My personal contribution to commemorate the EU 60th anniversary was to publish a second edition of my 1987 book on Economic Integration and Growth, to which I added a second part dealing with enlargement and the risk of disintegration following Brexit. A link for the book is found on the left and next I reproduce its concluding chapter.
How to Rebuild a Collapsing Castle
As in relation to historical buildings, common sense dictates that the restoration of a collapsing integrated union cannot be done by demolishing first to build after. Instead, it needs some education about the value of preserving past achievements. Here lies the difficulty, but not at the technical and legal level. This is so because the required political will to preserve economic freedom is not only wavering, it risks being reversed by rising political populism in America and Europe.
This book provides plenty of theoretical and empirical evidence about the economic superiority of free trade over protectionism. However, integration is not just about economic gains and losses; it is also about institutional and political arrangements that are efficient and fair to mobilise all members regardless of their specificities. As said in chapter 10, there is no point in being a member if a country wishes to be part of other integration process or believes that an atomised world of independent states is a better road to achieve global liberalisation.
So far, it is not yet clear which of these roads Britain wishes to follow. However, this is not really important for the remaining EU members. What they need to consider is whether they should use the Brexit opportunity to change their own organisation to deal with other “unsatisfied members” and future entries and exits.
The current situation, in relation to neighbouring countries, is depicted in the diagram shown above in page 207, which needs to completed by a list of six Western Balkan countries, of which four (Albania, Macedonia, Montenegro and Serbia) are already official candidates and two (Bosnia and Kosovo) are potential candidates. The Balkan problem can be resolved swiftly through a bold enlargement. Although the Balkan countries are problematic due to rampant criminality (Albania), ties to Russia (Serbia), and Islamic population (Bosnia and Kosovo), they should not be excluded.
Indeed, their membership would make more compelling the need to transform the European Union into an official multi-tier union, based on a variable geometry as discussed in chapter 10. The institutionalisation of a variable geometry would allow member countries to opt out or to be demoted from some policies without major political upheavals. For instance, temporarily, Greece could leave the euro until she has sorted out her foreign debt. Romania could be demoted from the free movement of people while the current members could repatriate professional beggars from that country. Likewise, countries like Hungary and Poland, which are diverging from the EU pattern of democracy, could be demoted to a lower level of integration.
The long-waiting candidacy of Turkey to join the European Union should be abandoned; it seems to have replaced its strategic membership of the EU by an attempt to become the leading Islamic power in the Middle East.
Indeed, the end of the American leadership in the free world brought about by the new Trump administration is likely to generate a new drive towards the creation of rival spheres of influence. In Europe, Britain, Russia and Turkey are likely to strive to create their own spheres of influence at the expense of the European Union.
This new XXI rivalry will differ from nineteenth-century imperialism. It will use modern weapons to impact on the policies pursued by the European Union. For instance, Erdogan’s Turkey might use migration and refugees to destabilise Europe; Putin’s Russia may use energy and its spies and corrupt oligarchs to trap neighbouring countries and discredit democratic EU institutions; while Theresa May’s Britain may be tempted to use tax competition to break the social security net in the European Union.
Although individually, each of these countries is too small to threaten the EU economically, when combined, their challenge cannot be ignored in the design of new EU policies to keep and foster the integration process.
To cope with this challenge, the EU needs to simultaneously launch new common policies whilst disengaging or scaling back some of the current, more divisive policies. Moreover, the new exclusive policies should have a significant budgetary value (e.g., raising its level from less than 2 percent to a value closer to 10 percent) to have a macroeconomic role. Moreover, they should not be of a sector nature and distort international competition.
At the top of the list should be a single policy on migration and refugees, inspired by the Canadian or Australian models. In second place should be a policy of common defence and security, including a nuclear deterrent, so that the EU becomes ready to lead NATO should the United States weaken its commitment to the alliance.
Next should be the financing of the high end of two fundamental public services—education and healthcare. Given the success of the Erasmus student mobility program and the rising costs and competition of research, higher education and hospital healthcare are two obvious candidates to be funded at the European level.
