The Owl Of Minerva

Last week was the fifth anniversary of the outbreak of the global financial crisis. Not uncoincidentally it was also the fifth anniversary of continually rising unemployment in Spain , since it was in early summer 2007 that seasonally adjusted Spanish unemployment embarked on its steady upward path. And after it started climbing, naturally it hasn’t stopped since. Indeed we seem to have at least another year of growing unemployment before us, maybe more.



Anyway, as if to celebrate this uncanny anniversary the Spanish government has decided to take the bold step of officially requesting an EU loan to recapitalise the country’s banking system. In addition, part of the money will be used to set up some form of bad bank with the objective of cleaning up some of the toxic property and other assets off the bank balance sheets. Smart moves both of them. Pity the people responsible weren’t prepared to accept the need to do this five years ago, when unemployment was only running at 8%, and when the economy and Spain’s citizens were better placed to accept the kind of burdens that are now about to be imposed upon them.

Just to round the commemorations off, in the August edition of their monthly bulletin the ECB finally let out that dirty little secret than every insider in the know has already discounted. The Bank have finally accepted that the much heralded Spanish labour reform isn’t going to work. At least not as planned. As the Financial Times put it, the Spanish labour market reform approved in February was “far-reaching and comprehensive” but came too late, the ECB implied, saying it “could have proved very beneficial” in avoiding job cuts if the measure had been passed some years ago.

Exactly. But once we recognise this point, isn’t that rather leaving the Spanish economy adrift in stormy seas without a rudder? Simply cutting the deficit back and cleaning up bank balance sheets won’t get the economy back to growth.

Indeed this habit of continually getting behind the curve, and trying vainly now that the economy is spiralling almost out of control to introduce measures which should have been brought in a decade ago extends well beyond the issue of labour reform. Take reducing the generosity of unemployment benefits. This is also something that should have been done years ago, since the two year allotment really did encourage people to refrain from actively seeking work in times of relatively full employment. But cutting benefits now, as the Rajoy government has just done, when unemployment stands at 25% and rising seems insensitive and even cruel. A government’s job is to introduce policies to create employment, not to cut benefits going to those who cannot find work in an environment where total employment is falling and has been doing so for five years. Quite frankly, if cuts have to be made, better to reduce pensions, but that is political dynamite, so it doesn’t happen.

Again, reducing the fiscal advantages of home ownership made mountains of sense during the years of the property bubble, but it didn’t happen. Now, with around two million housing units (between finished and uncompleted) needing to be found purchasers removing tax benefits on mortgages, increasing VAT rates on property transactions and raising the local property taxes – all of which make buying a homea lot  less desirable – looks very much like trying to shoot yourself in the foot. There is a lot of merit behind the desire to stabilise Spain’s public accounts, but shouldn’t we also try to remember why the country has this crisis in the first place?

Anyway, having recognised that the labour reform comes to late to really change course decisively this deep into the crisis – something incidentally which we much maligned macroeconomists have been arguing all along – what does the ECB propose to supplement it? Well, according to the bulletin “countries with high unemployment also needed to abolish wage indexation, relax job protection and cut minimum wages.” Indeed the bank went beyond its usual practice of avoiding country specific commentaries to issue a direct prescription, saying it expected a “strong decline” in wages in Greece and Spain, countries which have the highest levels of youth unemployment in the eurozone, with more than 40 per cent of under-25-year-olds in the labour force out of work.

This strong decline in wages does not, mark you, form part of the kind of “internal devaluation” some of us have been arguing in favour of  for some years now, whereby a battery of measures are introduced to try and bring down both prices and wages at one and the same time. Not at all. July inflation in Spain was running at 2.2% compared to 1.7% in Germany. Prices in Spain are going up, largely due to all those tax increases laid down in the adjustment measures. Annual inflation will probably surge by around two percentage points in September as the new consumption tax rates fall into place. So it is only wages which are likely to be coming down, and this makes it all feel much more like 1930s type wage deflation than the sort of internal devaluation that has been being advocated (see my January 2009 piece “The Long And Difficult Road To Wage Cuts As An Alternative To Devaluation” as a harbinger of all this).

