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Economic discussion paper 2011/10
EUROPEAN ECONOMIC GOVERNANCE: THE COMMISSION IS LETTING
SURPLUS COUNTRIES « OFF THE HOOK”
The Commission is currently preparing the start up of the policy process that is
supposed to detect and correct excessive macro economic imbalances, a new European
procedure which was recently approved by an agreement concluded between the
Parliament, the Council and the Commission at the end of September.
These preparations do not bode well. They testify to the fact that the Commission
continues to hold a biased view on the causes of Euro Area macroeconomic
imbalances. The consequence of this is that policies which have actually caused the
unbalancing of the Euro Area and the ongoing debt crisis will go undetected and
uncorrected.
The Commissioner’s letter: Blaming countries that have ‘lived beyond their
means”
A recent letter written by Commissioner Olli Rehn to the Polish Presidency makes the
Commission’s view on Euro Area imbalances perfectly clear. The thrust of this letter is
to shift the entire focus onto countries with current account deficits while completely
ignoring the role of member states running huge and rising huge current account
surpluses.
Commissioner Rehn’s letter argues that: “…large and persistent current account
deficits raise concerns about the sustainability of external debt of a country and can
pose solvency risks”. In other words, if a country is continuously running an external
deficit, this deficit needs to be financed by economic actors (be it households,
companies or governments) taking up more debts, year, after year, after year. Such a
process is unlikely to continue indefinitely. Sooner or later, financial markets will go
on ‘strike’, refusing to roll over existing debts and stop financing the economy
altogether, with economic collapse as a result. This is indeed the scenario the Euro
Area has become all too familiar with.
Whereas the Commissioner’s letter clearly identifies the problem that may be caused
by caused by external deficits, large and persistent current account surpluses are not
seen as a threat for the coherence of the single currency. The letter states: “However,
unlike current account deficits, large and sustained current account surpluses do not
raise concerns about the sustainability of external debt or financing capacity that affect
the smooth functioning of the euro area”.
All of this boils down to the fact that the Commission, when using this new process of
excessive imbalances, will zoom in on those countries which are “living beyond their
means” while countries living “below” their means are per definition considered not to
endanger the single currency. Instead, the Commission even considers them to be
good pupils that have simply improved their ‘competitive position in the global
economy’ and should not be lectured, let alone sanctioned, for doing so.
The real story behind the “unbalancing” of the European single currency
The Commission’s approach is clouded by its traditional view that ‘wage
competitiveness’ is of the upmost importance. However, a radically different story can
be told if one widens the perspective to include other dimensions of how economies
under a single currency regime function.
This story starts when one member state, representing almost 25% of the total
economic weight of the entire Euro Area, opted to pursue an encompassing program of
labour market deregulation from the moment the single currency was introduced. All
standard recipes from the standard economic textbook on labour market flexibility
were introduced. Unemployment benefits were cut in duration and the unemployed
were forced to accept any kind of jobs, even jobs paying substantially less than
collectively bargained wages. Interim agency work was ‘liberalised’ with the effect that
workers on regular contracts were replaced by precarious workers paid up to 50%
lower wages. ‘Mini-jobs’ and ‘one euro’ jobs were promoted or introduced, again with
the effect of turning what were otherwise full time jobs with regular contracts and
wages into precarious ones. This type of employer behaviour of switching to precarious
work practices was actually rewarded by topping up poverty wages with ‘in work’
benefits. Meanwhile, no overall wage floor existed in the form of a statutory minimum
wage to prevent workers on low wages from getting even lower wages. Finally, the
principle of the autonomy of collective bargaining, free from political interference that
is enshrined in the German constitution was thrown overboard by blackmailing trade
unions into ‘employment pacts at company level’. If trade unions did not agree with
clauses to open sector conventions and accept lower wages and/or longer unpaid
working hours at company level, the government threatened to intervene in sector
wage bargaining.
The results of ‘anglo-saxonising’ the German labour market have been disastrous. From
2000 onwards, the number of precarious and low wage jobs, profits and dividends,
simply exploded in Germany along with inequalities. In terms of averages, overall wage
dynamics simply stagnated, while real wages for low wage workers substantially fell.
However, even if a substantial part of the rents created by this policy of systematic
wage repression ended up on the side of profits and dividend payments, another direct
effect was stagnating domestic demand and inflation in Germany started to fall and
move towards a minimum of only 1%.
