The Labour Party was congratulating itself yesterday on having joined with Tory rebels to defeat the Tory-led government by voting to cut the EU budget. In truth, this was sheer opportunism. While the two Eds (Miliband and Balls) may believe that supporting belt-tightening in Europe is good populist politics, in truth, Labour has shot itself in the foot.
Why? Because the vote was not about whether the British hate Europe—doubtless many do and will continue to rally round the Daily Mail. Rather, it’s a vote about the principle of adopting further deflationary policies.
By voting to cut the EU budget, Labour is aligning itself with budget cutters throughout the EU—in the main, centre-right parties. With euro-zone unemployment now above 11% (in some member-states above 25%!) and Europe headed for even deeper recession, any sensible progressive politician should be shouting out for co-ordinated fiscal expansion. What’s needed is the opposite of budget cutting—a far larger EU budget which could be used to reflate the economy and transfer resources towards the neediest regions.
Granted, under current arrangements, the EU budget is nearly useless as a vehicle for driving reflation. Bright economics-trained shadow ministers like Rachel Reeves and Chuka Umunna—even the Pro-EU Shadow Minister for Europe Emma Reynolds—understand this and know what needs to be done, but sadly are forced to toe the party line.
But whether it’s about Britain or about Europe as a whole, it’s time to repeat the message loud and clear—balls to deflationary policies in the midst of recession!
François Hollande’s Prime Minister, Jean-Marc Ayrault, claims the new budget (unveiled on 28 September) is ‘fair, economically efficient and allows France to meet its priorities’. In the carefully chosen words of the Guardian’s economics editor, Larry Elliott, the claim is ‘total moonshine’!
It is true that more than half the €37bn in planned budgetary savings is designed to come from increased taxes on rich households and large companies whilst—in contrast to Britain—cuts in government expenditure spare the poor and the elderly. Particularly welcome is the new 75% tax band for those earning over €1nm a year. But whatever gloss one puts on it, the budget is about reducing the deficit from the current 4.5% to 3% new year—and to near zero by 2017. With the French economy stagnating over the past 9 months and persistent unemployment of 10% or more for over a decade, budgetary austerity—however achieved—is most definitely not the answer.
The success of this budget depends on two key assumptions. The first is that greater budget discipline will bring a return to private sector growth, or to use Paul Krugman’s expression, greater discipline will inspire the ‘confidence fairy’. Thus, the growth rate in 2013 is assumed to be 0.8% rising to 2% annually for the period 2014-2017. But elsewhere in Eurozone austerity is resulting in growing unemployment and stagnation. And a stagnating economy causes budget deficits to widen. For France to reach even the above modest growth target and to reduce its deficit, a strongly reflationary budget would be needed, particularly under conditions of generalised austerity throughout Europe.
Secondly, Monsieur Hollande’s Prime Minister claims that reducing the budget deficit will enable France to retain the confidence of financial markets and therefore to enjoy continued access to cheap credit. This too is nonsense. Throughout Europe, young people are increasingly angry about unemployment and growing job insecurity. As the French economy continues to stagnate, scenes now seen in the streets of Athens and Madrid will spread to Paris. Financial markets may be impressed by austerity in the short term, but in the longer term nothing rattles financial markets more than political unrest. An austerity budget today sets France firmly on the road to unrest in the coming years.
Why then has Monsieur Hollande reneged on his election promise to reject austerity? Why indeed is France going to ratify a so-called Budgetary Pact (TSGC: Traite sur la stabilité, la gouvernance et la coordination) which entrenches the Golden Rule of eventually reducing the annual structural deficit to zero. Some economists of the PS (Parti Socialiste) know perfectly well that such a rule is not merely illogical, but adopting it means abandoning discretionary fiscal policy altogether (having already ceded monetary policy to the ECB.) The pact has already created much discord in the PS and its governing allies; eg, Europe-Ecologie-les-Verts (EE-LV) voted against it in late September, resulting in the departure of the MEP Daniel Cohn-Bendit.
The answer is as simple as it is perplexing. François Hollande wishes to please the Germans. He wishes to please not just Frau Merkel—whose coalition will collapse next year—but the German social-democrats (SPD) whose economic beliefs are not so different from those of Merkel’s CDU. Crucially, Hollande’s argument is that if France is to retain its leading role within Europe and the Eurozone, in the short term it cannot afford to anger either the financial markets (and follow Italy and Spain into spiralling borrowing costs and insolvency) or the northern European austerians.
