the structural deficit path towards the Medium-Term Objective (MTO) set in the country specific recommendations, or the MTO for Member States that have reached it, provided that:
(1) the economic growth of the Member State remains negative or well below its potential
(2) the deviation does not lead to a breach of the 3% of GDP deficit ceiling, and the public debt rule is respected; and
(3) the deviation is linked to the national expenditure on projects co-funded by the EU under the Structural and Cohesion policy, Trans-European Networks (TEN) and Connecting Europe Facility (CEF) with positive, direct and verifiable long-term budgetary effect.
This application of the provisions of the SGP concerning temporary deviations from the MTO or the adjustment path towards it is related to the current economic conditions of large negative output gap. Once these temporary conditions are no longer in place and the Member State is forecast to return to positive growth, thus approaching its potential, any deviation as the above must be compensated so that the time path towards the MTO is not affected.
For once, the Commission is not vague about what is allowed and what is not, and the result is that this announcement will turn out to be nothing more than a well conceived Public Relations operation. Allow me to attach some numbers to the Commission proposal.
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.
Kenneth Rogoff has a piece on the Project Syndicate that is revealing of today’s intellectual climate. What does he say?
- The eurozone problems are structural, and stem from a monetary and economic integration that was not followed (I’d say accompanied) by fiscal integration (a federal budget to be clear). Hard to disagree on that
- Without massive debt write-downs, no reasonable solution to the current mess seems feasible. Hard to disagree on that as well
- Some more inflation would be desirable, to bring down the value of debt. Hard to disagree on that as well.
In a sentence, intra eurozone imbalances are the source of the current crisis. Could not agree more…
Unfortunately, Rogoff does not stop here, but feels the irrepressible urge to add that
Temporary Keynesian demand measures may help to sustain short-run internal growth, but they will not solve France’s long-run competitiveness problems [...] To my mind, using Germany’s balance sheet to help its neighbors directly is far more likely to work than is the presumed “trickle-down” effect of a German-led fiscal expansion. This, unfortunately, is what has been lost in the debate about Europe of late: However loud and aggressive the anti-austerity movement becomes, there still will be no simple Keynesian cure for the single currency’s debt and growth woes.
The question then arises. Who ever thought that a more expansionary stance in the eurozone would solve the French structural problems? And at the opposite, why would recognizing that France has structural problems make it less urgent to reverse the pro-cyclical fiscal stance of an eurozone that is desperately lacking domestic demand? Let me try to sort out things here. This is the way I see it: Read more
Just a quick note. The two largest surplus economies have lately decided to take radically different paths. China expressed concern for the imbalances lying behind its large current account surplus, and pledged since at least 2009 to re-balance its growth model towards higher domestic demand. I had already discussed that a little more than one year ago, noticing how the challenge for China was to steer away not only from exports, but also from excessive investment. In the same piece I had argued that while China seemed fully conscious of its contribution to the global imbalances that had led to the crisis, Germany had decided to walk the opposite path.
And here we are. With timely synchronization, we learn that wages in Bavaria will increase by 5.6% over the next two years, maybe triggering a more generalized increase. Or maybe not. While in China they increased 17% in the year 2012.
Even taking into account differences in inflation and in growth, the difference is revealing. China is actually playing the game it committed to. Not only it tries to reduce its dependence on foreign demand; but, domestically, it is trying to boost consumption and to curb investment.
In the meantime Germany is stuck with its small-country syndrome: export-led growth and restraints to domestic demand (both public and private). In spite of recent troubles, austerity remains the course Europe is following (with disastrous results). It is telling that even when partially acknowledging that austerity did not bring the fruits she hoped for, Angela Merkel can only suggest, as an alternative, structural reforms to boost competitiveness. Expanding domestic demand has not, is not, and will not be an option for the German government.
The Berlin View is alive and kicking.
Yesterday I published a note on OFCE le blog (in French), analyzing one possible outcome of the recent Italian elections: A center-left minority government, with external support of the Cinque Stelle movement led by comedian Beppe Grillo. The last part of the post argues that if a convergence between the Democratic Party and Beppe Grillo were to be found (at the moment the scenario is rather unlikely), it would happen on a number of progressive issues, like for example minimum citizenship income. But then, I conclude, this has implications for Europe as a whole. Here is a translation of the last paragraphs: It is clear that the convergence could hardly happen within the bounds of the current fiscal consolidation. An agreement would therefore need a prior reversal of austerity that, it is worth repeating, was disavowed by the voters. This would not be easy for the Democratic Party that, like the Socialist Party in France, made the choice of fiscal discipline, and has kept a very ambiguous position along all the electoral campaign. But in turn, this has implications for Europe as a whole. European leaders in the next weeks may face a choice between demanding that Italy stays the course of fiscal consolidation, condemning the third economy of the eurozone to political paralysis and probably social chaos; or, accept that a new government is formed, that will most likely abandon austerity. In both cases it will be impossible to act as if nothing had happened. Europe could be forced to rethink its own economic strategies, that are failing not only in Italy. An some countries reluctantly embracing fiscal consolidation (France to name one) could take the opportunity to challenge austerity as the only policy for growth.
Let’s be clear, here. I am totally aware that at the moment this is nothing more than wishful thinking. But hey, you never know…