The next step in this process concerns the reaction of the ECB. If German inflation
kept falling, it would eventually push the Euro Area average rate of inflation below the
ECB’s price stability target of 2%. (Recall that Germany accounts for a quarter of the
Euro Area). Moreover, the ECB could not stand by and let the core member state upon
which the entire construction of the single currency had been built slide into a
domestic demand led depression with the possibility of extremely low inflation turning
into outright deflation. The ECB, even if it was reluctant to do so, finally cut interest
rates to a historic low of 2% in 2002 and kept rates at this level over a period of several
years.
The following graphs illustrate how developments in Germany dominated the ECB’s
interest rate policy. In the first graph, the Euro Area’s short term interest rate is set out
against German inflation and economic growth. With the benefit of hindsight, a clear
picture emerges: There’s a remarkable parallel between the interest rate policy of the
ECB on the one hand and disinflation and economic slowdown in Germany on the
other. Note that while the policy of wage stagnation made the German economy
continue to struggle to recover from the 2002 economic stagnation, the Spanish
economy for example maintained growth rates of 3, even almost 4% over the same
period.
Graph I: Germany’s depression pulling down ECB interest rates
Source: OECD
Unfortunately, the ECB’s low interest rate policy of the mid-2000’s turned out to be a
poisonous gift for what has now become known the group of the ‘deficit’ countries. In
several of these countries, the economy was already doing well and growing at rather
robust growth rates (Spain, Ireland). The ECB’s low interest rate policy was simply too
loose for them. With households and banks expecting their nominal revenues to grow
at 5 to 6% a year, whilst the interest rate on loans is down to only 2%, the incentive to
take out more loans and debts becomes strong. Graph II shows how the gap between
nominal growths rates in the Southern part of the Euro Area (Spain, Italy, Portugal,
Greece, France) on the one hand and the ECB’s interest rate on the other hand opened
up from 2002 until 2007.
Graph II
Source: Natixis. Flash 2011/857
Moreover, the financial sector of these countries is characterised by the extensive use
of mortgages with ‘variable’ interest rates. The ECB’s cuts in official interest rates was
therefore almost immediately reflected in the interest rates to be paid by Spanish,
Irish, Italian households on their mortgages (see table below).
Source: Natxis. Flash 2011/857
The inevitable followed: huge debt and housing booms were triggered, these
economies started to ‘overheat’ with domestic demand and inflation accelerating
(which actually intensified the perverse monetary stimulus even further), and their
external deficits took on gigantic proportions. Graph III illustrates how private sector
(not public sector!) debt loads in Spain, Ireland and Greece (Italy, France and Portugal
to a lesser extent), exploded in this first decade of European monetary union.
Graph III: Private debt as a % of GDP
Source: European Commission, Note from ECFIN to the EPC on the scoreboard
for the surveillance of Macroeconomic Imbalances.
The Euro Area economy now finds itself in the final stage of this process: The debt
booms resulting from the combination of loose monetary policy with financial market
flexibility have blown up and countries with high debt loads are no longer able to find
sufficient and affordable access in the European or global marketplace to finance their
economies. This situation is threatening the European single currency project itself,
with markets increasingly counting on a chaotic breakup of the Euro Area.
Implications for European Economic Governance
The narrative on what actually happened during the first ten years of European
monetary union shows that the story that is usually told is overly simplistic and
misguiding. It is not just about countries that have been ‘living beyond their means’, it
should also be about countries which have been ‘living below their means’. In
particular, the systematic policy of wage dumping and repressing decent jobs pursued
by German policy makers carries a heavy responsibility. It is this type of policy which
has seriously distorted the single currency’s monetary policy regime, thereby providing
other Euro Area members with perverse financial impulses and saddling them up with
the debt booms which are now no longer sustained by financial markets.
By openly and formally stating that ‘external surpluses’ do not pose any risk for the
proper functioning of the Euro, the Commissioner’s letter turns a blind eye to what is a
fundamental issue of the single currency. The fact that a policy of wage repression in
some countries, combined with a single interest rate regime, creates substantial
negative spill over effects towards the rest of the Euro Area. Moreover, the Commission
follows this up by proposing a scoreboard of indicators on imbalances which defines an
upper threshold for (unit) wage costs without also installing at a lower threshold. This
actually means that policies of wage dumping will simply go undetected in this brand
new European policy process!
As previously indicated this does not bode well for the way economic governance will
be implemented in practice. One actually fears that the Commission and the Council
will uphold the labour market deregulation policies that unbalanced the single
currency in the previous decade as the example to be followed by the whole of the
Euro Area, in particular the ‘deficit’ countries’. This type of ‘unbalanced’ and unfair
European economic governance will lead us into an Euro Area wide economic
depression.
Rjanssen/Brussels/ 12th December 2011