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Too Much Trust in EU Institutions

9. January 2014, von Adriaan Schout, Comments (0)

The general impression is that the EMU zone (which gathers countries belonging to, or potentially belonging to, the euro) suffers from a crisis of trust. How can we move forward with European integration when people lack trust in EU institutions? The facts may however be quite different: there is too much trust in the EU institutions and too much trust in the reform capacities in the EMU countries.

The guiding rule for EU-leaders has been to restore trust in the EMU and to get economic growth in the EU back on track. Many steps are being taken to rebuild trust ranging from fiscal compact and banking union, to measures to increase the relevance of subsidiarity. Overall, these measures and the fight for trust will – optimistically – lead to deeper integration.

However, the EMU zone may not suffer from a lack of trust. Paradoxically, this is bad news. First of all, there is generally more trust in EU institutions than in national institutions. Over the past few weeks, I sat in meetings with senior officials and politicians from different parts of the EU. On the question whether they would like to see the EU institutions take over economic tasks and develop into an EU economic government, the answer was decidedly ‘yes’. According to the responses, national institutions (including central banks), have been the cause of the economic and banking problems.

This trust in EU institutions is in accordance with the Eurobarometer which indicates that the people in 17 euro countries have (much) more trust in EU institutions than in their national governments. The bottom of the list with trust in national governments shows euro countries Spain (8% trust national government), Greece (9%), Slovenia (10%), Portugal (10%) and Italy (11%). Other countries with low national trust and higher trust in EU institutions include France (only 24% trust national government) and Ireland (18%).

The consequence of this situation is that there is not so much a lack of trust in the EU (and the related euro institutions) but a national trust crisis – and EU institutions are trusted to manage national economies. If the discussions of the past week are anything to go by, there is a majority of countries in the EU that would like to see the development of stronger European economic governance because they are themselves too weak to run their own economies. In the words of a minister from a country preparing for joining the euro: “the Commission can better decide what is good for us”.

The second reason why there is not a lack of trust in EU institutions is that the EU seems to suffer from traditional over-optimism. Judging by the hope that the EU is better in taking economic governance decisions than national governments closer to their voters, this over-optimism still exists. Greece, Portugal and East European countries were allowed into the EEC/EU. Similarly, accession into Schengen also proved quite easy. Membership was assumed to lead to reforms. In the same vein, despite an argument between monetarist and economic governance economists, euro membership was granted ahead of economic reforms, trusting that membership would do the trick. Hence, the EU has been gambling with economic history based on naïve trust in EU reform mechanisms.

Thirdly, countries have been trusted to be flexible and to develop. However, the French competitiveness index fell from 15th position in 2000 to 22nd in 2013. Italy’s competitiveness eroded as underlined by the drop from 24th position to 49th. Greece managed a slight but hugely painful improvement from 33rd to the 31st position.

Deeper integration is on the agenda. The EU Council meeting of December 2013 concluded additional steps towards banking union and economic contracts. The basis of the economic governance, however, remains a collection of mostly week states; states that seem to have given up managing their own economies and that place their hope in the EU. The EU might as well be doomed with this trust in the EU to solve national reform problems.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

A Not-So-Surprising Accession

9. January 2014, von Alexandre Abreu, Comments (0)

On January 1st, 2014, the day on which the euro had its 15th birthday, Latvia became the 18th member of the eurozone. This accession was prepared over many years and Lithuania is scheduled to follow in 2015, but still this will have come as a surprise to many. Given the predicaments to which eurozone members, and especially the more peripheral and economically-fragile ones, have been subjected to in the last few years, one would imagine eurozone exits to be more likely than eurozone accessions. And yet here we have Latvia proving just the opposite. So what are we to make of all this?

Let us begin by rewinding the tape a few years. Latvia was hit by a severe financial crisis in 2008, as a consequence of the bursting of a credit bubble. In its core, the mechanism was not dissimilar from those which affected most crisis-ridden countries of the eurozone periphery: an inadequate exchange rate (in the case of the Latvian lats, due to its peg to the euro since 2005) giving rise to a mismatch between external economic competitiveness and financial-market inflows and a gradually inflating bubble leading to an inevitable bust triggered by the Global Financial Crisis.

