ShareThis“O tempora! O mores!” – Cicero
by Paul Ballard
February 16, 2013
“ Don’t impose a property tax on a burned-out village.” –
~ Jelaluddin Balkhi known as Rumi, 1207-73
Like me, you will have noticed, since 2009 every few months, with great fanfare the political leaders of Europe huddle together in conference. Each time, the goal is to agree a grand solution to Europe’s lingering debt and growth problems. Yet so far achieving this has eluded them. The USA triggered the Great Recession. The economic meltdown from the Wall Street crash metastasized and spread world-wide. But ironically the USA has emerged from the 2008-09 economic crisis much more strongly than Europe.
The USA is now poised to notch up faster economic growth – over 3%. Meanwhile, Europe will slip into recession. US unemployment is still worryingly high but is below 8%. European joblessness is at an all-time high over 11%. In the worst hit countries – like Greece and Spain – it is over 25%! Across Europe, youth unemployment is over 20%. Resulting skills’ losses will ravage many countries for a generation. By 2012, the US economy has fully recovered the output drop it suffered in 2008/09. In Europe, it may be a decade before all countries do. European nations focused on cutting government spending, where the USA did not. Ironically, their government debt levels rose faster than the USA’s, and their economies are recovering more slowly.
The conundrum of Europe ‘s higher government debt and lower growth holds important lessons for US policymakers. The European Union (EU) – over 500 million population – is a quarter of the world economy, China’s principal export market, and a major US trading partner – 18% of US exports, second only to Canada and twice as much as China. It is a major market for investment and operations for US multi-national corporations. The Wall Street crash dealt a massive blow to Europe. Now, Europe’s continuing weak economy will impact the USA substantially in years to come.
The USA needs Europe to grow faster for its own economic prosperity to increase substantially. It is surprising, then, amidst the wrangling in Washington over debt and the U.S. Federal budget, little attention is given by Pres. Obama and Congressional leaders to economic policy coordination with Europe.
For me, the key questions are : What can America learn from Europe’s continuing economic woes and how to avoid these? What alternative policies could help Europe recover more quickly from the Great Recession? How did Europe’s political system affect how its economy has performed? How well does the Eurozone work in practice?
Europe’s Response to the 2008-09 Global Crash : European policymakers’ response to the 2008-09 global economic crash was quite different from the USA’s : ~ Most EU countries cut government spending in response to reduced economic activity. They delayed assessing weaknesses in their banks and recapitalizing them. Most EU government debt is of short-medium maturity. So, EU governments quickly faced repeated quarterly repayment calls just as tax revenues were plummeting due to falling output and employment. EU governments came under an intense double squeeze : reduced liquidity and greatly increased calls for unemployment and safety net benefits. ~ Government spending cuts added falling government demand to massively reduced private demand. This further deepened the recession. ~ EU banks came under still greater pressure. EU governments borrowed more to make up revenue shortfalls, and private business dried up.
“Austerity” Policies in Action : Successive rounds of EU “austerity” policies did not revive economic activity. They deepened a downward spiral in which government deficits and debt grew – faster than in the USA – due to deepening declines in output, employment and tax revenues. Vulnerability of EU states depended upon : ~ Their exposure to global trade in relation to their economic size – small countries with big exposure (like Greece, Ireland) were far more at risk; ~ The size of their government debt and private bank debts – again small countries with high debt levels ( Ireland, Greece, Portugal) were most vulnerable; ~ The bursting of domestic property market bubbles (UK, Spain, Ireland), coming on top of the US crash, that aggravated the crisis; ~ Underlying structural weaknesses in their economies, notably rigid labor markets, inefficient distorted tax systems, inefficient corrupt governments, and expensive public pension systems.
Fundamental Misdiagnosis of the Global Crash : Until 2008, all EU economies experienced strong economic growth. This includes countries later most affected – notably Greece, Ireland, Portugal, Spain. Eurozone membership – sharing the common currency, the Euro – had not prevented Ireland and Greece from annually growing their economies at six per cent and four per cent respectively. Yet a populist mythology rapidly spread about the so-called “weak” countries of Europe – the aptly named PIIGS (Portugal – Ireland – Italy – Greece – Spain) – mainly in the south of Europe. This said they had only themselves to blame for the deep crises they now faced, as these were due to government profligacy and general laziness of their populations. All the most affected countries were said to be “less competitive” than the less affected ones – particularly Germany. Their labor costs were said to be too high and labor productivity too low. The solution – agreed in the “bail out” plans for such countries as Greece, Ireland and Spain – was to cut government spending, raise taxes and allow deepening recession to force wages to even lower levels.
