Archive for May, 2010
It’s not just Britain’s £6bn in cuts—deficit hysteria is sweeping the rest of the EU. First it was Ireland where draconian spending cuts have led to an estimated 9% annual fall in GDP this year and resulted in widening the budget deficit. Then Greece, where an EU-IMF imposed deficit reduction plan of 10 percentage points over two years has led to a forecast fall in GDP of 20%.
Today it’s Spain and Italy which have recently announced €15bn and €25bn respectively in austerity measures. Portugal has accelerated its budget reduction programme to get from 9% in 2009 to below 3% by 2013, or by about 2.5% a year. In France, where the budget deficit is 8%—well below Britain’s—President Sarkozy is under pressure to follow Ms Merkel’s budget balancing act. Lest anybody forget, in 2009 Ms Merkel committed Germany to a permanently balanced annual budget after 2016, the so-called ‘debt-brake’ law, which means extra budgetary cuts amounting to €10bn per annum.
A lost decade?
As though all this fiscal tightening were not bad enough, the OECD has recommended tightening monetary tightening as a precaution against inflation. Both the Bank of England (BoE) and the ECB are thought to be considering raising interest rates at the end of 2010, despite the fact that the ECB forecasts that the Eurozone will contract by 4.6% this year and that in June inflation fell 0.1% compared to a year ago, the lowest inflation rate since 1953.
What does all this mean for growth? Take the Eurozone-16 countries alone; their average current deficit in 2010 is about 7% of GDP, and it will probably be 8% next year. The current aim is to bring this figure within the 3% limit by 2013; ie, to make budgetary savings of 5% over two years. If we assume a (small) government spending multiplier of 1.5 and that its impact is distributed evenly over the three years following 2013, this would mean a 2.5% annual loss in growth until 2016. But average Eurozone growth since 2001 has only been just above 1% per annum, so we can expect deficit cutting to lower future growth to near zero (or less).
In short, Europe’s pro-cyclical budget cutting will, at worst, prolong the slump turning it into a 1930s style depression. At best, it will produce Japanese-style stagnation, a ‘lost decade’. Whichever of these outcomes occurs, the economic and social costs will be high. Growth elsewhere in the world will be affected—this is what the quick European tour by Messrs Geithner and Summers is about. Prolonged unemployment means that a whole generation will remain jobless, and even when recovery takes place, they will enter the labour market without the skills they would otherwise have acquired and thus with little bargaining power. Many industries will decline, and some will disappear altogether, as will the wider communities which they helped support. Income and wealth inequalities will grow.
Perhaps most disturbing is that Europe’s ‘social model’ will be so deeply damaged by lack of public finance that it will in effect cease to exist, or else become a patchwork of support programmes for the ‘deserving poor’ (those in work) as in the Anglo-Saxon countries. The deficit cutters are burrying Social Europe.
Why has it come to this? The answer lies partly in the power of the financial sector, and partly in the near universal acceptance of neo-liberal ideology. Like Britain and America, Europe has poured in excess of a trillion euros into bailing out its banking sector. Doubtless this was correct at the time. But as the recent sovereign debt crisis has shown very clearly, the very same financial markets that governments bailed out have raised sovereign borrowing costs to exorbitant levels for Greece and others while making fistfuls of money short-selling their Eurobonds.
Although there has been fresh impetus for greater regulation of financial markets—led to their credit by France and Germany—there has been no corresponding change in ideology. The orthodox ideology is not so much monetarist or even Austrian—-it is quite simply the ‘common sense’ notion of bankers and shopkeepers alike that an economy’s budget is no different from the family budget. They assert that a sound budget, whether private or national, must balance.
As I have argued elsewhere, both Friedman and Keynes would have agreed that the financial crisis required the banks to be bailed out—which Europeans have done generously. Where Keynes disagreed with the prevailing orthodoxy during the Great Depression was on the question of balancing the budget. Keynes argued famously that when the private sector was rebuilding its saving, government must spend more; otherwise, aggregate demand would fall leading to falling output, employment and tax revenue.
Some of Ms Merkel’s slightly more sophisticated followers (eg, George Osborne in the UK) would argue that more state spending leads (through inflation or increased borrowing) to higher interest rates which ‘crowd out’ private sector investment. Unfortunately, for this argument to be true, one would need to show that ‘full’ crowding out takes place, something which according to this theory can only happen at the natural rate of unemployment. Since the ‘natural’ unemployment is unknowable, the argument fails.
