Well, what a week that was. 7% was the new 6%, the cows broke through the ECB’s electric fence, the Greeks took a week to decide who ought to be prime minister after, to be honest, the G20 decided George Papandreou shouldn’t be, and Silvio Berlusconi went the same way.
It’s hard to feel much for bunga boy, but this post from James Hamilton at Econbrowser explains why I feel some sympathy for the old devil. Basically, as everyone sort of knows, the long term constraint on a government budget is that nominal GDP growth is ahead of the nominal interest rate on the debt it needs to raise (or roll-over) every year. As Italy is close to primary-balance, the roll-overs are the interesting bit.
How you think about this is important – quite a few people are arguing over whether Italy is “illiquid or insolvent”. But this is a distinction without a difference, as it’s quite possible to get from solvency to insolvency (or the other way around) just through changes in the nominal interest rate. The rate is both cause and effect at once. On the other hand, you could say the same about GDP and indeed Hamilton and our own Ed Hugh do.
But once you accept this, there are some important policy implications. For a start, it creates the possibility of self-defeating austerity.
If you decide to increase taxes and/or reduce government spending in order to increase the primary surplus and pay down the debt faster, you are basically going to reduce nominal GDP. Public-sector saving is a withdrawal from national income. You may argue that this represents supply-side reform that will have good consequences down the line, but does anyone imagine that the long run was uppermost in anyone’s mind last week? And if it was, how come Italy can sell one-year treasury bills at better rates than it can 10-year bonds? Clearly, the markets actually expect that the worst is still to come.
Similarly, you might argue that it is internal devaluation, but then, the constraint is nominal GDP growth higher than nominal interest rates. And you’d have to make some brave assumptions about the price-elasticity of your exports, the percentage of their price accounted for by labour, and the impact on the consumer sector of the internal devaluation. The condition of non-exploding debts says nothing about whether growth is internal or export-led.
Another problem is that the market can stay irrational longer than you can stay president. Imagine a scenario in which there really is some package of reforms that need a dramatic cuts plan right now, but certainly will pay off in higher GDP growth in the future. I mean, I can’t, but perhaps others can, as so many politicians seem to manage it. Does anyone doubt that, if it depressed GDP in the first year enough to get significantly under the constraint, that the interest rate wouldn’t spike high enough to bring about a massive budget crisis in short order?
So yes, Berlusconi was dancing around the very real possibility of a completely pointless and indeed self-defeating purgebinge. Wouldn’t you?
There is a wider point here. Kantoos is very keen on the point that Italy lost a sizable margin of competitiveness during the 2000s. (And who’s responsible for that? we all cry – would it be the dynamic businessman from Milan with the permanently refilled Viagra prescription by any chance?) But this Street Light post makes an excellent point. Southern Europeans put in more hours per worker, and in some countries more of them work, than Germans. The fact that all this effort is going to waste should embarrass everybody, and especially Silvio Berlusconi. But it is more embarrassing that the proposed solution is to put a lot of them out of work!
That reminded me of this post of Peter Dorman’s at Econospeak on another frequent AFOE concern, demography. He makes the excellent point that it is a problem in so far as productivity growth per worker doesn’t keep up with the dependency ratio, and only in so far as it doesn’t. If you want me to take you seriously about why Italian or Greek wages should fall, kindly set out your proposals for what Italian and Greek management can do to close the productivity gap.
There’s an argument that the best thing managers could do would be to resign and leave the workers to self-manage, but it’s somehow unlikely that this will be on offer. It’s true, however, that getting rid of employment protections has no measurable benefit in terms of GDP growth.
All that said, Dani Rodrik has a fascinating paper out on manufacturing and productivity. Specifically, it’s the only sector that shows a clear global trend in which less productive economies catch up with the best in class. Worryingly, this is most pronounced in exactly the subsectors that the German economy is strongest in. That certainly puts this Blodget Insider post in an interesting light. On the other hand, even in China, we’re seeing the end of cheap labour.