What is perplexing is that the combination of an austerity budget today and the Budgetary Pact (TSGC) tomorrow ultimately condemns France to long-term economic stagnation. This in itself will kill Monsieur Hollande’s European aspirations. Ironically, some of today’s socialist ministers who in 2005 voted against the EU Constitutional Treaty (eg, Bernard Cazeneuve and Laurent Fabius) now support the TSGC. Indeed, Elizabeth Guigou (Minister in the 2003 Jospin government), who is on record as strongly opposing the Pact, is now willing to vote for it. The so-called ‘sovereignty problem’, much discussed by both the left and right in France, is in reality a red herring.
The fundamental issue is about economics. Unless the left of the French socialists forces a change of course, the PS and the centre-left in France will ultimately suffer grave damage. What is need is not austerity, but a massive stimulus to get France—and more generally the EZ—moving again.
Sadly, throughout Europe, the timidity of the social-democratic response to the economic crisis is resulting in unemployment and disillusion of a scale which threatens to destroy social democracy within a generation.
Nouriel Roubini famously described the long decline of the euro as a ‘slow motion train wreck’. Mind you, economists disagree on exactly when the wreck will happen. Professor Vincente Nabarro has argued that the euro will survive for as long as it serves the purposes of the German (and European) elite while, in the Financial Times, Wolfgang Münchau mischievously suggests the crisis could last another 20 years given Germany’s proclivity for muddling through. By contrast, Megan Green at RGE sees the confluence of crises in Greece, Spain, and Italy during September and October, 2012, as potentially lethal. But all agree that—sooner or later—it will happen.
In Greece, the coalition government will have to agree a package of measures with the troika to secure the latest tranche of bailout money. The problem is twofold: first, Mr Samaras has asked for an extra two years to impose further austerity measures required by the troika, a request which the Germans have already rejected. Secondly, the Greek Parliament must approve the measures, failing which another general election would almost certainly need to be called.
Even if one assumes that Greeks can be paper over their differences once again (or else that Greek default does not produce catastrophic contagion), Portugal is likely to remain locked out of the financial markets and thus forced into a second round of difficult negotiations with the troika. Because the ESM comes into existence in September—assuming the Germans Constitutional Court rules in its favour—Spain too will require negotiations with the new body both on bailing out its private banks and on sovereign bond purchases.
Elsewhere, the campaign in Italy for the April 2013 general election will begin in earnest and Mr Berlusconi can be expected to launch his political comeback on an anti-euro platform, having said quite plainly earlier this year that either Italy gets bailed out or it leaves the EZ. However one views Berlusconi, there should be no doubt about the seriousness of this threat. In September too, France’s President Hollande will advance a budget which is bound to be controversial, while at the same time the Dutch will hold a general election likely to lead to a euro-sceptic coalition.
The situation might not be so dangerous were it not for growing euro-scepticism in Germany. While a majority of Germans may still favour remaining in the euro, over a third of those questioned favour a return to the old currency, the highest percentage in the large EZ countries. Public opinion, moreover, is strongly against what is perceived as further German ‘aid’ to the Club-Med countries (which is reality is ‘aid’ to their own banking system). Spurred by such neo-liberal economists as Hans-Werner Sinn, centre-right German politicians continue to insist that: (a) neither commonly backed Eurobonds nor bank insurance are an option; (b) further ECB sovereign bond purchases are dangerous, and (c) there can be no bank recapitalisation without EZ banking union, and such banking union must be preceded by political union.
But the strong EZ banking union required is not what the German centre-right has in mind, and even were it to accede on this point, German actions (and inactions) to date mean that the chance of achieving political union is growing ever more remote. Nor can we expect much to change were the SPD to enter into a new grand coalition in late 2013. After all, it was the previous SPD-CDU coalition which embedded austerity into the German constitution in the form of the debt-brake law, and the then SPD Finance Minister Peer Steinbrük—now a strong candidate to lead the party into the 2013 election—famously dismissed the Keynesian notion of a pan-European economic stimulus package. Moreover, the ex-central banker, Thilo Sarazzin , whose 2012 book Europa braucht den Euro nicht (Europe doesn’t need the euro) has been a best-seller, is a well-known SPD member.