As for Keynesian economics, despite the near Depression of 2007-09 many of Ms Merkel’s colleagues appear to remain blissfully ignorant of the subject. As Keynes explained in his ‘paradox of thrift’, although saving may be a good thing for individuals and businesses, the more a country tries to save, the more income falls and the less it can actually save. A good example of economic illiteracy is the oxymoronic title of a recent piece published by two journalists in the influential magazine, Der Speigel, ‘European austerity is the first step to recovery’. As the Berliner Zeitung put it, the end result of this sort of nonsense is that: ‘Europe will save its way into the next recession’. A deeply pessimistic conclusion, but inescapable I’m afraid.
 See http://www.ibtimes.com/articles/22922/20100509/portugal-promises-eu-to-cut-budget-deficit-more-in-2010.htm
 See http://www.spiegel.de/international/germany/0,1518,696760,00.html
 See http://www.guardian.co.uk/business/2010/may/26/oecd-backs-coalition-spending-cuts
 See http://blogs.euobserver.com/irvin/2010/04/13/why-sound-money-is-unsound/
 See http://www.spiegel.de/international/europe/0,1518,697098,00.html
 See http://www.spiegel.de/international/europe/0,1518,697098,00.html
In a few hours on Tuesday the 11th of May, the vision of a coalition between Labour and the LibDems appeared briefly and then evaporated. There are many different version of why it could not succeed; Clegg’s personal affinity with Cameron, the speed with which John Reid and other Labour tribalists denounced it and the spurious numbers-didn’t-add- up argument rightly dismissed by Lord Ashdown. Nick Robinson, speaking later on the BBC, aptly described the Lib-Con government as a coalition of socially liberal Cameronites and economically liberal Cleggites.
In reality, what was destroyed on Tuesday was far more than a short-lived LibDem-Lab flirtation. We saw the an unwritten pact torn up between many supporters of both parties—perhaps even a majority—who had watched the last 13 years with growing dismay as Blair and Brown lined up with the US in unpopular wars, trampled on our civil liberties, pursued City-friendly policies which made Britain even less egalitarian and toadied up to the barons of the tabloid press. On Tuesday, the goal of uniting Britain’s two main centre-left parties, sustained by many common campaigns at grassroots level over many years, was shattered.
The long-term cost of this act is potentially far greater than the questionable benefit of heeding the City’s panicked cry to fill the ‘black hole’ in the budget and form a ‘strong government’, a cry used repeatedly to justify a LibDem-Conservative coalition. Firstly, the LibDems membership base will be eroded, perhaps on a scale comparable to Labour after the folly of Iraq. Clegg’s Cabinet team will share in the ire provoked by the Tories’ deep spending cuts and the ensuing rise in unemployment, all the more so as it becomes clear that the budget cannot be balanced unless we restore the growth necessary to reverse the collapse in tax receipts. Clegg’s apparently neoliberal economic instincts risk make him the the LibDem’s Tony Blair.
Secondly, the Labour Party opt-out of a progressive coalition will not, as claimed by some, give the Party a chance to ‘regroup and rebuild’ in opposition. Instead, it will fortify the spirit of ya-boo politics, facilitating an easy return to the antics of Prescott, Blunkett and other UK Labour politicians who, in the absence of any long-term political vision, thrive on gainsaying their latest ‘enemies’.
Perhaps the greatest cost of all will be the failure to secure genuine electoral reform. For many years, Britain’s FPTP (First Past The Post) electoral system has been a barrier to political change, giving disproportionate weight to the marginal constituencies of middle England and effectively ruling out any electoral platform that might rock the boat. Although we now appear to have the promise of a referendum on PR for the Commons, it will take place under circumstances dictated by PR’s fiercest opponents, the Tories. Moreover, as is now clear, many Labour veterans who opposed the recommendations of the Jenkins Commission in 1998— Jack Straw and John Prescott amongst others—have been joined by new MPs such as Ed Balls, Kate Hoey and Diane Abbott.
Critically, only the most non-proportional form of PR is on the table: AV, not AVplus (which resembles the German system). If, as seems likely, voting reform is opposed In a future Referendum by both the Tories and Labour tribalists and supported by a much-diminished LibDem Party, we shall not have further progress on this front for another generation.
To be sure, Britain today does not lack the issues to animate a more progressive politics—-climate change, fighting poverty, minority rights, a fairer income distribution, to name but a few. But the centre-left is no longer to be found in a single party, and in some cases it is more engaged in grass-roots movements.