Such were the terms of the successive “bail-out” plans agreed by these countries with the so-called Troika – the European Central Bank (ECB), the European Commission (EC) and the International Monetary Fund (IMF). The German Government, led by Chancellor Angela Merkel, and the Bundesbank (BB), the German central bank – have been strong advocates of such programs.
But the “bail-outs” were based upon a fundamental misdiagnosis of the Great Recession’s causes and the economic crises the worst hit countries faced. The main driver was not lack of competitiveness or high government debt. It was the “external shock” from the sudden massive drop in global economic activity in 2008/09. This had emanated from the US economy, the largest market in the world. Little if anything could have been done by small countries in Europe – such as Greece and Ireland – to prevent it! The global crash overnight sent global demand hurtling downwards. Beleaguered US banks – hit by high leverage and impending real estate loan losses on a massive scale – withdrew credit from US firms on Main Street, causing massive lay-offs. In six months, Chinese exports – mainly to the USA and Europe – fell by 20%. Empty ships plied the seas. Global consumer demand , including tourism, collapsed.
Greece, Ireland and One-Size Does Not Fit All : Despite the standard approach adopted in their Troika supported “bail-outs”, the EU’s worst hit countries faced very different situations, each requiring differing solutions.
Greece. – Dependence upon merchant shipping ( as number one global shipping operator) and upon tourism, both of which collapsed in 2009, caused Greece’s economic crisis. Its severity was to be sure aggravated by high government debt and spending, rigid labor markets (including a 50% payroll tax!), low tax revenues and high evasion from excessively high tax rates. Greece’s government debt was too high. And too short-term in nature. This precipitated an almost immediate payments’ crisis. Despite populist anger in Germany at “lazy” Greeks, the average Greek works 1900 hours a year, to 1450 hours for the average German! Doubtless the Greek government has been quite inefficient and patronage-ridden. However, the Greek bail-out plans agreed with the Troika aggravated not solved Greece’s economic problems. By increasing already high tax rates as well as spending cuts, and not rescheduling Greece’s debt, they deepened the Great Recession into a Greek depression. Greece’s economy has shrunk by 25% since 2009! The bail-outs are also at cross-purposes with the structural reforms Greece’s economy needs. The tragedy is Greece has a highly educated labor force, but now faces a big “brain drain” of talent, and massive unemployment.
Ireland. – In 2001-07, prior to the Great Recession, Ireland had possibly the most productive export-led economy in all the EU. Its government debt and public spending were much lower than Germany’s. The average Irish income – about $47,000 a year – was even higher than the average German’s or the average Frenchman’s. It was the bursting of the Irish property market bubble combined with the failure of Ireland’s three global-sized private banks that precipitated Ireland’s economic collapse in 2009. The Irish Government took the rash decision to underwrite fully the massive losses of these banks – thus more than tripling the government debt overnight! Again, failure to reschedule the latter, under the “bail-out”, led to massive tax increases and spending cuts, further depressing the economy and increasing unemployment.
Key Lessons from Europe : –
~ EU “austerity” policies aggravated the Great Recession. Unlike the US Federal Government and Federal Reserve, the EC and the ECB failed to to combine fiscal stimulus, monetary easing and debt consolidation immediately to bolster consumer demand.
~ EU political institutions are dominated by national political leaders of individual EU states. They lack broad popular legitimacy and representativeness across the entire EU population – as the U.S. Federal Government has across the USA. This makes economic policy making for the EU as a whole extremely contentious, difficult and time-consuming. The largest EU states (notably Germany) with divergent priorities from other states, have forced through policies not in the best interests of the smaller, less powerful states. These have weakened the EU overall in terms of growth and the functioning of the single market.
~ EU leaders have, after much delay, begun to recognize these weaknesses. Efforts are underway to strengthen fiscal policy coordination, and to set up EU-wide bank supervision and regulation. However, they will only kick in in 2014-2015.
~ The urgent priority of debt rescheduling still needs to be addressed, and faces continuing ECB and German resistance. It is nevertheless essential – both for worst hit governments – to create headroom for fiscal stimulus to jump start growth; and to recapitalize banks to finance expanded private business activity.
~ EU economic recovery is vital for the USA. For without it, America stands to lose one third of its economic growth.
I, for one, sincerely hope the EU moves quickly to relaunch economic growth, and that the US Government actively supports these efforts! Let’s make 2013 the year we put the Great Recession behind us!