Adriatic Surprise

The International Monetary Fund has released a staff analysis of economic competitiveness in the southern Euro area — France, Greece, Italy, Portugal, and Spain.  It’s a fairly technical document – written as a series of papers with a brief overview chapter at the start, which probably means that many of its messages will be missed.  But the bottom line is that all five countries are found to have done badly in most areas of competitiveness, meaning loss of export shares in global markets, lack of specialization in rapidly growing products and markets, and only limited success in services.  

Whether you’re surprised will depend on what you expected going in but for me the main news was the relative success of Greece, which rarely merits a mention as an EU tiger.   Greece seems to have 3 factors in its favour: a trade orientation towards its northern neighbours (who have been growing while still low profile in terms of competitor countries), tourism, and transport — all that Greek-owned shipping has been in heavy use around the world.   The world may be ever more mobile, but history and location still matter.

Sobering News

First off, Dave at MacroBlog has a good summary of the core of the economic policy programme adopted by the new German government. He also has some to-the-point comments about ECB credibility issues

But the big news today must surely be the surprising state of the European consumer . Perhaps the most indicative reading on the situation comes from a report from business consultants Deloitte which states that spending on xmas gifts is expected to fall this year by an average 3 per cent (year-on-year) across nine European countries. Revealingly they find that 49 per cent of Europeans believe their economies are currently in recession.

Now that German domestic consumption is declining comes as no surprise. Economic theory offers us sound explanations as to why this might be the case, nonetheless the pace at which this decline is progressing is pretty striking:

Third quarter growth figures for Europe’s largest economy released yesterday showed that after five years of stagnation, Germany’s economy is locked in a schizophrenic phase. On the one hand the country’s robust exports, which rose 4.7 per cent from the second quarter, are finally translating into stronger investments, up 2.2 per cent.

But consumption, an essential ingredient of a healthy recovery, fell for the third consecutive quarter, pressed by high unemployment, stagnating disposable income and a broader crisis of confidence.

Hanging as a twin threat over this one-legged recovery are the prospect of an imminent rise in eurozone interest rates and Ms Merkel’s pledge to cut spending and raise taxes to restore the country’s public finances by 2007.

However, the recent news from France does come as a surprise. Economic data from France had been rather more encouraging lately, and thus the fact that French consumer spending on manufactured goods declined for a second successive month in October – down by 0.6 percent from September, when it fell a revised 0.3 percent – does come as something of a surprise, and is probably like a bucket of icy water over in Brussels and Paris, and, possibly more importantly, over at the ECB in Frankfurt.

It was only last Monday that Morgan Stanley economist Eric Chaney was taking IMF chief Rodigo Rato to taskfor the latter’s argument that “it would be good to see more internally driven recovery” before starting to normalise interest rates. Chaney took the opportunity to make a full-frontal-assault on what he calls “the legend that only exports explain euro area growth”.

Since 2003, the contribution to growth of external trade has been constantly negative or null for the euro area, while almost constantly positive for Germany. The French GDP data out on November 18 are confirming this once again: French final domestic demand was up 0.9% in Q3 (3.5% SAAR), driven by strong consumption (0.7%Q despite a sharp drop in food consumption) and even stronger corporate capital spending (1.1%Q).

Now normally I would be agreeing with him, since as he says the ‘legend’ is derived from the fact that many analysts take Germany as a proxy for the euro area, and this can be deeply misleading. But this latest round of data counsel caution (and maybe some of that caution could have been reflected in Jean-Claude Trichet’s performance last Friday, at least if the Central banker’s job is to stay ahead of the curve it could have been). Lesson: don’t make yourself a hostage to fortune if you don’t want to end up being hoisted on your own pettard. (And Btw: Touché Señor Rato).

Something Worries Me About Peter Bofinger

Really I realise I have been remiss in another important sense. I have long assumed that in fact the decision to reduce deficits was taken due to the coming fiscal pressure from ageing. This certainly was the background to the discussion. However now I look at the details of the SPG this area is not mentioned (as far as I can see) and the other – the free rider and associated – is the principal consideration.

So those who criticize the bureaucratic and infexible nature of the ECB are in the right to this extent. Of course the underlying demographics *should* be part of the pact, but that is another story.

I find myself in a tricky situation, since I am deeply sceptical that the euro can work, and now after the French vote even more so, but since it has been set in motion, the best thing is obviously to try and make it work (even while doubting). So I am thinking about all this. Obviously I should try and write a longer post making this clearer.

The SGP was adopted at the Amsterdam Council 1997. A history of the implementation of the pact, and a summary of the debate over the new pact can be found here. The Stability and Growth Pact was designed as a framework to prevent inflationary processes at the national level. For this purpose it obliges national governments to follow the simple rule of a balanced budget or a slight surplus.

Now if we go back to the origins of the pact, to the communication of the European Commission on 3 September 2004, you will find the following:

“As regards the debt criterion, the revised Stability and Growth Pact could clarify the basis for assessing the “satisfactory pace” of debt reduction provided for in Article 104(2)(b) of the Treaty. In defining this “satisfactory pace”, account should be taken of the need to bring debt levels back down to prudent levels before demographic ageing has an impact on economic and social developments in Member States. Member States’ initial debt levels and their potential growth levels should also be considered. Annual assessments could be made relative to this reference pace of reduction, taking into account country-specific growth conditions.”

Now curiously I have found nothing in Bofingers argument which seems even to vaguely recognise this background.

A good starting point for this topic would be the conference “Economic and Budgetary Implications of Global Ageing held by the Commission in March 2003.

The European Council in Stockholm of March 2001
agreed that ?the Council should regularly review the
long-term sustainability of public finances, including the
expected strains caused by the demographic changes
ahead. This should be done both under the guidelines
(BEPGs) and in the context of the stability and
convergence programmes.?

This document on the history of EU thinking on ageing and sustainability is incredible.
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