Like the crisis-ridden countries of the eurozone periphery, Latvia requested, and was given, a bailout package (worth €7.5Bn) by the EC-ECB-IMF troika. Quite unlike the peripheral eurozone countries, however, Latvia did have a significant margin to choose between two alternative courses of action when it came to responding to the crisis: given that it had not actually adopted the euro, but merely pegged its currency to it, the choice between internal and external devaluation was a real one. Thus, the Latvian government of the time could perfectly well have abandoned the ERM II mechanism, devalued the lats, undertaken external stabilisation in a way which ensured that the cost of adjustment was borne by the whole of society, and subsequently pursued counter-cyclical fiscal policies. Instead, it chose internal devaluation: keeping the peg and having the overwhelming cost of adjustment be borne by workers through the reduction of ‘labour costs’. The class dimension of this choice is not difficult to see: between having everyone pay (through devaluation-induced inflation) and having workers and the popular classes pay (through wage cuts and austerity measures such as school and hospital closures), the Latvian government chose the latter. And it did so with more than a little cynicism, by attempting to suggest that this choice was made out of social considerations.

Now, we cannot say for sure what would have happened had Latvia made the alternative choice. What we do know, however, is what the selected course of action brought about: a 24% drop in GDP, including a drop by 17.7% in 2009 alone; an increase in unemployment from 8% to 18% in 2008-2009; and the emigration of about one-tenth of the labour force. What the ‘austeritarian’ camp hails as one of its greatest success stories (because of the subsequent recovery: 5.5% in 2011, 5.6% in 2012) is arguably anything but: six years into the crisis, Latvian output remains below the pre-crisis level, unemployment remains at 11% despite mass emigration, poverty and inequality have increased, social services have been slashed, and the demographic fallout of mass emigration will only be felt in earnest further down the road.

What is most interesting to note, then, is that the Latvian government was in a much better position to avoid the social pains of austerity than the countries of the eurozone periphery but nevertheless chose not to do so – and it chose not to do so because what seems like a dysfunctional choice from the point of view of society as a whole, is in fact a perfectly rational course of action from the point of view of particular vested interests. From the standpoint of the financial elite and of the politicians that represent it, joining the euro and abandoning the lats has little to do with the pursuit of noble continental ideals, and a lot to do with further reinforcing of class power. Little wonder then that not more than 22% of Latvians favour joining the euro. And so the tragedy continues.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Pushing on a String: LTRO, Endogenous Money and the Eurozone Crisis

24. October 2013, von Alexandre Abreu, Comments (1)

(slightly wonkish, as Paul Krugman would put it)

At a press conference about a month ago, the President of the ECB, Mr Mario Draghi, raised the possibility of a new round of LTRO (Long Term Refinancing Operation), which, for those less familiar with the topic, consist of large-scale, long-term, low-interest loans to commercial banks across the eurozone, which serve to increase what’s called the ‘monetary base’. While many people think and use the analogy of ‘printing more money’ as the equivalent of undertaking expansionary monetary policy, the reality is that the vast majority of money consists of deposits and is created by the banking sector through credit provision. By extending loans to customers and crediting those loans to their accounts, banks effectively create money (i.e. generally accepted means of payment); and by extending loans to commercial banks, the ECB enables the former to increase the amount of credit, hence money, made available to the economy. The relationship between the monetary base and the total money supply is called the ‘money multiplier’ and the standard view, widely taught to economics undergraduates around the world, is that central banks are largely able to control the total money supply, namely by expanding or contracting the monetary base.
However, this ‘standard’ account of how monetary policy works is shattered to pieces by the abundant evidence provided by developments in the eurozone since the onset of the crisis. As shown in the Figure below (taken from here), between 2008 and 2012 the ECB more than doubled the eurozone’s monetary base (through such programmes as the LTRO), and, lo and behold… there was neither runaway inflation (as most delusional neoclassical economists might have expected) nor anything vaguely resembling a solution to the crisis (as some crude Keynesians might have expected). Quite simply, the enormous expansion of the monetary base did not translate into an increase in the total money supply, i.e. into more credit extended to the economy (M3 in the Figure).

