Paul Krugman has a short post on the Eurozone, today (I’d like him to write more about us; he has been too America-centered lately), pointing out that the myth of fiscal profligacy is, well, just a myth. in fact, he argues, the only fiscally irresponsible country, in the years 2000 was Greece. It is maybe worth reposting here a figure that from an old piece of this blog, that since then made it into all my classes on the Euro crisis:
The figure shows the situation of public finances in 2007, against the Maastricht benchmark (3% deficit and 60% debt) before the crisis hit. As Krugman says, only one country of the so-called PIIGS (the red dots) is clearly out of line, Greece. Portugal is virtually like France, and Spain and Ireland way better than most countries, including Germany. Italy has a stock of old debt, but its deficit in 2007 is under control.
So Krugman is right in reminding us that fiscal policy per se was not a problem before the crisis; And yet, what he calls fiscal myths, have shaped policies in the EMU, with a disproportionate emphasis on austerity. And even today, when economists overwhelmingly discuss unconventional measures available to the ECB to contrast deflation, fiscal policy is virtually absent from the debate and continued fiscal consolidation is taken for granted. I will write more on this in the next days, but it is striking how we aim at the wrong target.
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
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
So, on today’s FT the German finance minister Wolfgang Schauble forcefully argued that Europe is on the right track, that austerity is paying off, and that “Despite what the critics of the European crisis management would have us believe, we live in the real world, not in a parallel universe where well-established economic principles no longer apply.”
He then proceeds listing all the benefits that austerity and “well-established economic principles” brought to Germany, and to other countries that followed them. Today, he claims, Germany has strong growth, fueled by domestic demand, and grounded on robust investment and innovation.
Ok, let’s see who lives in a parallel world. Read More
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.
A quick note on Portugal. Let’s start from three facts:
- Austerity did not work. Portugal is in a recessionary cycle. The economy will shrink by 2.3 per cent this year, more than twice as much as the previous government forecast (and the slowdown of exports to the rest of the eurozone, is not helping).
- Austerity is self defeating: the deficit-to-GDP ratio widened from 4.4 per cent in 2011 to 6.4 per cent last year, and is forecasted to be 5.5 per cent in 2013. Far above the target of 3 per cent that the government had agreed with the Troika. My guess is that it will be even larger than that.
- The magic wand of confidence is not magic. The budgetary cuts did not boost private spending, and expectations remain gloomy. The Financial Times article cites the Portuguese daily Público writing “Portugal has entered a recessionary cycle. People have no reason to believe the future will be any better. The [adjustment] programme has failed and has to be changed.” So long for the confidence fairy…
Is this surprising? Not at all. Austerity is likely to be recessionary and self-defeating, when a number of conditions are met. (a) Monetary policy is at the zero lower bound, and cannot compensate the recessionary effects of budget cuts with interest rate reductions. (b) Trading partners are also in a slump (and/or they are also implementing austerity measures), and hence exports can not substitute for decreased domestic demand. (c) The private sector is deleveraging, and subject to a credit crunch. Read more
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…