Looking forwards, a regionally differentiated basic-income policy for unemployed, destitute, and old people should also be considered.
Of course, a multi-tier Europe with new single policies can only work with proximity and the trust of the people. The model based in the centralisation of the European civil servants in Brussels is no longer efficient or acceptable to guarantee accountability and democracy.
The current institutions have not done enough to prove their accountability, and direct elections for the European Parliament have not contributed to create truly European parties where the electors feel represented. Moreover, the idea that the current institutions—commission, council, and parliament—may transform into a government, senate, and congress of a future federation or confederation is utopian.
The EU needs to create institutions that are adapted to its diversified country basis. One such solution would be to split the European Parliament into upper and lower houses, the first made of members elected by the national parliaments and the second by members elected directly in European lists.
To sum up, like the founding fathers had to select policies that were then crucial, any restoration of the European Union has to do the same. Back then, the challenge was to reconstruct a democratic Europe from destruction. The obvious industries were atomic, coal, steel, and farming. Now the challenge is to win the race for talent and technology and to do so with social stability and security, in a world threatened again by multi-polar power players.
Showing posts with label Euro Zone. Show all posts
Showing posts with label Euro Zone. Show all posts
Friday, 24 March 2017
Monday, 16 April 2012
German fun vs. Spain´s pain
The debt markets are focusing on Spain again, and the debate between fiscal conservatives and stimulus proponents rages once more. Paul Krugman has just published another post showing that before the real estate bust Spain´s public debt was much lower than Germany´s. He compares net flows in 2010 and 2007 to state his case. This is not a reliable method to compare leverage levels. So here are the most recent balance sheet values as published by the OECD.
It is true that with an economic size of less than half the size of Germany (43%), Spain´s government debt was just one fifth of Germany´s public debt. However, the Spanish economy as whole had a net debt equivalent to almost 80% of GDP, while Germany was a net creditor, and between 2007 and 2010 increased its creditor position from 6% to 21% of GDP.
In what concerns the shares of public consumption in total GDP we can see from the following table that the share in Spain is only marginally higher than in Germany.
The fundamental difference between the two countries is that Spanish companies borrowed more than German firms while Spanish households saved very little when compared with those in Germany.
Moreover, some of the borrowing was financed by Germany and was mostly invested in loss-making real estate. Indeed, the robust public finances in pre-crisis Spain were the result of paper profits generated during the real estate bubble (in a fashion not much different from the Clinton surplus during the internet bubble).
So, the Spanish problem is a banking problem and should not be transformed into a long term fiscal problem, like in Ireland, which will compromise its future growth.
It is true that with an economic size of less than half the size of Germany (43%), Spain´s government debt was just one fifth of Germany´s public debt. However, the Spanish economy as whole had a net debt equivalent to almost 80% of GDP, while Germany was a net creditor, and between 2007 and 2010 increased its creditor position from 6% to 21% of GDP.
In what concerns the shares of public consumption in total GDP we can see from the following table that the share in Spain is only marginally higher than in Germany.
The fundamental difference between the two countries is that Spanish companies borrowed more than German firms while Spanish households saved very little when compared with those in Germany.
Moreover, some of the borrowing was financed by Germany and was mostly invested in loss-making real estate. Indeed, the robust public finances in pre-crisis Spain were the result of paper profits generated during the real estate bubble (in a fashion not much different from the Clinton surplus during the internet bubble).
So, the Spanish problem is a banking problem and should not be transformed into a long term fiscal problem, like in Ireland, which will compromise its future growth.
Monday, 12 December 2011
The German Surplus and the Euro Zone Demise
Here are some figures someone should have explained to Mrs. Merkel, before she coerced European leaders (with the exception of Mr. Cameron, the UK prime minister) into fiscal fundamentalism.
First, a look at German savings:
With a slow growing economy, Germans save every year €130 billion, or 6% of their income, that they have to lend abroad. With the exception of the government, all sectors of the economy are net savers. Even the government managed to run a balanced budget during the financial crisis of 2008.