Source: European Central Bank, Statistical Warehouse.

Source: European Central Bank, Statistical Warehouse.

The reason for this, as explained by the largely-ignored Post-Keynesian school, is that banks aren’t actually constrained by the monetary base or fractional reserve requirements when it comes to extending credit: as even bankers themselves will tell you, banks neither function as mere intermediaries between depositors and borrowers, nor do they give out loans to the extent allowed for by the amount of reserve deposits that they hold with the central bank: rather, they extend loans first, credit them into their customers’ accounts and only subsequently do they deposit a fraction of that new credit with the central bank. So in the real world, banks are virtually unconstrained in their ability to create money. Unconstrained by reserve requirements and the monetary base, that is, for in reality they are constrained by other things – crucially, by the demand for credit on the part of potential borrowers, with potentially profitable investment projects, who provide sufficiently good guarantees of paying back the loans.

And that’s exactly where the problem lies. In a situation where aggregate demand for goods and services in the eurozone is constrained by both a massive debt overhang and widespread austerity, many firms are unable to take out additional loans due to over-indebtedness, and the vast majority of the remainder are much less willing to undertake productive investments due to the slim prospects of getting a return on those investments. Thus the attempts on the part of the ECB to control the money supply become like pushing on a string: additional narrow money creation doesn’t actually get pumped into the economy, or only does so to a very limited extent, instead causing the banking system (or some parts of it) to accumulate excess liquidity. Indeed, the reason why the monetary base has been decreasing in the last few months (see Figure above) is that many banks across the eurozone have been paying back their own loans to the ECB so as not to hold on to liquidity for which they don’t have any use. There aren’t that many profitable productive investment opportunities around these days, and even the financing of asset-price bubbles – housing, gold, food derivatives – no longer seems as attractive as it used to.

Now, to be accurate, it’s not necessarily the case that monetary policy has been entirely ineffective: it is probably true that the money supply in the eurozone would have collapsed were it not for the unprecedented expansion in the monetary base. However, the complete breakdown in the stability of the money multiplier shows quite clearly that: i) money is created endogenously in the economy by banks and effectively limited by aggregate demand; ii) we’ve reached a point where narrow money creation is neither inflationary nor expansionary – it’s largely ineffective; and iii) the root cause of the problem is stalled aggregate demand across the eurozone as a whole, owing to rising inequality and over-indebtedness built up over the course of the last 2-3 decades and only made worse by austerity. So whether or not a new round of LTRO is indeed implemented won’t really make much of a difference, at least for the purpose of reviving the eurozone economy and overcoming the crisis.
Want some really ‘structural reform’? Reconnect fiscal and monetary policy, so that the latter is backed up by sufficient stimulus to aggregate demand, and actively promote 5%-6% inflation, so that the debt overhang can be gradually overcome. Of course, the chances of this occurring without major political and institutional overhaul are, well, zero – as are the chances of overcoming the eurozone crisis in the next few years.

Parallel Currencies are no Alternative for the Euro

21. October 2013, von Adriaan Schout, Comments (0)

Many are upset about the ‘TINA-type solutions’ for the euro crisis. ‘There-is-no-alternative’ (TINA) seems to have been an irrevocable characteristic of the euro right from the start. A sense of ‘having been forced onto the people’ was kindled by the fact that in most countries the single currency was adopted without referenda. Subsequently, many of the measures including EFSF, ESM, disputable bail-outs of governments and banks by the ECB, sharpening up of the stability and growth pact and the 2pack (which forces Member States to hand in national budgets before being adopted in parliament) have all contributed to the image of the euro as extremely risky and as an undemocratic intrusion on national competences. On top of this, many countries struggle with the constraints of the dubious 3% rule. If economic governance is to work, Barroso in his blueprint has given a clear insight into what it involves, including an EU finance minister and EU bonds.