Well, if you let things go to hell for the best part of five years, naturally the patient is in a poor state and in need of radical surgery. I won’t say “I hope they know what they are doing,” since I am pretty sure they don’t. Perhaps I would rather say I hope Mariano Rajoy knows what he is letting himself in for when he asks for help from the ECB.

Talking of which, and turning to another of the “troubled” countries, Italy, I see Finance Minister Vittorio Grilli has come out today and confirmed two issues I was conjecturing about in my blog post only yesterday. In the first place he admitted in an interview in the newspaper La Repubblica that it was unlikely the country would meet this years deficit target due to the depth of the recession, and in the second one he confirmed my fear that getting agreement to ask for EU help would be much more difficult than Mario Monti recognised during the press conference he held with Mariano Rajoy at Spain’s Moncloa Palace. Italy plans to wait for the ECB to act, and see what the measures look like, despite the fact that Mario Draghi has made it quite clear he will only do so after a request for assistance goes to the EU.

So instead of preparing a “battery of measures” to go to the root of Italy’s problems it looks like we what we may well face is protracted debate about how to avoid making any kind of formal  request. The latest idea to surface is that of trying to get ECB agreement for the Cassa Depositi e Prestiti, a state-financing agency controlled by the Treasury and managing some €220bn in postal savings deposits, to be allowed to use its banking licence to secure loans from the central bank in order to explicitly buy government debt. As the saying goes, this one can run and run.

Which all brings me to the main point I have been thinking about all weekend, which is why it is that policymakers find it so incredibly hard to see situations coming, and to take corrective action before the train crash occurs?

“One more word about giving instruction as to what the world ought to be. Philosophy in any case always comes on the scene too late to give it… When philosophy paints its gloomy picture then a form of life has grown old. It cannot be rejuvenated by the gloomy picture, but only understood. Only when the dusk starts to fall does the owl of Minerva spread its wings and fly”.

G.W.F. Hegel, Preface to the Philosophy of Right

This post first appeared on my Roubini Global Economonitor Blog “Don’t Shoot The Messenger“.

This entry was posted in A Fistful Of Euros, Economics, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo' is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

17 thoughts on “The Owl Of Minerva

  1. .. but cutting spanish wages would certainly make everything worse. Arrgh.

    Heck, I would even argue that the focus on bank balance sheets is trying to fix a problem with the economys legs by preforming surgery on elbows. If you fixed unemployment, nearly all the “bad loans” on the books of spanish banks would suddently start preforming – The reason they are at risk is not reckless lending – Spanish banks and banking regulations were very conservative. The problem is that paying your mortage without a job is very difficult!

  2. “why it is that policymakers find it so incredibly hard to see situations coming, and to take corrective action before the train crash occurs?”…

    A bit presumptuous, perhaps. One could also ask why policymakers are so inept, and pundits so brilliant. Wouldn’t the world be a better place if the commentariat became politicians, and vice-versa?

    Turning back to your question, I submit the following answer. The ‘situation coming’ in Spain is the consequence of the existence of the euro, at two different levels. First, the Germany-friendly lowish interest rates in the early days of the Euro resulted in negative real rates for Spain, creating the bubbles. Second, had Spain be outside the euro, all its other problems (competitivity, competitivity and competitivity) would have quickly resulted in currency attack and depreciation, as was the case in the old days of the European monetary system, resulting in automatic adjustment. The system worked very well for more than 20 years.

    Likewise, the only solution for Spain is to leave the euro. This will happen when people realize that the pain to stay inside is greater than the shock of the departure. Will this realization occur at unemployment of 30%, 35% or 50%? Your guess is as good at mine.

    Unfortunately, no mainstream policymaker or analyst — so far — dares to admit the simple truth that the euro is the disease, not the patient. A lot of them still even believe that it is a good thing! Thus no one will blame the euro for the present situation, nor take the required corrective action of killing it.

