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The Golden Rule: “He who has the gold makes the rules” Discourse on the Political Economy of the Eurozone 29March 2012 Agenda Part I. Politics - New economic governance in the EU • The “Sixpack” • The “Fiscal Compact” (“Begrotingspact”/”Pacte Budgétaire”) Part II. Economics – Separating truth from fiction • The myth of excessive public spending • The myth of competitiveness Part III. What to do? • The democratic deficit • Proposals PART I : POLITICS The Sixpack • Five regulations and one directive introduce a new framework for economic governance, greatly extending the powers of the Commission and the Council • Approved in 2011 by the Member States and the European Parliament • Entered into force on 13th of December 2011 • Includes the “European Semester” (recent policy initiatives frequently overlap) • Reinforces the Stability and Growth Pact of 1997 (rules on public debt and deficit) • The Commission determines and monitors macro-economic variables and makes binding recommendations to Member States • Visbility and peer pressure is created through the “scoreboard” • In case of non-compliance the Commission may trigger: 1. Excessive Deficit Procedure (EDP) • As of March 2012 only four Member States are NOT in EDP 2. Excessive Imbalances Procedure (EIP) • Penalties in case of non-compliance • Between 0,2 and 0,5% of GDP for violations of the EDP • 0,1% of GDP for violations of the EIP • Only the Council may block the fine(s) through Reversed QMV (almost 75% of the votes needed) Example Scoreboard The Scoreboard • Reflect the real priorities of the EU • No social (except unemployment) or ecological variables • Nominal ULC • No lower limit • No academic references proving this variable to be problematic • Unemployment • Constant unemployment levels of 9% are not a problem? The Fiscal Compact • Is an Intergovernmental Treaty • Ratification is ongoing, will enter into force 1 January 2013 if by then at least 12 Member States have ratified it • … hence a referendum in Ireland can not halt adoption (although the political implications of a “no” would be substantial) • The United Kingdom and Czech Republic haven’t signed it (yet) • Perhaps a novelty: the Treaty is opposed by the European Trade Union Federation (ETUC) • The Treaty reinforces the Sixpack: • Stresses the “Golden Rule”: structural deficit must be lower than 0,5% of GDP • Only those who agreed to the Fiscal Compact will be able to draw funds from the European Stability Mechanism (ESM), the permanent “rescue fund” • Compulsory anchoring of provisions in the Constitution of Member States • Penalties (European Court of Justice decision): • 0,1% of GDP if the Treaty is not embedded in the Constitution or equivalent PART II. ECONOMICS The Golden Rule • The Golden Rule: the structural deficit must be lower than 0,5% of GDP, but this policy goal raises a number of questions 1. The Golden Rule relies on “Potential GDP”, an elusive figure • “As a measure of fiscal rectitude, [the Golden Rule] mandates use of a statistic that is unobservable and can be estimated only with a plethora of assumptions about cyclically adjusted revenues, expenditures and output.” – Prof. David R. Cameron (Yale University) • Example: in 2007 the IMF estimated that Ireland had a structural deficit 0,1% of GDP, a number which was revised in October of last year to 8,4% of GDP 2. Public debt will be forced below 60% • The structural deficit limit is raised to 1% of GDP when debt is below 60% • According to Prof. Karl Whelan (University College Dublin) it follows that in the long run, given a nominal GDP growth of 4%, public debt will tend towards 25% of GDP (one unit of debt for four units of growth) Public Debt: Ireland Public Debt of Ireland (1991-2011) 120 110 100 90 80 70 60 50 40 30 20 10 0 Public Debt: Greece Public Debt of Greece (1991-2011) 180 170 160 150 140 130 120 110 100 90 80 70 60 Public Debt: Italy Public Debt of Italy (1991-2011) 130 120 110 100 90 80 Public Debt: Portugal Public Debt of Portugal (1991-2011) 110 100 90 80 70 60 50 40 Public Debt: Spain Public Debt of Spain (1991-2011) 70 60 50 40 30 Comparing Government Debt Comparing Gross Government Debt Economy Absolute debt increase (2000->2011) 120% 120% 115% 115% 110% 110% 73% 76% 86% 176% 105% 105% 100% 100% 95% 95% 90% 90% 85% 85% 80% 80% 75% 75% 70% 70% 65% 65% 60% 60% 55% 55% AAA eurozone Periphery AA eurozone US From 2000 until 2007 the combined periphery was steadily decreasing its debt level. Increasing debt was clearly a consequence , not a cause of the crisis. 50% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 AAA rated eurozone countries 58% 56% 58% 61% 62% 63% 62% 59% 62% 69% 78% 77% 77% AA rated eurozone countries 65% 64% 65% 68% 69% 70% 67% 66% 70% 80% 83% 86% 88% Periphery 87% 86% 83% 80% 79% 79% 78% 75% 79% 91% 98% 105% 108% United States 55% 55% 57% 60% 61% 62% 61% 62% 72% 85% 94% 100% 105% 50% Private Sector Debt Private sector debt (as a percentage of GDP) 350 300 Percentage of GDP 250 200 150 100 50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Greece 49.4 58.0 65.0 68.2 72.0 78.6 90.2 98.0 107.6 119.3 122.7 124.1 Spain 97.2 122.3 132.5 139.5 147.8 159.9 176.6 200.4 215.1 221.1 227.2 227.3 149.4 160.1 153.5 170.9 192.3 205.3 215.3 284.0 336.1 341.3 Ireland Italy 74.9 79.5 84.0 86.7 90.8 94.5 101.0 107.5 114.9 119.3 125.6 126.4 Portugal 161.4 173.0 186.7 191.0 196.3 197.4 205.1 209.4 223.1 240.4 252.0 248.5 Household debt Household debt-to-income ratio 220% 200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 1995 1996 1997 1998 1999 Spain 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 69% 72% 79% 88% 99% 111% 124% 130% 127% 125% 128% 111% 125% 144% 168% 187% 197% 196% 206% 203% Ireland Portugal 35% 42% 57% 67% 77% 84% 89% 96% 102% 108% 114% 122% 127% 128% 131% 130% Italy 24% 24% 25% 27% 31% 34% 35% 38% 40% 44% 48% 53% 57% 58% 63% 65% Conclusions on the Deficit • The claim that “soaring government debt” caused the crisis: • • • Has no validity for any of the peripheral countries … although the persistently high level of debt made it more difficult for Greece to react Overlooks the important fact that rising private debt was far more problematic • The macro-economic scoreboard does not take into account different levels of economic development of the member states and imposes a one-size-fits-all framework • During the run-up to the crisis the ECB kept interest rates low, which was helpful for the struggling German economy, but caused overheating in the peripheral countries • Soaring yields on government bonds in peripheral countries have a lot to do with the fact that Eurozone members borrow in a currency they do not control (“original sin” syndrome), not with the fact that the overall public debt level is high • The United States currently borrows at 2%, despite debt and deficits levels that are higher than in a lot of Eurozone countries that are currently in trouble • Reliance on fiscal policy alone in times of financial turmoil significanly increases risk of default and investors (speculators) know it • Recent decreases in bond yields are a consequence of the LTRO rounds more than anything else • Austerity has proven deadly to Greece while the economies of other peripheral countries have also taken a dive and are currentely stalling • The “golden rule” depends on an estimate of Potential GDP which is an elusive figure • If applied consistently the “golden rule” implies the debt-to-gdp ratio will fall way below 60% Current Account Imbalances 10 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -5 -10 -15 Germany Greece Ireland Netherlands Portugal Spain 2010 Wages in Germany Germany – Sources of NCO Germany - Potential sources of increasing Net Capital Outflow since 2000 The blue line represents capital that became available as a consequence of reduced gross fixed capital formation (i.e. reduced domestic investment) since 2000. 250.000 200.000 The red line represents the "extra" exploitation surplus as a consequence of wage repression, especially since the "Hartz reforms" that started under the Schröder-Fischer coalition in 2003. 150.000 The purple line adds up the blue and the red line. 100.000 The green line represents the increased Net Capital Outflow since 2000. 