There is a sizeable group in the eurozone that does not want these TINA-type steps towards a federalised and centralised EU. Many would like to leave the EU straight away. Others, such as German Professor Kerber and adepts of The Matheo Solution, suggest to introduce types of parallel currencies or currency units (calculation currencies such as the ECU). According to Kerber, if southern states do not want to leave the euro zone, then the countries with a current account surplus should introduce their own currency. He suggests that since the relevant northern countries are only Germany, the Netherlands, Austria, Finland and possibly Luxembourg, the new currency might as well be the DM under the watchful eye of the Deutsche Bundesbank.

Hopes of a parallel currency immediately lead to serious questions (even if we ignore the political complications and impossibilities). Firstly, there are legal questions about breaking away from the eurozone. Will the Commission use all legal means to ensure the integrity of the eurozone? Secondly, one should not think lightly of the consequences for the competitiveness of the new DM block when the DM revaluates. Thirdly, a break-up would complicate the necessary steps towards the banking union even more and thwart the internal market at least in financial services. With bouts of devaluations, any banking resolution mechanism would be frail. However, most worryingly of all would be the fall back towards the ERM (European Exchange Rate Mechanism) days when especially southern countries had to devalue repeatedly. This had profound economic consequences including financial losses while structural changes continued to be stalled and spells of high unemployment because countries mostly postponed devaluations to ensure prestige. (B. Connolly (1994), The Rotten Heart of Europe, Faber and Faber.)

The changes for successful reforms in countries outside the euro framework are (decidedly) lower than within the eurozone. The best options for structural changes in expenditures, labour market reforms, tax reforms, deregulation, anti-corruption policies, rule of law measures, banking supervision, etc. are within the euro system. This will, in the long run also benefit the eurozone and EU more broadly.

Evidently, the costs of dealing with the current bubbles in the eurozone are huge. However, these costs in terms of ban risks and government deficits have already been committed and have been shifted to, among others, the balance of the ECB. They will not go away with a break-up of the euro. Inside or outside the euro, adaptations will remain expensive.

Of course, we can throw away all hope for reform in countries such as France, Italy and Greece. If we are so negative, we would better dismantle the euro as soon as possible. However, it would be in all our interests to ensure reforms. Changes seem to be taking place in and, in any case, prospects for reform are best within the eurozone (ask the Dutch).

Parallel currencies show at least that alternatives for the euro do exist but it seems wise to keep such disruptive alternatives at bay for the time being. Thoughts about parallel currencies are signs of serious euro frustration but not of ‘cold thinking’.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

German Federal Constitutional Court Chews on Role of European Central Bank

18. June 2013, von Almut Möller, Comments (0)

Verdicts from Karlsruhe usually serve as pacifiers for the German public and, more recently, for the eurozone as a whole. Remember the ruling on the ESM and the Fiscal Compact, which the German Federal Constitutional Court concluded was reconcilable with the country’s basic law, or Grundgesetz, in September 2012. What a relief this announcement was for the eurozone’s capitals in their step-by-step struggle for the rescue of the common currency. Germans tend to have a great deal of respect for their constitutional court, and fellow Europeans over the past years learned that every year or so they would have to set eyes onto this city in the southwest of Germany: What does Karlsruhe say?

However, on the euro, things remain far from being put to rest. The overall question that continues to loom is to what extend the more recent rescue measures are covered under the Grundgesetz, or whether they lead to a further Europeanization that the German constitution does not allow for in its current shape. The eurozone continues to be a moving target and at the time of the ESM verdict in the fall of 2012 the judges already knew they would have to chew on another measure of the euro rescue: the ECB’s Outright Monetary Transactions (OMT) programme announced as the court was still dealing with the ESM and the Fiscal Compact. With the programme the ECB said it was ready to buy government bonds of eurozone countries affected by the crisis in order to stabilize their interest levels.