  3. a battery of measures are introduced to try and bring down both prices and wages at one and the same time. Not at all. July inflation in Spain was running at 2.2% compared to 1.7% in Germany. Prices in Spain are going up, largely due to all those tax increases laid down in the adjustment measures. Annual inflation will probably surge by around two percentage points in September as the new consumption tax rates fall into place. So it is only wages which are likely to be coming down

    Isn’t it just? The well specified bit is always the wage cut. The rest is promises. I keep saying this.

    At some point, don’t we just have to accept that POSIWID, and the people in charge want this? Nobody would have done the Spanish labour reform if it hadn’t got so bad. It therefore had to get that bad.

    The left-eurosceptics were damn right, and I presume that’s why you can’t find’em any more.

  4. The underlying issue is this:

    Which society’s political culture gets preserved and which gets destroyed. The crisis is fundamentally about the unsustainability of current mechanisms of political class perpetuation (witness the costs of post-fascist socio-economic organization in medit countries) in various countries. The greek elites, for example, want to keep much of what made Greece dysfunctional in the first place, and they want transfer payments to make that possible. The Germans elites, on the other hand, wants to keep that Hartz reform setup, and needs the euro to help maintain the import of wage deflation pressures. Among other things. Therefore, the sand in the gears derives from awareness of zero-sum bad faith strategies. Nobody believes anyone will follow through on any initiatives the instant the pressure is off. Thus, ultimately, the euro will probably break up.

  5. “If you fixed unemployment, nearly all the “bad loans” on the books of spanish banks would suddenly start preforming”

    Absolutely Thomas. Strange how so many people find this so hard to see.

  6. “A bit presumptuous, perhaps. One could also ask why policymakers are so inept, and pundits so brilliant”

    Possibly perplexed, but I’m happy to put my record on Spain (or Italy, and we’ll get round to Latvia later, up against that of the Troika any day of the week. They can choose the day). The IMF are still saying the labour market reform will work, and they have constantly underplayed the depth of the issue in the Spanish financial system. One day someone may ask why this was.

    It isn’t a question of pundits, but systematically ignoring the opinions of one part of the economics community – the macroeconomists. Of course, it is cheap and easy to ridicule us, it is just that reality has a nasty habit of coming rounding and hitting those who do smack in the face.

    Saying the Troika have got it wrong has become a one way bet. An easy road to fame for some, and to money for others (the hedge funds).

    The issue is that having gotten it wrong on the Euro in the first place (here we would agree) they have boxed themselves into a corner, and becoming completely ideological, only listening to the opinions of micro economists who by definition carry out partial analyses and don’t study economies as systems.Hence the emphasis on structural reforms. You know, longer shopping hours will save Spain.

    I think things went wrong in Latvia, where the EU refused to allow them to devalue as the IMF wanted. Then the EU took over the IMF, and now we are all headed for catastrophe. We can defy Newton, what goes up can be sent back up again. What is that expression? “Sending people to hell is easy, we can set that up for you in a couple of weeks, but real catastrophe, that takes longer. Just give us time”.

  7. Edward,

    Comparing yourself to the Troïka, you put the bar pretty low ;)

    Note that the Troïka is un-elected. On average, stupid unelected policymakers tend to be far more dangerous than stupid elected policymakers. One reason for that is that they can afford to be ideological without fearing the electoral consequences. From this point of view, the European Union looks more and more like the Soviet Union.

    As you note, the laws of physics will eventually be rediscovered. I wonder how long it will take, how much pain will be inflicted meanwhile to innocent people, and also what political side effects there will be.

    Keep the good job. Your series of graphs are always very informative.

  8. Edward, you mentioned Latvia, and I believe you are absolutely right that this is where the rot really set in. They carried out insane policies to avoid devaluation, in what was loosely termed “internal devaluation” (even though their competetiveness hasn’t actually improved significantly), and the fact that they avoided devaluation was hailed by the EU apparatchiks as a success and as proof that I.D. was indeed the way forward for troubled EU (or quasi EU) states. However, Latvian debt/GDP ratio shot up from 12 to close to 60, and umemployment went from 5 to 20%. This they could just about handle, but the point is that if you apply the same medicine to economies where unemployment starts at 6-7-8-9%, and where debt/GDP ratio starts around the then EU average of say 70, then disaster is the only possible outcome. I know Ireland and Spain started out better than that, but Ireland went ahead with the incredibly stupid decision to guarantee the bank debt, and Spain had the mother of all property bubbles, which ensures that the Spanish banks by and large will end up like the Irish ones. In my book it really is that simple. Please correct me if I’m wrong.