The problem with this Teutonic frugality is that it puts a burden on its trading partners, in particular those in the Euro Zone. Germany is currently running a current account surplus of about €140 billion per year, of which more than half (€73 billion) with her Euro Zone partners (of which Italy, Spain, Greece and Portugal account for half):
Simple national accounting arithmetic tells us that the reverse picture of a surplus is a deficit. Therefore, a reduction in the external deficits in the southern European countries will have to be matched by a partial reduction of the German surplus.
Should Germany succeed in the policy of bringing its Government deficit to zero as well those of the other Euro countries, this would have to be matched either by an increased external surplus (with the US, UK and other countries) or by a reduction in German economic growth and savings. Lower growth with the same rate of saving by Germans will depress the exports of other Euro area deficit countries to Germany and will depress further their growth in a recessionary spiral.
In summary, the misunderstanding of economic interdependence between Euro Area member countries and Mrs. Merkel housewife economics risk ruining the rest of Europe.
First, a look at German savings:
With a slow growing economy, Germans save every year €130 billion, or 6% of their income, that they have to lend abroad. With the exception of the government, all sectors of the economy are net savers. Even the government managed to run a balanced budget during the financial crisis of 2008.
The problem with this Teutonic frugality is that it puts a burden on its trading partners, in particular those in the Euro Zone. Germany is currently running a current account surplus of about €140 billion per year, of which more than half (€73 billion) with her Euro Zone partners (of which Italy, Spain, Greece and Portugal account for half):
Simple national accounting arithmetic tells us that the reverse picture of a surplus is a deficit. Therefore, a reduction in the external deficits in the southern European countries will have to be matched by a partial reduction of the German surplus.
Should Germany succeed in the policy of bringing its Government deficit to zero as well those of the other Euro countries, this would have to be matched either by an increased external surplus (with the US, UK and other countries) or by a reduction in German economic growth and savings. Lower growth with the same rate of saving by Germans will depress the exports of other Euro area deficit countries to Germany and will depress further their growth in a recessionary spiral.
In summary, the misunderstanding of economic interdependence between Euro Area member countries and Mrs. Merkel housewife economics risk ruining the rest of Europe.
Friday, 2 December 2011
Is the ECB-IMF Proposed Back-to-Back Loan Enough to Stop the Euro Suicide?
It seems that the ECB is considering moving towards the type of back-to-back loan solution that we advocated in a previous post to stop the speculative bet on the collapse of the Euro. Bloomberg has just announced that the ECB is in talks with the IMF to set up a special $270 billion lending facility that would bypass the legal constraint of acting as lender of last resort to Euro Zone governments.
Although the details are not yet known, this is a positive development. Its main advantage is that it leaves the onus of imposing the necessary conditionality terms to the IMF, a task outside the remit of the ECB. However, the IMF failure in the Greek adjustment program raises serious doubts on its ability to deal with the Euro zone crisis.
We would prefer a European solution, intermediated and co-financed by private banks backed by the reformed European Financial Stability Facility, once it gets competence in adjustment lending.
Still, to be credible the ECB needs to go further. First, it needs to make sure that the size of the facility is big enough to leave no doubt about its power (the $270 billion reported are a fraction of what is needed). Second, it needs to ensure that the IMF can speed up its decision-making process. Finally, and most importantly, needs to stop its programs of bond buying in the secondary market that are feeding the speculation. A substantial reduction in the bond supply issued by some sovereigns is indispensable to squeeze those shorting the Euro.
In conclusion, the ECB has finally taken the first step in the right direction. Let us hope that it is followed by additional measures and is not offset by the fiscal fundamentalism that the surplus countries are trying to impose in whole Euro zone.
Although the details are not yet known, this is a positive development. Its main advantage is that it leaves the onus of imposing the necessary conditionality terms to the IMF, a task outside the remit of the ECB. However, the IMF failure in the Greek adjustment program raises serious doubts on its ability to deal with the Euro zone crisis.