Critics say that this programme violated EU treaties, in particular article 123 of the Treaty of the Functioning of the EU. It is however widely assumed that without this bold move of the ECB the eurozone would not have made it into 2013. What is being questioned though by several groups, among them the NGO “Mehr Demokratie” supported by various organisations and 37.000 German citizens is the legality of the rescue measure. Did the ECB go well beyond its mandate and did it thereby violate the budgetary rights of the German parliament and of German taxpayers? Clearly, these are fair and reasonable questions to ask.

With an impressive line-up including Minister of Finance Wolfgang Schäuble, powerfully eloquent political figures such as Gregor Gysi, the head of DIE LINKE in the Bundestag, and the euro-critic MP Peter Gauweiler, the president of the Bundesbank Jens Weidmann and ECB executive board member Jörg Asmussen, the stage was set for drama in Karlsruhe. The media particularly loved what was framed as two gladiators, reportedly friends from university days in Bonn, confronting each other in the courtroom: Jens Weidmann, well-known for its critical stance on the ECB’s bond buying programme, was the only member of the Governing Council that voted against the programme in the fall of 2012. Jörg Asmussen then has been an articulate and public advocate of the ECB’s programme, making the point that while indeed the mission of the central bank was to work for price stability in the eurozone, there was no point in sticking to a narrow interpretation of the mandate when the eurozone was facing a breakup. There are a number of very complex issues that the court will have to look at in the months to come, and many of them are without precedent. But not surprisingly, German gladiators deliberate even the hottest issues in the calmest way – no big surprises in the courtroom last week.

Politically speaking the issues on the table are certainly powerful, and potentially challenging what has perhaps been the most effective intervention in the euro rescue so far. The weird thing is that while the current German government and all that work for a further recovery of the eurozone certainly long for yet another pacifier made by Karlsruhe, the court might have to disappoint when it announces its conclusions in the fall: de facto, Karlsruhe for now is dealing with a non-issue. So far, the ECB only announced the OMT programme without implementing it in detail, a move that proved enough to prevent the breakup of the eurozone. Can a mere announcement form the basis of a court case? The president of the Federal Constitutional Court Andreas Voßkuhle during last week’s hearings made the point that the court’s power was limited. The ECB was an independent European institution, indicating that it was beyond Karlsruhe’s competence to rule over the ECB’s action. Commentators say there is a chance for the case to be conveyed to the European Court of Justice in the end – which perhaps would bring a different dynamic to the outcome.

What has already been a feature of last year’s deliberations on the ESM and the Fiscal Compact was visible again last week: The highest German judges would perhaps like to stay away from the politics of the euro rescue, but because of the nature of the complaints clearly struggle to do so. Ironically, the ECB would (or should) also be more in its comfort zone in a less politicised role.

The real baffling issue around last week’s shoulder rubbing between Karlsruhe and Frankfurt is therefore the weakness (some would even argue the absence) of politics. Without any doubt, the OMT will not solve the problems of the eurozone in the end. For the eurozone’s governments still to make their case! I am not sure the June summit will bring some of the much-needed decisions and will get back to this.

Reckless Spending and Excessive Wage Growth: Myths Debunked

13. June 2013, von Alexandre Abreu, Comments (0)

If I were to pinpoint the two most harmful and most often repeated myths at the core of the orthodox account of the euro crisis, these would surely be, first, that the public debt crisis across the eurozone was solely or mostly caused by reckless government spending; and second, that the fundamental competitiveness problem of the economies of the eurozone periphery is a result of excessive real wage growth. Both of these propositions have been repeated so often that they have become a sort of common wisdom – and yet they are both false.