Without a fundamental shift in the German position—not just on the above issues but on domestic demand reflation and trade imbalances–the euro seems doomed. Since there is no sign of such a shift, Europe sits on its hands awaiting the inevitable economic shock. One source has put the cost to Germany in the first year alone as a 10 per cent collapse in GDP. Perhaps this is the sort of price which, sooner or later, all of us will pay as a result of accepting the deep flaws in the initial structure of the common currency.
In the past 30 years a great number of utilities in the developed world have been privatised. That trend seems likely to be reversed. Why? Because the ideology which drove the project—in particular, the notion that the private sector is always more efficient than the public sector—is collapsing. Effective public ownership is being reconsidered not just for the banking sector, but in rail transport, in water and power provision, in communications—in short, in a range of industries where large scale privatisation and deregulation over the past decades has been tried … and found wanting.
Banking provides the most dramatic example. Deregulation and demutualisation, particularly in the USA and Britain, led to a near-meltdown of the financial system in 2008 and, in consequence, a major and on-going recession—-in Britain, one longer than that of the 1930s. Willem Buiter, chief economist at Citi, argued in favour of taking the biggest banks into public ownership in 2009. Although there was a period of recovery after 2009, recession seems to be returning—and with it ominous signs of another financial and economic crisis, a ‘perfect storm’ potentially far more serious than that of four years ago.
After the banks were bailed out in in 2008, there was much talk of regulation. Today, new revelations and scandals (eg, Barclays’ fixing of LIBOR, HSBC’s money laundering) have again raised the issue of regulation and public ownership. While it is true that in the UK, the public owns two of the largest banks (RBS and Lloyds) and that Labour wants to set up a British Investment Bank, in reality almost nothing has been done to take effective control of the largest banks.
The simple truth is that the financial sector is too big and powerful to regulate effectively. In the US the sector’s ‘lobbying power’—the problem of regulatory capture —is now acknowledged on both the political left and right. And even if the biggest banks are broken up, as Professor Gar Alpervitz of the University of Maryland argues, it is likely that they will come back in even more concentrated form.
Britain is less transparent than the US, but few can deny the baleful influence of the City of London in emasculating the 2011 Vickers Report. Instead of calling for the physical separation of commercial and investment banking, Vickers called for ‘ring-fencing’—and then, only by 2019.
Typically, the argument against publicly-run banks is that they are inefficient; ie, that ‘civil servants cannot run banks’. But the key issue is not one of public efficiency—there are many well-run publicly owned or mutualised banks in the world. The issue is of private efficiency.
Can we afford not to take the largest players into public ownership, particularly if there is another financial crisis? The big private banks have cost the taxpayer trillions and brought about economic depression, resulting in a massive loss in output and jobs throughout the OECD. By speculating against sovereign bonds, private banks are a major player in the current Eurozone crisis. One might add, too, that these same banks have been a major driver of growing income inequality: tax havens have thrived and the culture of bankers’ bonuses has worsened since 2008!
Note that it is not being argued here that all banks should be publicly owned. But if banking scandals multiply, if the advanced economies continue to stagnate, if jobs are scarce and unemployment grows—and particularly, if the taxpayer is asked once more to bailout the banks in the wake of another financial crash—then it is a near certainty that within a decade, the largest banks will become public utilities.
While the punters speculate on the outcome of the Greek election on 17 June, in truth ‘Grexit’ is already happening. Because of massive withdrawals from the Greek banking system, the country is on emergency life support from the ECB. First, following the inconclusive May elections, the ‘troika’ decided that it would postpone the €48bn recapitalisation payment until after the June election. Then, a fortnight ago, the ECB stopped accepting collateral from the Central Bank of Greece (BoG) for several of Greece’s major banks. This collateral is required for weekly refinance operations required to keep the country’s private banks liquid.