  9. Pingback: Spain and The Owl Of Minerva |

  10. Henrik,

    Nice to hear from you. I trust you are well.

    Yep, I agree. Latvia was the policy turning point. The problem is the whole issue has now become so ideologically charged that it is hard to get a serious discussion. I even posted on my facebook the expression “the Latvian economy maintains momentum in the second quarter” only to find it being interpreted as a criticism of Paul Krugman, which it certainly wasn’t. It was simply a statement of the fact that Latvia hasn’t fallen back into recession at this point, and you can draw whatever conclusion you want from that fact. I think we need to let the dust settle a bit, then people will see more clearly.

    Certainly Spain and Ireland are both in very difficult situations to which there is no easy answer. Spain’s unemployment starting point was a lot worse, naturally, and this has certainly added to the problem. I think the ECB are right, there was a huge structural problem in the Spanish labour market, since having 8% unemployment at the same time as 5 million immigrants enter to work… well something wasn’t working as it should have been. But again, as I say in the post, enacting the reform now won’t make all well, not at all.

    On the debt, there is a chink of light in the idea of burden sharing, with the whole Euro Group getting involved with Spain’s banks. But somehow I can’t help feeling that this isn’t going to be as easy as it looked at first sight. People are beginning to understand what they have agreed to. Spain’s banks will doubtless eventually need a lot more than that initial 100 billion euros, Ireland will want retrospective parity with what Spain is getting, and then Slovenia will want the same.

    The ESM ratification in Germany is turning out to be much more sensitive than anticipated, and I’m not surprised. So while we are constantly told that everything conceivable will be done to save the Euro, I can’t help maintaining skepticism about how far German voters will really be prepared to go.

    Incidentally, Anders is coming to BCN in September. Give him my regards.

  11. Dear Hugh,

    How would you compare Latvia’s and Portugal’s economic achievements? While Latvia shows us the most spectacular numbers, going from double digit growth to double digit declines, according to me Portugal is doing the most terrible. Twenty years ago Portugal’s GDP per capita was double as big as Latvia’s, now Latvia is not so far away from overtaking Portugal. The same is true for the other Baltics.

  12. Hello Fricis,

    I agree, Portugal has been performing terribly. See my recent post on Portugal on this site published on 14 July. Latvia’s record is that of a roller coaster, Portugal is one of long term decline. And as I suggested in that post, Portugal’s recession accelerated in the second quarter of this year. Difficult days ahead for Portugal.

  13. Pingback: Brussels blog round up for 11 – 17 August: 5 years of growing unemployment in Spain, the return of the lira in Italy, and is Germany in for a summer of discontent? | EUROPP

  14. I don’t understand. How do you bring down internal prices, except by cutting wages? Are you calling for cuts in consumption taxes? How will that affect the government’s debt problems?

  15. Taking in to account that in August 2007 Spain had less un employment that it had had in the previous 25 years and that it wasn’t until late 2010 that it reached levels of unemployment seen in 2004:
    http://www.publico.es/dinero/221150/espana-supera-los-cuatro-millones-de-desempleados
    http://www.larioja.com/20080724/economia/paro-subio-personas-segundo-200807240905.html
    It seems that the whole argument of trying to date a year earlier a crisis that did not start until Sept 2008 is just bogus.

  16. For example, let us have a question here.

    Were there more people working in Spain in March/2004 or in Dec/2011?

    We all know unemployment just went through the roof and 2004 was a year of wine and roses vs. 2011 being the doldrums, so the answer might be paradoxical:

    http://www.ine.es/prensa/epa_tabla.htm

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