This economic government is neither economic nor government

I don’t know why the FT Brussels blog thinks it’s surprising that the Portuguese economy is showing signs of life, or at least non-catastrophe, while the “German growth engine” is slowing down. This shouldn’t be complicated – a current account surplus increases GDP, a deficit reduces it, and globally, current accounts must sum to zero. If the Portuguese – or southern Europe in general – reduce their trade deficit, as the large majority of their trade is within the Eurozone, Germany has to reduce its surplus or else redirect it to extra-European trade. Because the EU is the wealthiest trading bloc on earth, such redirection implies that Euro-exporters need to cut prices. Whether they lose some aggregate demand by cutting volume or by cutting prices is a secondary question.

What is true, however, is that if the trade-deficit states in the Eurozone try to solve their problems by reducing their current accounts, their living standards will fall and so will the trade-surplus states’ GDP. This appears to be precisely what is happening.

So what about that “economic government”, eh? Even the title doesn’t fill me with confidence. It amounts to a cliché of European politics, an old tune favoured by the French foreign ministry (because it rivals the Bretton Woods institutions) and the EU Commission’s ECFIN and internal market directorates (because it offers them more power). This is, at least, the first time I’ve seen any detail about what it is and what it’s meant to do. And all it seems to have to offer is yet more deflation.

Let’s go through this one. The original Stability Pact demanded restrictions on government budgets. The Eurozone states did try hard to implement this and therefore got less of the late 90s boom than other countries did. In the early 2000s recession, France and Germany ran substantial budget deficits and eventually breached the pact. Some other countries, like Ireland, were enjoying a massive property boom and ran budget surpluses. The IMF, ECB, DG ECFIN, etc, couldn’t have been happier.

So, how’s that working out for you? It’s almost as if those eurosclerotic ol’ social democratic finance ministers from the early Bush age had had a point all along!

And the answer is apparently another Stability Pact, just bigger, badder, and more, with balanced budget clauses and a ban on wage settlements being indexed to inflation. To put it another way, you personally are being asked to trust the ECB to put you out of work if prices look like going up. That’s the only way to deal with inflation!

Things the economic government does not cover include – anything about intra-eurozone trade, anything about macro-prudential bank regulation, anything about unemployment, anything about growth. You might think these are some pretty big issues. But the Merkel-Sarkozy paper doesn’t even mention any of the problems that actually happened. There was a massive housing bubble (nothing) fuelled by spectacularly dodgy banking (nothing) recycling a massive trade surplus (nothing) that led to a huge recession (nothing).

Finally, it’s not actually true that southern Europeans don’t work as hard as Germans. Greeks actually put in more hours. It seems fair to say that the differences are not due to Germany’s vast resource wealth. If it’s not land or labour, it must be either capital – the Germans have more and better tools to work with – or entrepreneurship – German companies are better organised. (Look, this isn’t a controversial statement, is it?) It’s rare that you have to bring your own computer, tractor, machine-tool, or whatever to work. It’s rarer that anyone asks you how you think your workplace should be organised.

But for some reason, the only answer anyone is prepared to offer to the failure of half Europe’s management class is that everyone else should take a pay cut.

15 thoughts on “This economic government is neither economic nor government

  1. Still all the discussions does not answer to the following important issue: if the Central bank is not able to eliminate disfunctionalties attributable to monetary system – 1) disfunctionality of interbank market, i.e. the credit crunch, 2) disfunctionality of payment system – what are the immediate duties of the ECB or can the ECB dismissed then? If a person with a positive balance can not pay for his cucumbers, then the Central Bank must immediately print the money – 500 bn, 1 tn, 3 tn or more, in order the payment system functions again. So there is really not a clue why the CB’s in southern Eurozone members could not print euros at a sped of 100 bn per week, if monetary systems get dysfunctional there. If the charter of ECB is annulated because the payment system is not functioning anymore, annulated is everything else, and the creation of money in arbitrary amounts is completely legitimate.

  2. Surely one of the main reasons why the Greek economy tanked and their debt spiraled out of control was the 2008-9 recession? Their economy is very dependent on tourism, and holidays are always the first things that people cut when they are feeling the pinch. They must have experienced a massive fall in GDP.