In consequence, the central bank has had to seek €100bn from the ECB’s Emergency Liquidity Assistance (ELA), whih is slowly being chanelled to four major private banks. The difference between money received through the ‘normal’ ECB refinancing channel and the ELA is that, in the former case, the loan from the BoG to the private Greek banks is guaranteed by all ECB members while in the latter case it is guaranteed by the Greek state. In the words of one commentator, ‘think of what this means about keeping your money in your local bank?’ Or in the words of another:
“Essentially, ELA represents the ECB passing the risk back to the sovereign. That could be the trigger for potential default … ”
Some think that Greece’s departure may be a good thing. The arguments are familiar enough: first, Merkel and her allies want Greece out ‘pour encourager les autres’. Secondly, a numbrer of prominent economists (eg, Nouriel Roubini) believe Greece will benefit from leaving now rather than later. With Greece gone, a deal can probably be done between Merkel and Hollande over Eurobonds or (minimally at least) ‘project bonds’. The latter would be construed as a victory for the anti-austerity camp. Until recently, that is certainly what I had thought.
As Martin Wolf and others have noted, Greece’s disorderly departure will in all likelihood shatter faith in the Eurozone forever. Given the slow motion bank run in Spain, a Greek bank run will almost certainly trigger massive flight from the single currency. We shall not return to the comfortable prosperity of post-war Europe soon or even later—in all probability, that world has now died.
At the moment, the Euro Area is stagnating, unemployment is rising and the entire banking system is dangerously fragile—in Nouriel Roubini’s phrase, we are watching a slow motion train wreck. But if the opinion polls are right, François Hollande will very soon be President of the French Republic and economic policy in the Euro Area (EA) could become decisively more progressive. ‘Austerity’ could be ditched and Europe could go for growth and jobs.
Hollande can talk the talk, but can he ‘walk the walk’? Whether genuine change is possible depends on a number of factors difficult to evaluate; eg, how markets will react, how Hollande manages the relationship with Germany in the coming months, whether the German SPD can form a government after the 2013 general election and, crucially, whether social-democrats in the EU scrap the current economic orthodoxy. Let us consider each in turn, bearing in mind the speculative nature of any such discussion.
How will markets react to a progressive government in France? The knee-jerk reaction is to invoke Mitterrand’s experience in 1981-3 when financial turbulence forced the social-democratic left to change course within two years and into ‘cohabitation’ within five. And, yes, it must be added that financial markets are far more powerful today. Nevertheless, there are important differences. First, the once-powerful French Communist party (PCF) is no longer of any significance, so there is no red revolution to fear. It is easily forgotten, too, that Mitterrand’s policy failed largely because of rising inflation which rocketed in 1983; inflation is no longer a serious threat today.
An even more important difference is that, with every passing day, politicians and financial ‘experts’ are becoming aware that fiscal austerity leads to a dead end. Far from leading to budget balance, deep expenditure cuts leads back to recession which makes things worse—as we see in Greece, Portugal and Ireland and will soon see in Spain too. Hollande’s message is simple: in a recession, fiscal rectitude is achieved through state-led growth—it is higher national income that generates higher savings, not the other way ‘round. Even the IMF appears to agree.
Doubtless there will be capital flight from France as a result of higher taxes on the rich, but it is unlikely to be massive. Young middle-class French people migrate not because of high taxes but because there are too few jobs, and the extra income from higher taxes on the rich—and from clamping down on tax dodges—can be used to create jobs. Unlike the early 1980s, the French today are far more aware of the inequities of neoliberalism and the time-bomb of unemployment. But if Hollande wants jobs and growth, his proposed ‘stimulus’ will need to be far more than 1% of French GDP.
Hollande’s most difficult task upon coming to power will be calming the Germans while renegotiating the so-called Stability Treaty. There are two issues here. First, Angela Merkel, by openly backing Sarkozy, has declared war on the Hollande camp, presumably because she believes that by so doing she can preserve her own brittle CDU-FDP coalition government. But even assuming she can remain in power until the German general election deadline of September 2013, her popularity is on the wane and numerous polls suggest the most likely electoral outcome to be either an SPD-Green coalition or else a ‘grand coalition’ without Merkel.
The second—and crucial— issue is that of the Stability Treaty. This Treaty requires countries wishing to borrow from the European Stability Mechanism (ESM) to adopt a German-style ‘debt brake’ law limiting their structural fiscal deficit to 0.5% of GDP. As shown in detail elsewhere , the debt brake law is only possible in Germany because of the country’s current account surplus—it is economic nonsense to think such a law can resolve the problem of deficit countries. (This is not a matter of Keynesian economics but follows from simple National Accounting identities.)