Let us begin with the first proposition. The problem with it, of course, is that it disregards the crucial facts that: a) budget deficits are an endogenous variable whose ‘receipts’ and ‘expenditures’ components are both adversely affected by recession, as indeed they have been in the last few years and especially so in 2008-2009; b) that in many eurozone countries, bank bailouts account for a substantial portion of the budget deficits of the last few years and c) that factors other than budget deficits contribute to public debt levels spiralling out of control – namely the compounding interest charged on that debt, particularly when far in excess of GDP growth (the so-called ‘snowball effect’). Take all of these into account and you get a very different picture from the alleged government largesse.

Of course, there is a lot to be said about the quality of public finance in many of these countries in the last few years or decades, including with respect to ruinous public-private partnerships, tax exemptions and other forms of government capture by vested interests. However, the idea that the simultaneous public debt crises of numerous eurozone countries was caused by governments in all of these countries suddenly and recklessly deciding to increase spending on a whim is, quite simply, not true. What really underlies the public debt crisis is the lethal combination of recession, deflation and the unbelievably Byzantine financial-sector mediation between the ECB and governments (a case-study in financial expropriation for many decades to come). And the corollary is that austerity only makes everything worse and will continue to do so; the only way to solve the (public and private) debt crisis is growth along with moderate inflation (and in some cases the inevitable write-downs).

The second fallacy is also a particularly persistent and pervasive one, and usually relies on showing how the nominal compensation of employees, or alternatively unit labour costs (ULCs), increased in excess of productivity in the eurozone periphery in the last couple of decades, thereby causing competitiveness to deteriorate. In turn, this argument very quickly leads to the conclusion that regaining competitiveness requires sharp wage cuts (internal devaluation). This, too, has been repeated to the point of exhaustion, perhaps most notably and recently by Mr. Draghi in a two-hour session with the eurozone’s 17 heads of state and government in March (see the power point here). Both the argument and the conclusion are plainly wrong, however.

As Felipe and Kumar show in one of the most important (and neglected) papers to have been written on the euro crisis , while ULCs lend themselves to an intuitive and correct interpretation at the firm level (say, the labour cost of producing a table or laptop), at the aggregate level of the economy they are constructed using the economy’s value added, rather than physical quantities, as the measure of output – and therefore the ‘intuitive’ interpretation is no longer appropriate. Rather, these authors show algebraically that, at the aggregate level, ULCs are nothing other than a simple product of two factors: the labour share in the functional distribution of income multiplied by the price deflator (rate of inflation). Allow me to rephrase this: an increase in aggregate ULCs can only be accounted for about by an increase in the labour share of income and/or by inflation. Indeed, we can construct an exactly analogous indicator, called Unit Capital Costs (UKCs), which increases to the extent that the capital share of income increases and/or that there is inflation. And what do we get when we do compute this indicator for the eurozone economies? Refer back to Felipe and Kumar (p. 16) and… lo and behold: with the sole exception of Greece, UKCs increased more than ULCs in every single euro zone country both between 1980 and 2007 and between 1995 and 2007.

The interpretation should by now be obvious: Greece was the only euro country where the functional distribution of income changed in labour’s favour in the last three decades; in all the other countries, the capital share of income increased at the expense of labour; and the extent to which the various economies had greater or lesser increases in both their ULCs and their UKCs was a consequence of differential inflation. So ULCs are really quite distinct from real wages; and following this aggregate approach to its logical policy consequences would entail measures to cut down profits, not wages, in order to regain competitiveness. The real culprits of the differential change in ULCs (or the nominal compensation of employees) across the euro zone is differential inflation and the real wage decrease in the European core – not real wage increases in the periphery.

Promoting competitiveness in the periphery through wage compression is therefore both cynical and wrong – in several different ways. First, workers are being forced to foot the bill twice over; second, the prime determinant of economic competitiveness is not sale price per se, but rather sale prices combined with the pattern of productive specialisation (and recessionary internal devaluations are not helping with the latter, either); and third, the Great Stagnation that the US and Europe as a whole have been living through is a consequence of insufficient demand in the context of a massive (though protracted) process of debt deflation, so compressing wages in the current context is a sure way to further compress demand and curb growth (see here for more detailed information on this).