50.000 Source: Ameco Online 0.000 Surplus capital available from disinvestment 2000 0.000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 29.488 65.933 79.068 89.575 93.076 78.920 73.462 70.327 100.489 98.131 80.664 76.756 Surplus capital available from wage repression 0.000 8.054 Total surplus capital 0.000 37.542 83.084 98.448 136.579 162.370 183.476 199.450 173.017 127.813 162.830 131.197 118.440 Net differential Capital Outflow 0.000 25.510 71.490 69.930 131.680 141.840 179.380 212.350 182.710 166.080 172.650 160.024 145.627 17.150 19.380 47.004 69.293 104.556 125.988 102.690 27.324 64.699 50.534 41.684 Competitiveness problem? Exports of Goods & Services: the Periphery vs the AA(A)s 200 190 180 170 160 150 140 130 120 110 100 90 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 AA(A) rated countries 100 103 105 104 113 122 137 146 151 127 146 161 169 Periphery 100 106 107 107 115 122 134 146 147 125 141 155 164 Current Account Imbalances • • • • • • • • • Scoreboard thresholds: -4% < CA/GDP < +6% The Netherlands and Germany were both above 6% CA imbalances are a zero-sum game ! … but according to the Commission surplus issues are to be dealt with in the mid-term while deficits require immediate attention, hence all the burden is on the deficit countries The debate is not new; for example at Bretton Woods in 1944 J.M. Keynes argued that both deficit and surplus countries ought to change policies in case of imbalances According to the International Labour Organization (ILO), wage repression in Germany is one of the main causes of the current crisis … but competitiveness as such is not the main channel through which trade imbalances came about, because … if salary increases in the peripheral countries were such a problem, how come their export volume grew faster than in many core countries? Liberalization of capital markets and high savings in Germany as a consequence of disinvestment and wage repression lead to the Current Account imbalances and overfinancing of peripheral countries PART III. WHAT TO DO? The Democratic Deficit • The new treaties, regulations and directives leave the European Parliament (EP) completely out of the picture • The EP can not determine what macro-economic variables are monitored, what the thresholds are, what the recommendations to the Member States will be or whether a Member State will receive a fine • Everything is in the hands of the Commission with limited power to the Council to block a fine (Reversed QMV, almost 75% of the votes) • The EP still has no right of initiative: • This renders elections meaningless because the EP can’t overturn any of the new regulations or directives • The European Parliament can not pass any directive the Commission doesn’t agree with • Motion of censure by the EP against the Commission requires a two third majority • The European Council is the most powerful of EU institutions, but this is the seat of European “realpolitik” (large member states are in control) • When push comes to shove the European Council moves around the treaties at will (cfr. the “no bail-out clause” or the Fiscal Compact) Proposals • On Current Account Imbalances: • Monitor debt-driven growth • Have surplus countries carry the burden • Re-introduce capital controls to alter the composition of capital flows • Minimum stay requirements • Prefer Foreign Direct Investment (FDI) over debt • To reduce dependency on volatile financial markets, keep 75% of public debt national, even if that implies higher interest rates • On financial stability: • • • • Keep banks small, have public and support cooperative banks Separate savings from investment banks Let the EU take responsibility for systemic risk Have an EU system for orderly bankruptcy of financial institutions • Have a macro-economic scoreboard that monitors social and ecological variables: inequality, poverty, carbon emissions, etc. The Confidence Fairy Off-topic: the 1% US Federal Income Tax & Share of Income for the 1% (1913-2010) 100% 8% 90% 10% 80% 12% 70% 14% 60% 16% 50% 18% 40% 20% 30% 22% 20% 10% 24% 0% 26% Federal Income Tax (highest bracket) Share of income for the 1%