Although many EA governments are in the process of ratifying it, the Treaty is deeply unpopular—-and not just in Greece, Portugal and Ireland. In Italy, Signor Monti has made it clear that he thinks it foolish and that jointly-backed Eurobonds constitute a better solution. Belgium’s Guy Verhofstatd agrees and even Sr Barroso appears to support this position. In demanding that the Treaty be changed, François Hollande would have the support not just of the EA periphery but of some of its major players and many of its economic experts. One should bear in mind that the poll indications for Italian Parliamentary elections to be held next spring suggest a centre-left coalition will emerge. Whether the Germans and their Dutch and Austrian allies could long hold out against a majority of the larger EA economies is doubtful.
In short, the victory of François Hollande on the 6th of May might well mark a turning point for the economic future not just of France, but of the EU and of Europe as a whole. While the chain of events outlined above is necessarily speculative, what is certain is that the coming 15 months will see fascinating changes take place. After all, two centuries ago France’s revolution embedded the Enlightenment values of liberté, égalité, fraternité which inform the European centre-left today, values which today’s Europe disregards at its peril. Without a growth strategy, the euro—and the European project—is doomed.
The late Tony Judt once remarked that today’s young people have little sense of social collective public goods and services. The economist’s notion of a public good has lost currency in this age of commodities, not just in the EU but particularly in the Anglo-Saxon world.
Two generations ago, economics undergraduates were taught that such goods were different from soap flakes and hamburgers. Public goods and services are things which need to be supplied—or at least regulated– by the public sector because they are by their very nature collective. Clean water, unpolluted air, education and law and order are obvious examples; there is no doubt that everybody should have such goods, not merely those who can afford to buy them privately.
Public Goods today
These days, because the distinction between ‘public’ and ‘private’ has become blurred, and because amongst mainstream economists the consensus appears to be that the private sector is more efficient than the state, it is commonly thought we should limit the public role almost entirely to that of supervision. In Britain, for example, in the 1990s the railways were privatised and an ‘internal market’ was created within the National Health Service on the grounds that this improved the efficiency of service delivery for ‘customers’. In the USA, it has become common for everything from mass transport to prison services run for private profit. Indeed, there are some politicians who—as followers of the economist Friedrich Hayek— would abolish all forms of state supervision or control, and a few who would abolish all taxation.
Anti-state ideology has its roots in 18th and 19th century romantic libertarianism, but its major driver in the past century was doubtless the Reagan-Thatcher revolution and, at a global level, what became known as the ‘Washington consensus’; ie, the right-wing orthodoxy associated with the IMF and the World Bank. Amongst others, economists such as Anne Krueger and Jagdish Bhagwati helped popularise the notion that civil servants are really ‘rent-seeking’ bureaucrats whose contribution to society is nil.
Market fundamentalism, the best-known US apostle of which was Milton Friedman, was developed inter alia by Thomas Sargent into ‘rational expectations theory’ which argued that markets contain all available information and are populated exclusively by fully informed consumers and producers for whom all future risks are calculable. Such notions provided the intellectual foundation of the anti-Keynesian, anti-state views which came to dominate the profession.
The brief return of Keynes
For a short time after the financial collapse of 2008, it appeared that the Thatcher-era ideology of market fundamentalism—or ‘neoliberalism’ as it is known today—was in terminal decline, but this view proved to be an illusion. While Keynesianism was briefly rolled out to save the advanced countries from total economic meltdown, once disaster was seen to have been averted most politicians returned to the dreary game of peddling austerity to the poor while helping the rich to prosper.
Nowhere was there more enthusiasm for this dismal sport than in Europe in general—where a ‘transfer union’ was unthinkable and the welfare state was soon deemed ‘unaffordable’—-and Britain in particular. In Britain under David Cameron and his Chancellor, George Osborne, privatisation is set to reach new heights as private companies bid for fat contracts to build and manage hospitals, schools, roads and whatever else can be hived off to the private sector in the name of reducing public debt.
The privatisation of everything
Although there are some circumstances in which it is sensible to privatise, there are many good reasons why wholesale privatisation should be shunned. The first and most important reason is that abolishing universal free access to public services will make us less equal. For example, the notion of being ‘equal before the law’ is a hallowed principle which goes back to ancient Greece. Few would deny that where legal aid is denied to the poor while the rich can evade it with the help of clever (and very expensive) lawyers, not only does this make a travesty of justice, but it also threatens social cohesion.