  3. The explanation of German superiority is very biased. The reality is completely different.

    First, Germany is the largest economy, and therefore the best place whereto get economies of scale. At the same time German market is enormously protected, with all kinds of bureaucratic mechanisms. EU regulations and directives are openly ignored in Germany, and the courts feel free to interpret them freely. Especially that is true for highly monopolised industries as pharmaceuticals. Despite the fact that all traditional pharmaceutical companies in Eastern Europe are completely GMP etc., you will not find any medicines from there in German pharmacies. They just do not get permissions from German regulatory gendarmes, despite of superiority of European regulations.

    If the respective conflicts escalate to European levels, you will realise immediately that most key positions in the EU are occupied by Germans or German-friendly (Austria, Nederland –they have forgotten Rotterdam Blitz) officials, which act on direct control from their home countries.

    So despite ALL the possible economic reason (prices competition up to 4-th order trade theories) the reality is that German pharmaceuticals have flooded the EU’s Eastern Europe, but nothing produced in Eastern Europe will be found in Germany’s Apotheken.

    This model explains 99% of the German superiority, only the exceptions can be where some unique patents are at work (as in case of US products).

  4. I agree with the thesis point of this analysis.

    European leaders, in this case French President Sarkozy and German Chancellor Merkel cling on to the same failing policies that allowed for (a) divergence among the constituent economies of the euro area, (b) contagion of the crisis to the core.

    The idea of enforcing and strengthening (and expanding) the various pacts that ostensibly bring about stability, growth and lead to convergence must be abandoned as it fails to grasp a couple of profound issues. First that the crisis was not caused because these were not strictly enforced on member-states – the crisis is systemic and is caused by the structural flaws of the euro, the ill regulated banking system and the consistent under-investment in the periphery. These were the cracks of the system that allowed for the financial crisis to evolve into such a serious crisis that now threatens the very existence of the single currency. The second issue is that the Stability and Growth Pact no matter how effectively is enforced, will still be the source of divergences, since it paradoxically is a pact that prevents growth and therefore causes instability.

    The point is not to insist on the same failing policies that allowed the crisis to threaten the Euro, but to introduce new truly decisive measures that will (a) fundamentally revise the architecture of the Euro, (b) will mobilize the European Investment Bank within the framework of a fundamental redesign of the SGP, in order to produce real growth and true stability, not nominal growth figures and shaky economies.

    So yes this new “economic government” is neither economic nor government.

    In case you wish to view my analysis on the joint Sarkozy-Merkel letter you can visit my blog. Here is the link to the analysis:

    http://protes-stavrou.blogspot.com/2011/08/full-analysis-of-joint-sarkozy-merkel.html

    Thank you and keep up the good work.

  5. Sorry to say, but there is no perspective to construct any successful government, charter, law, etc., until the extreme problems with the EURO monetary system are solved (or dropped together with EURO). The first, completely unsolved problem – how to deal with large insolvent banks? The second problem – the obsession with sterilisation. If the ECB itself remains highly dysfunctional, there is no way the present system can be repaired.

  6. “It seems fair to say that the differences are not due to Germany’s vast resource wealth. If it’s not land or labour, it must be either capital – the Germans have more and better tools to work with – or entrepreneurship – German companies are better organised. (Look, this isn’t a controversial statement, is it?)”

    Typically in econospeak, this overlooks the first, second and third most important factors of economic development: education, education and education. Eurocore countries (or the US) are wealthier because their populations receive the training that makes them a good basis for an advanced, high value-added economy. No mention of that in the stability pact 2.0 either, mind you.

  7. There’s something to the “organized” bit: generally, you can’t get good service in Portugal; and if — miraculously — you do, it will cost you what it does in Germany, or more. Foreigners attribute this mysterious fact (with a shrug) to “Portugueseness”, by which they mean something like “dumb-lazy”; this can’t be true — Portuguese are good and reliable workers/businesspeople *once they emigrate. I don’t believe it’s the air (“good weather makes you want to sit around and drink coffee all day”). What is it?

  8. @ To
    But I don’t think that greek, spanish or italian education is tat much worse than german one: we are still speaking of OECD countries.