A new politics is needed, a politics of coalition between the different organisation and campaigns across the spectrum of centre-left parties. An essential ingredient of such politics is a change in the voting system, a new constitutional settlement which breaks with the smug insularity of those who argue for the unique virtue of Britain’s creaking voting arrangements. Theirs is the language of Thatcher and Sons, a language which must finally be abandoned if progressive politics is to thrive again in Britain.
In truth, Greece does have an alternative. Instead of submitting to the ferocious and pro-cyclical conditionality imposed by Germany and the IMF—cutting its budget deficit by 11 percentage points over three years in return for a €120bn loan—it could follow the Argentinean example of 2001-02 and default on the bulk of its sovereign debt. This would mean abandoning the euro, introducing a ‘new drachma’ and probably devaluing by 50% or more.
Some weeks ago, I had a private exchange about this scenario with an influential economist at the Center for Economic Policy and Research in Washington. He favoured considering an Argentine-style default option; I did not. But given Ms Merkel’s politically-motivated foot-dragging, the failure of the ECB to deal with the problem at an earlier stage and the strongly pro-cyclical nature of the cuts required, I am having second thoughts.
Eight years ago, Argentina defaulted on the major part of its sovereign debt and survived quite well. Many economists predicted that Argentina’s debt default would result in currency collapse, hyperinflation and even greater economic contraction than it had endured during its 1999-2002 recession. Instead, after the 2001-02 debt default and subsequent devaluation against the dollar (from 1:1 to 3:1), GDP grew at over 8% per annum over the period 2003-2007 and annual inflation fell from over 10% per month in early 2002 to less than 10% per annum over the recovery period. By 2005, Argentina had sufficient reserves to allow President Kirschner to pay off its remaining $9.8bn loan from the IMF in full and discontinue its programme with them.
European leaders would do well to read up on the Asian, Russian and Latin American financial crises of 1997-2002. The Nobel laureate Joseph Stiglitz famously published a open letter citing his reasons for resigning from his post of Chief Economist at the World Bank. Amongst his other criticisms of the Bank and the IMF was their imposition of drastic deflationary measures on Thailand and Korea in 1997, and on Russia in 1998, mainly to protect the balance sheets of private Western banks. The conditionality imposed was paid for dearly by cuts in economic and social expenditure imposed on ordinary citizens. In Greece—however corrupts some of its politicians—much the same is happening. The average Greek is being asked by the EU-IMF to tolerate vicious cuts mainly so that German (and other EU) banks won’t have to take a ‘haircut’.
A central lesson of all this is that unless protective action is taken early, a country can rapidly be overpowered by the financial markets. Once traders start betting against a country’s bonds or its currency, the herd instinct takes over. Greece’s budget deficit is not particularly high by world standards; 13.6% versus 11% in the UK, and 12.3% in the USA, but traders perceived its sovereign debt structure as too risky and prophecies of doom became self-fulfilling.
There is a further problem, too. The spending cuts needed to meet the government’s deficit target will undermine Greek government revenues. As an economist at London-based Capital Economics put it., “The key risk to its target is that deeper recession will lead to lower tax revenues, offsetting some of the savings that the Government expects to make as a result of its fiscal tightening,” In short, even though the bailout package has been agreed, the cuts may prove counter-productive and Greek recovery is far from assured.
The ECB could have nipped this crisis in the bud several months ago, both by continuing to accept Greek government bonds as collateral and by quantitative easing. Although the ECB had used quantitative easing to bail out the EU banking system, it refused to the same for Greece. There are clear signs that contagion is spreading to Portugal, and possibly to Spain and Italy. Can the ECB really be counted upon in future to prevent the gradual unravelling of the euro?
As the French economist Jean-Pierre Fitoussi argued in a recent interview in Libération, even if the Greek crisis is successfully contained for a time by an EU-IMF package, the financial markets will hope to profit by squeezing other European countries. Meanwhile, ordinary Greeks are taking to the streets to protest against further draconian austerity measures while the EU’s political class continues to focus entirely on its narrow domestic interests?
Europeans need to recall that we are really paying for the spill-over into the real economy of the 2008 bank bailout. Most important, only a few voices have begun to question seriously whether placating the financial markets by means of drastic cuts is unavoidable. Perhaps it’s time to start thinking the unthinkable, namely, that financial markets should be our servants, not our masters.
(For an earlier version see: http://www.guardian.co.uk/commentisfree/2010/may/02/greece-default-debt-choice)