By analogy, a major reason for providing universal health care as a public service is that decent medical treatment should not be a privilege reserved for the few. Equally, because capitalist business cycles result in economic downturns, all tax-payers contribute towards funding unemployment benefit for those unlucky enough to lose their job during such times. When there are ten job-seekers for every vacancy, ‘getting on your bike’ to find a job simply doesn’t work.
The same public logic holds for education. Universal literacy may be instrumental to developing a skilled work force—a notion much loved by Tories—but the real reason we value education is because it is a necessary (though insufficient) component of a well-functioning democratic society. Education is not a commodity to be purchased according to individual preference; it’s central to the meaning of civilised society.
The superior efficiency of the private?
What of the argument that the private sector is more efficient at running things because of competition? Although this may hold true for the production of many commodities (as we know from the sad experience of Soviet-style central planning), it is by no means a universal principle.
It used to be argued that publically-owned industries are necessary in the case of ‘natural monopolies’; ie, where long-term economies of scale in production make for ‘monopoly profits’. It is only fair that government—through ownership or regulation—captures such revenues for the public benefit. Also, because natural monopolies (eg, water, energy, transport) typically require very large initial capital outlays, often the state alone is in a position to finance them. What has happened in recent decades to many public utilities is that, having been established and run by the state often with a strong element of public subsidy, they have been sold to private interests at knockdown prices on the grounds of fiscal rectitude (and with the blessing of the IMF).
Another reason for preferring public provision is where ‘external’ costs or benefits exist. A contemporary example of such an externality is where an industry damages the environment. A private company might want to cut down swathes of forest to grow crops for biofuel, disregarding the long term environmental impact. Such companies typically have short time horizons—they must make profits for shareholders next year, not next century. Government needs to step in to take the long-tern environmental effect—or any other form of market failure—into account.
The notion that competition always makes the private sector more efficient than the public sector is therefore quite unjustified. Markets are not perfect, the future is uncertain, externalities are important and some goods and services by their very nature must be publically provided. What politicians typically mean when they speak of ‘greater efficiency’ is lower costs, typically achieved by employing cheap, non-unionised labour. This is the real reason so many public services are outsourced.
In short, arguments favouring private over public provision are not just theoretically flawed, but typically favour the few at the expense of the many. We may choose commodities at the supermarket, but public goods require collective choices; ie, choices made as citizens at the ballot box. Abolish well-informed collective choice and one abolishes democracy—little wonder Margaret Thatcher argued there was ‘no such thing as society’.
Does the Greek Parliament’s latest vote in favour of further cuts—despite the 40 deputies who defied the whips and were forced to resign—mean that the Greek crisis is resolved? Of course it doesn’t. For one thing, the troika (ECB, IMF and EU) will not approve the €130bn ‘bailout package’ next Wednesday unless Antonis Samaras, leader of the New Democrats, agrees to sign. Samaras has made it clear he will not do so until after the April elections because he knows that if he signs now, his party is toast.
For another, even with Parliamentary endorsement of nearly €4bn in cuts for 2012, it is hard to see how the government of Mr Papademos—or whoever succeeds him after the elections—can deliver. And of course, there must be a serious question about whether Ms Merkel and her Eurozone (EZ) allies want Greece to stay in the euro. As the Dutch PM, Marc Rutte, is reported to have said last week, the EZ is now strong enough to weather Greece’s departure—eurospeak for ‘get out’.
Recall what the troika is demanding for 2012 alone:
- a 22 per cent cut in the monthly minimum wage to €586;
- layoffs for 15,000 of civil servants;
- an end to dozens of job guarantee provisions;
- a 20 per cent cut in its government work force by 2015;
- spending cuts of more than €3 billion;
- further cuts to retiree pension benefits.
These demands come as the country faces its fifth consecutive year of recession, and recent OECD figures showing GDP to have fallen by nearly 15% since January 2009 with unemployment standing at 18.7%. As Helena Smith reports in The Guardian, ‘Greece can’t take any more’. Even with the latest cuts and bailout, it is optimistic to forecast that the country’s debt/GDP ratio will be 120% in 2020. According to the FT’s Wolfgang Münchau: “[a] 120% debt-to-GDP ratio by 2020? That’s 9 years of strikes in Greece,” and that is not sustainable.