On some occasions, this erroneous diagnosis takes on an especially aberrant and cynical twist: that’s when the argument is constructed around a comparison of nominal ULCs (or the nominal compensation of employees) with real (i.e. deflated) productivity. Seems obviously wrong even to a first-year undergraduate, wouldn’t you say? Well, that’s actually what many analysts and commentators have been doing for quite a while – and it’s also a key part of Mr Draghi’s story (check slides 9 and 10 in his power point presentation, link above).

So neither is the public debt crisis caused by reckless spending, nor is declining competitiveness a consequence of excessive wage increases. And yet, these ‘fairy tales’ are repeated again and again to make us believe them and are used as a pretext for deleterious and counterproductive policies. We’ve been here before (does the name Heinrich Brüning ring any bells?) – and it wasn’t pretty. Shouldn’t we be taking the lessons from history far more seriously?

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

The French Squeeze

14. March 2013, von Adriaan Schout, Comments (0)

There are signs that the economies in the eurozone are picking up in various ways. Recent figures of the ECB on Target2 (the capital account of the eurozone countries within the ECB) show remarkable signs of improvement. The claims of the triple-A countries Germany, Finland and the Netherlands on the problem countries are going down. The Dutch and the German claims at the peak of Target2 lending in 2012 amounted to € 173 billion and € 750 billion, but these have dropped by almost 20% since. There are many explanations for this development. Draghi’s promise to do ”whatever it takes” to keep the eurozone intact, has created the trust needed to restart trade in sovereign debt of Spain, Ireland, Portugal and Italy. In addition, (wage) reforms and austerity measures have reduced the imports; investors are returning and exports of for example horticultural products are increasing.

These developments in the south imply enormous reductions in risks for the budgets of northern countries. If the situation in the problem countries had deteriorated, the Target2 claims could have end up as losses – and downgrades – for the triple-A countries. These claims are not just important in terms of abstract risks on the ECB books, but they also have practical implications for the national debt positions. The Dutch government used the profits from the Central Bank on the sovereign debts from Southern countries to lower its public debt figures, so that the deficit is at least cosmetically closer to the 3% monitored by Olli Rehn. However, including the Target2 risks of the ECB in the national budgets would show that national debts are potentially much higher. Also in this respect the drop in the ECB’s Target2 exposure is good news.

However, the difficulties in the eurozone and the Target2 risks are far from over. The Global Competitiveness report for 2012-2013 displays the many remaining economic hurdles in the eurozone including repeated warnings over inflexible labour markets in Spain. Moreover, the outcome of the recent elections in Italy obviously creates additional challenges.

The real worry however is France. Its Target2 deficit has not gone up due to the deterioration of its current account. Moreover, its public debt is rising above 95% – which means that its debt becomes unsustainable. The global competitiveness index of France has fallen last year from 18 to 22. It is doubtful whether the French social economic institutions – including its labour relations – are up to the economic challenges France is facing. Despite the efforts of Olli Rehn with the reinforced EU semester, France has shown few signs of improvement over the past year. Worryingly, with the economic reforms in its neighbouring countries including Spain and the Netherlands, its competitiveness and current account balance is being threatened from all sides.
We saw in August 2011 that financial markets woke up to the worries over Italy’s economic situation. Typically, this awakening did not happen with a whisper but with a bang. The crisis in the eurozone was then probably at its worst because of the size of the Italian economy. An immediate crisis over France may not be around the corner, but all ingredients for the next major euro problem are present. Symbolically as well as economically, a eurocrisis over France would be extremely damaging to the European integration project as a whole.