  9. The simple facts of a currency union are as follows, and not really subject to anything more mutable, like whether this or that politician happens to agree with your political worldview (and I’m generally more leftie than rightie, as is the writer of this piece, from what I can figure out):

    1 – Interest rates and currency exchange rates will be heavily influenced by the needs of the largest economy, meaning
    2 – the smaller guys get interest rates and exchange rates that are usually (although not always) inappropriate to where they are in the economic cycle, so that
    3 – if the central bank keeps rates inappropriately low because the largest economy needs them there, the smaller guys get to have a property boom because those low rates will tend to fuel real estate speculation, this being the sector of the economy that responds fastest to friendly interest rates, so that
    4 – when rates have to be raised, as inevitably they must, the smaller guys go bust, and drag down the big guys with them.

    That’s the number one structural flaw. Number two, which for the purposes of this region of the world we can label “The Greek Structural Crack” is that this union was set up so that it acted more like a peg to the old deutschemark than a real union anyways, which meant that states such as Greece, who would normally be forced to borrow at higher rates because of the higher default risk, wound up being able to borrow at German rates despite not having German creditworthiness.
    Inevitably, you would get what’s going on now.

    So now you’ve got a big overhang of unsold or defaulted on houses on the one hand, and bonds that are worth maybe half of their face value but for which the issuing government is on the hook for the full amount, on the other hand. All of this is due to getting crazy, entirely inappropriate price signals on money, as both interest and exchange rates are meant to signal the price of said money. In both cases, as the price of money was set too low, you had a supercharged demand for it, but not enough supply of it for the demand.
    And that’s all there is to it.
    Get rid of the currency union, and you get rid of the problem of either having more demand for money than is appropriate, or, if the largest economy needs higher rates, less of a demand than is appropriate, in which case you get a recession everywhere but in the largest economy in the union.
    Long, I know, but should be clear?

  10. People, check out Ed’s post just above this one. It’s a case study of my point here but Ed doesn’t know it.

    Countries like the Czech Republic, Slovakia, Poland have seen good economic numbers on the back of their new export industries. Most of this industry is made up of either suppliers to German (and Dutch, Austrian, Scandinavian, French) industry or offshore assembly plants for it. Most of the fraction this represents is automotive.

    In an economic geog perspective, it’s an extension of Mittelwestdeutschland’s auto cluster. In a business/management perspective, it’s part of VW-Audi and Daimler Benz’s global supply chain.

    This means that their economic prospects are tightly coupled to German (and Scandi and French) automakers’ success or failure in selling into their downstream export markets.

    Amazingly enough, now demand in the downstream importers has dried up, demand in the supply chain is drying up.

    If we’re going to take out a chunk of aggregate demand by reducing the southerners’ trade deficit, we’ve got to think about where that can be made up or else we’re all screwed.

  11. For the Euro to “survive”, whatever that means, the Germans and French who really run most of the show must do the following: if spending restrictions are imposed on member governments, then they must also impose trade restrictions preventing any member nation to have a trade deficit. It’s not rocket science that those countries with serious trade deficits are also broke. The USA thinks it can print its way out of its troubles, but the piper is coming there as well since its trade deficit has allowed its industrial base to be dismantled and scattered across the globe.

  12. Re Pantom’s comment:
    “Get rid of the currency union, and you get rid of the problem of either having more demand for money than is appropriate, or, if the largest economy needs higher rates, less of a demand than is appropriate, in which case you get a recession everywhere but in the largest economy in the union. Long, I know, but should be clear?”

    Bravo to that. I was dumbfounded back in the late 90’s to hear that so many countries would give up sovereignty, and their ability to control their own monetary policy to best suit their citizens for entry into “the club”. Was no one thinking?

  13. Regarding Pantom’s comment:

    “Get rid of the currency union, and you get rid of the problem of either having more demand for money than is appropriate, or, if the largest economy needs higher rates, less of a demand than is appropriate, in which case you get a recession everywhere but in the largest economy in the union. Long, I know, but should be clear?”

    Bravo to that. I was dumbfounded back in the late 90’s to hear that so many countries would give up sovereignty, and their ability to control their own monetary policy to best suit their citizens for entry into “the club”. Was no one thinking?

  14. Pingback: These Five Charts We Totally Stole Explain What’s Up With the Italian Economy | A Fistful Of Euros

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