Is Greece’s problem high labour costs? Nouriel Roubini’s influential think-tank RGE estimates that as far as labour costs are concerned, the view that Greek wages rose too much during the good years is pure myth. In fact, over the period 2005/08, Greek wages rose less quickly than the average for the EZ.
Further cuts mean further recession, and it should be perfectly obvious by now that Greece cannot pay down its sovereign debt as long as the economy is shrinking. As I (and many others) have explained elsewhere, the debt/GDP ratio can only fall where the rate of interest on the debt is less than the rate of GDP growth. Just as Osborne’s cuts are jeopardising the future of the UK economy, so Merkel’s cuts are sinking a (far weaker) Greece.
Unlike some of my colleagues on the left, I have always been pro-euro. But the suffering imposed on Greece now makes me ashamed of being European.
Europe is obsessed with the growing stock of public sector debt; fiscal austerity has become the watchword of our time. Little does it seem to matter that fiscal austerity means reducing aggregate demand, thus leading to economic stagnation and recession throughout the EU as all the main forecasts are now suggesting.1 Even the credit rating agencies are worried, as S&P’s downgrading of France and eight other countries shows. Whether it’s Angela Merkel or David Cameron speaking, public debt is denounced as deplorable, and all are told to get used to hard times. As Larry Elliot puts it: “The notion that economic pain is the only route to pleasure was once the preserve of the British public school-educated elite, now it’s European economic policy”.2
In Britain, immediately after the general election, the Tory-led coalition decreed that in light of the large government current deficit, harsh cuts were necessary to win the confidence of the financial markets. But although the current deficit was high, the stock of debt (typically measured by the debt/GDP ratio) was relatively low and of long maturity, the real interest rate on debt was zero (and at times negative) and, crucially, Britain had its own Central Bank and could devalue. As Harriet Harman argued in June 2010, Osborne’s cuts were ideologically motivated. The aim was to shrink the public sector, and the LibDems—fearing a new general election—chose to go along with the policy.
In the Eurozone (EZ), where a balance of payments crisis at the periphery has turned into a sovereign debt crisis, the German public has been sold the idea that if only all EZ countries could be like Germany and adhere to strict fiscal discipline, all would be well. The ultra-orthodox Stability and Growth Pact (SGP) has now been repackaged under the heading of ‘economic governance’ under which Germany and its allies will vet members’ fiscal policies and impose punitive fines on those failing to observe the deflationary budget rules to be adopted. Never mind the fact that indebtedness in countries like Spain and Ireland was mainly private, or that the draconian fiscal measures imposed on Greece have, far from reducing public indebtedness, increased it.
Is debt always a bad thing? In the private sector, obviously not since corporations regularly borrow money for expenditure they don’t want to meet out of retained earnings, while most households aim to hold long-term mortgages. Public debt instruments like gilts in the UK or bunds in Germany are much sought after by the private sector, mainly because such instruments are thought to act as an excellent hedge against risk. Remember, too, that when a pension fund buys a government bond, it is held as an asset which produces a future cash stream which benefits the private sector. So ‘public debt’ is not a burden passed on from one generation to the next. The stock of public debt is only a problem when its servicing (ie, payment of interest) is unaffordable; ie, in times of recession when growth is zero or negative and/or interest rates demanded by the financial market are soaring.
The question is when is debt sustainable? Sustainability means keeping the ratio of debt to GDP stable in the longer term. If GDP at the start of the year is €1,000bn and the government’s total stock of debt is €600bn, then the debt ratio is 60%; the fiscal deficit is the extra borrowing that the government makes in a year – so it adds to the stock of debt.3 But although the stock of debt may be rising, as long as GDP is rising proportionately, the debt/GDP ratio can be kept constant or may even be falling.
Consider the following example. Suppose the real rate of interest on debt is 2% (say 5% nominal but with inflation at 3%, so 5 – 3 = 2). That means government must pay €12bn per annum of interest in real terms. But as long as real GDP, too, is rising—say at 2% per year—there’s no problem since real GDP at the year’s end will be €1020bn. Even if the government were to pay none of the interest, the end-of-year debt/GDP ratio would be 612/1020 or 60%; ie, the debt ratio remains unchanged. By contrast, if real GDP growth is zero, the ratio would be 612/1000 = 61.2; ie, the debt ratio rises only slightly. The rule is that as long as the real economy is growing by at least as much as the real rate of interest on debt, the debt/GDP ratio doesn’t rise. Moreover, this holds true irrespective of whether the debt ratio is 60% or 600%.