It is surprising that the French interest rates are currently still comparable to those of Germany. Either financial markets are irrational or they are counting on Draghi’s unconditional support for France. Both explanations would be very dangerous economically and politically. Irrational financial markets could prove to be extremely volatile and a repetition of August 2012 is possible. Alternatively, German – and Dutch – patience with Draghi and the ECB could reach its limits. FDP chairman Brüderle already warned France that reforms are needed. The EU cannot afford an existential crisis because of French economic negligence.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Euro crisis: a View from Lisbon

20. February 2013, von Alexandre Abreu, Comments (0)

In my first contribution to this blog, I would like to start with outlining what I’ll set out to do in the coming months. The readers of this blog will be quite familiar with the ‘orthodox’ account of the current crisis in the eurozone: profligate public spending by governments in the European periphery, which need to be brought under discipline from the outside, coupled with anaemic growth/recession largely caused by excessively high wages and excessive labour market regulation, calling for ‘structural reform’. Moreover, readers will also be well acquainted with some of the systemic aspects which have long been emphasised by the more politically-progressive accounts: the inability on the part of peripheral economies to adjust to asymmetric shocks after having forfeited most of their economic policy instruments; their dramatic loss of competitiveness due to an overvalued Euro and an overvalued implicit internal exchange rate; the ECB’s late, indirect and highly conditional assumption of its role as lender of last resort; not to mention the deleterious effects of austerity upon growth, employment, social cohesion… and even the budget deficit and the sustainability of public debt themselves.

I will not be rephrasing these arguments in detail. Rather, in addition to commenting on new developments as they occur, what I’ll try to do is to render all of the above a bit more vivid to you by showing how these rival accounts apply to the Portuguese case; how general factors and forces at the European level articulate with class interests in Portugal; what the effects of the prescribed medicine have been in this country; and what the balance of forces and the state of the public debate are at any given moment.

As an appetiser of sorts, here are some of the issues that I’ll be expanding on in my next few blog posts:

  • Seen from the left, burgeoning public debt is largely a consequence of the crisis, not a cause (Portuguese public debt stood at 72% of GDP in 2008, compared to over 120% at present). However, there have been, and continue to be, serious issues concerning the quality of public spending (including public-private partnerships that commit the Portuguese Government to ensuring internal rates of return in excess of 10% to major conglomerates for decades to come).
  • Seen from the left, rising labour costs in Portugal have not been the cause of deteriorating competitiveness (indeed, unit capital costs have increased more than unit labour costs over the last two decades). Rather, the overvalued (implicit and explicit) exchange rate, alongside the inability to upgrade the pattern of productive specialization (itself explained by structural factors), are what is to blame.
  • Seen from the left, the medicine that has been prescribed in tandem by the ECB-EC-IMF “troika” and the right-wing Portuguese government places all the burden of an “adjustment” which will not work upon those who are most vulnerable and least responsible: workers and popular classes. This involves dismantling a Welfare State that is barely 40 years old, having been a product of the 1974 democratic revolution – a settling of scores long sought by the most conservative sectors of Portuguese society.
  • Seen from the left, the way in which the crisis has been addressed so far by both the Portuguese and European authorities is not at all about bringing public debt under control or boosting competitiveness. Rather, it is about seizing a unique opportunity to re-engineer society in neoliberal fashion, by dismantling the Welfare State and sharply compressing direct and indirect wages.

These are critical, dangerous, but also very interesting times. I hope you’ll find my left-leaning views from Lisbon to be interesting and informative, too.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Blog Authors

Adriaan SchoutAdriaan Schout

Dr Adriaan Schout is Deputy Director Research/Europe at Clingendael, Netherlands Institute of International relations. (read more...)

Alexandre AbreuAlexandre Abreu

Dr Alexandre Abreu is a 33-year-old Portuguese economist with a PhD from the University of London. Currently he is a lecturer in Development Economics at the Institute of Economics and Business Administration, Technical University of Lisbon, and a Researcher at the Centre for African and Development Studies of the same University.

Almut MöllerAlmut Möller

Almut Möller is a political analyst in European integration and European foreign policy. She is currently the head of the Alfred von Oppenheim Centre for European Policy Studies at the German Council on Foreign Relations (DGAP) in Berlin. (read more...)

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