Lilia Costabile, Guest Blogger
Massive strikes and demonstrations in Europe last week marked an important turning point in our history, and they may coalesce into an anti-austerity consensus among European citizens. It is as if these masses understood better than their governments the real size of the fiscal multipliers, which, as the IMF has recently pointed out, are large in a recession, implying that fiscal retrenchment has turned the rebalancing of public finances in the Eurozone periphery into a Sisyphean task.
Macroeconomic imbalances are at the root of the Eurozone crisis, which matured after the introduction of the Euro. It is vital to understand the nature of these imbalances in order to devise the proper remedies.
When the sovereign debt crisis exploded, the first to be blamed were the peripheral countries, gently dubbed the PIGS: Portugal, Ireland, Greece, Spain. I will call them GIPS. (NOTE: The PIGS became the PIIGS when Italy joined in as the target of financial speculation in the summer 2011. I will write on the Italian case, which is different from the others, in another post.)
Excessive state spending in these countries, so the narrative went, led to unsustainable levels of public debt and deficits, thus fuelling speculation and opening the stage for the debt crisis. Austerity was the remedy, to be complemented by severe sanctions and finally expulsion from the Eurozone for non-abiding countries: see e.g. Wolfgang Schauble, the Federal Finance Minister of Germany, and Mark Rutte and Jan Kees de Jager, respectively prime minister and finance minister of the Netherlands.
A closer look at the data disproves the “profligate countries” interpretation, because it cannot be extended to all the GIPS: true, Greece and Portugal ran large public deficits between the inception of the Euro and the eruption of the global crisis. But during the same period Spain and Ireland were more virtuous in the management of their public finances than some Center countries: between 2000 and 2008 Ireland produced an average Government surplus of +0.5% of GDP, while Spain was basically in equilibrium with a Government deficit of -0.2% of GDP. Both countries fared better than the Netherlands (-0.5%) and Germany, which, over that period, produced an average government deficit of -1.9% of GDP. As for public debt/GDP ratios, while Greece was the worst performing Euro country, still, in 2008 Ireland (44.5%) and Spain ( 40.2%) fared better than Germany (66.8%), and Portugal (71.7%) had only a moderate disadvantage in this respect. While Greece behaved “viciously” for the whole decade, it was only after the explosion of the global crisis, when capital ceased to flow to their private sectors, that the public finances of Spain, Ireland and Portugal deteriorated.
Attention then turns to intra-European balance of payments. The common feature among the peripheral countries was their current account deficits and, more to the point, the substantial increase in these deficits following the introduction of the euro. (See e.g. Kash Mansori, The street light, 22 Sept. 2011, ).
Current account deficits are the counterpart to surpluses on the capital account, and huge capital inflows were a “physiological” aspect of financial integration, which was one of the main objectives of the EU and EMU projects. The common currency reduced the perceived risks on investments in the peripheral countries, thereby encouraging a “capital flow bonanza,” which was later reversed when the contagion from the global crisis reached the European side of the Atlantic. Because capital initially flew from the Eurozone Core to the peripheral countries, and then flew back to the Core countries, both are responsible for the crisis. Hence, they should share the burden of macroeconomic rebalancing.
Concerning the financial side of the European imbalances, it should also be noticed that Germany has greatly benefitted from a “safe-haven” effect on its interest rates since the sovereign debt crisis erupted in the Eurozone.
So far, so good. However, intra-European imbalances are not entirely explained by financial flows and their sudden stops. Real factors also played a fundamental role. As Table 1 shows, Germany experienced a decline in its unit labour costs between 2000 and 2008, compared to very high positive growth rates in the GIPS.
|Unit Labour Cost (Whole economy) Cumulative % variation – 2000-2008|
Germany, whose main export markets are the Eurozone and the EU, obtained this substantial competitiveness gain by freezing money wages, which grew less than labour productivity (1.41% against 1.78% per year in 2000-2008). Its policy has been defined as “Mercantilist” by some commentators (S. Cesaratto, in 2010 and other subsequent papers: http://www.econ-pol.unisi.it/quaderni/595.pdf). The opposite happened in the GIPS. Thus, while these and other Euro-area countries (such as France) slid into current account deficits, Germany’s surplus rose from 2.8% of GDP in 2000 to 7 per cent in 2008, with its exports rising from 28 per cent in 2000 to 39% in 2008.
Summing up: the GIPS’s current account deficits are not simply the result of financial integration, with the related capital flows and sudden stops, but also the consequence of their reduced competitiveness.
What are the remedies? While wage and price deflation in the GIPS is recommended in some conservative quarters in Germany, the deflationary bias imposed on the Eurozone should be stopped. Economic rebalancing actually requires both expansionary policies in Germany and productivity gains in the Southern periphery. The European Commission now recognises that an expansion of domestic demand in Germany is a necessary condition for the correction of intra-European imbalances (see e.g. European Commission, 2010.)
But it still insists on austerity policies in the deficit countries as the main route towards recovery. These policies are self-defeating, because they reduce the size of the market for both surplus and deficit countries, as the current recession in the Euro-area testifies. (Apparently, the recovery of German exports to extra-Eurozone countries since 2010 was not enough to prevent the recession from spreading from the Eurozone periphery to the Core). Moreover, productivity gains are unlikely to emerge in the shrunken GIPS economies.
It is thus high time for European authorities and national governments to listen to what people are saying in the streets.
Lilia Costabile is Professor of Economics at the University of Naples Federico II and Life Member at Clare Hall, Cambridge.
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