But there’s a catch. In a modern economy, the public sector accounts for about half the economy. If a country panics about its debt ratio and cuts back sharply on public sector spending, this reduces aggregate demand and may lead to stagnation or even recession. When a country stops growing, financial markets decide that its debt ratio may rise and so become more cautious about lending and demand a higher bond yield (ie, interest rate). The gloomy prophecy of growing public indebtedness becomes self-fulfilling.
This is exactly the sort of ‘debt trap’ which faces much of the EU and other rich countries. The way out cannot be greater austerity. What works for a single household or firm doesn’t work for the economy as a whole. A household can tighten its belt by spending less, saving more, and thus ‘balancing the books’, but an economy cannot. If everybody saves more, national income falls. Of course, Germany and some Nordic countries can balance the government books because an export surplus offsets domestic private saving. But the Club-Med countries cannot match them. When no EZ country can devalue, to ask each EZ country to balance the books by running an export surplus is empirically and logically impossible. Even if all could devalue, what would follow is 1930s-style competitive devaluation.
The way out of the ‘debt trap’ is the same as the way out of recession: if the private sector won’t invest, the public sector must become investor of the last resort. It doesn’t matter whether new investment is financed by more government borrowing, quantitative easing or redistribution (some combination of the three would be optimal). What matters is growth.
 See Joe Weisenthal http://articles.businessinsider.com/2011-11-10/markets/30380618_1_fiscal-consolidation-economic-growth-slow-growth
3 See Paul Segal http://www.guardian.co.uk/commentisfree/2010/sep/03/government-debt-growth-unemployment
The other day, I was asked in an interview whether finance was killing democracy. Judged over the post-war period, the answer must be a qualified ‘no’. But things at present are not looking good.
Finance has not killed politics—if anything, the ongoing financial crisis is lading to a reawakening of politics on a scale we have not seen in many years, particularly a re-awakening amongst young people. If the young are out on the streets demonstrating, it is for quite understandable reasons. Most obviously, the crisis has illuminated the weaknesses of neo-liberal capitalism in a way many though inconceivable a decade ago.
Not only is neo-liberal ideology deeply misleading—the idea that ‘free markets are infallible and don’t require regulation—but the economics it has produced is disastrous. Inequality is growing everywhere, particularly in the main Anglo-Saxon countries where it is higher today than in the 1930s.Youth unemployment in the most of Europe ranges between 20- 40%, and we are at risk of producing an entire generation which is locked out of decent work and income. European ‘austerity’ is destroying the cornerstone of the post-war social settlement; ie, our welfare state.
As for democracy, we have recently witnessed the toppling of two governments by the bond markets, and doubtless there will be more. This is largely the fault of a political elite dominated by bankers which designed a Eurozone where each member- state’s borrowing was vulnerable to attack. This ‘fragility’ of the Eurozone—the lack of a common fiscal policy and a genuine Central Bank able to act as lender of the last resort—is leading to growing national antagonisms, the most obvious being between Greeks and Germans (a proxy for north v south Europe).
What is truly dangerous is that the financial markets’ notion of ‘common governance’ is all about ‘greater fiscal discipline’, by which is meant stringent enforcement of the 3% budget deficit limit, the 60% indebtedness rule and, most recently, the notion that all Eurozone countries should follow Germany in adopting a constitutionally binding ‘balanced budget’ (debt brake) provision. Such views are based on the simple-minded premise that a national economy can be run like a corner shop, the ‘handbag economics’ preached by Maggie Thatcher and more recently by the Schwabian housewife, Angela Merkel.
Not only are such views wrong (they ignore basic national accounting definitions), but they can lead Europe into even deeper economic gloom. As credit dries up, Europe is on the verge of a new financial crisis which will almost certainly lead to renewed economic depression. Moreover, the costs of all this is being borne once more by ordinary workers, and increasingly by the middle class. Like markets in the general, the financial market can be a good servant… but it is proving to be a very poor master.
If we know anything from history, it is that long periods of economic crisis tend to lead not to more progressive politics but rather to its opposite; the right-wing politics of xenophobia. Witness the German depression of 1932 under Chancellor Brüning which saw the extreme right rise from virtually nothing in 1929 to assume power in 1933. I am hardly the first to say it, but we are living in dangerous times.