We would prefer a European solution, intermediated and co-financed by private banks backed by the reformed European Financial Stability Facility, once it gets competence in adjustment lending.
Still, to be credible the ECB needs to go further. First, it needs to make sure that the size of the facility is big enough to leave no doubt about its power (the $270 billion reported are a fraction of what is needed). Second, it needs to ensure that the IMF can speed up its decision-making process. Finally, and most importantly, needs to stop its programs of bond buying in the secondary market that are feeding the speculation. A substantial reduction in the bond supply issued by some sovereigns is indispensable to squeeze those shorting the Euro.
In conclusion, the ECB has finally taken the first step in the right direction. Let us hope that it is followed by additional measures and is not offset by the fiscal fundamentalism that the surplus countries are trying to impose in whole Euro zone.
Thursday, 10 November 2011
How the ECB Can Prevent the Suicide of the Euro Zone
First, three facts:
1) For a currency that is in risk of imploding, the Euro has done better than the Dollar:
2) At the end of 2010 the total foreign net debt (private and public) of Italy was $0.5 trillion (26% of GDP) while that of the US was $2.47 trillion (17% of GDP); the current account deficit of the two countries was identical (3.24% of GDP); and the total central government debt was 109% of GDP in Italy and 61.3% in the US.
3) Yet the markets are pricing their sovereign debt in a way quite unrelated to these fundamentals (yesterday the 10-year Yield for Italy reached 7.48% while in the US it was at 2.01%):
This is clearly a speculative attack against the Euro itself.
Yet, the ECB seems hand-tied to do anything to repel such attack. By hiding behind its statutory limitations in lending to sovereigns; waiting for successive failed schemes of Merkel-Sarkozy to deal with the sovereign debt problems of Greece, Ireland and Portugal; and sticking to self-defeating half-hearted bond buying in the market, the ECB risks letting the downfall of the Euro occur before its own eyes.
This does not need to be so. By itself, the ECB can kill this speculative attack. First, it needs to point out to the European Union governments that if they persist in a simultaneous suicidal pursuit of restrictive budgetary policies it will need to offset them by pursuing an aggressive expansionary monetary policy. Second, it needs to send a strong message to the markets that, if necessary, it is ready to act as lender of last resort for the Governments under attack.
Here is a suggestion of how it can be done. The ECB should replace its bond-buying in the secondary market (which is fueling the speculation) by a new bank lending facility that in practice would work as back to back loan to the governments. There are various ways to structure such facility within the current lending practices of the ECB; and, as long as the loans would not feed back into the market, they would work.
1) For a currency that is in risk of imploding, the Euro has done better than the Dollar:
2) At the end of 2010 the total foreign net debt (private and public) of Italy was $0.5 trillion (26% of GDP) while that of the US was $2.47 trillion (17% of GDP); the current account deficit of the two countries was identical (3.24% of GDP); and the total central government debt was 109% of GDP in Italy and 61.3% in the US.
3) Yet the markets are pricing their sovereign debt in a way quite unrelated to these fundamentals (yesterday the 10-year Yield for Italy reached 7.48% while in the US it was at 2.01%):
This is clearly a speculative attack against the Euro itself.
Yet, the ECB seems hand-tied to do anything to repel such attack. By hiding behind its statutory limitations in lending to sovereigns; waiting for successive failed schemes of Merkel-Sarkozy to deal with the sovereign debt problems of Greece, Ireland and Portugal; and sticking to self-defeating half-hearted bond buying in the market, the ECB risks letting the downfall of the Euro occur before its own eyes.
This does not need to be so. By itself, the ECB can kill this speculative attack. First, it needs to point out to the European Union governments that if they persist in a simultaneous suicidal pursuit of restrictive budgetary policies it will need to offset them by pursuing an aggressive expansionary monetary policy. Second, it needs to send a strong message to the markets that, if necessary, it is ready to act as lender of last resort for the Governments under attack.
Here is a suggestion of how it can be done. The ECB should replace its bond-buying in the secondary market (which is fueling the speculation) by a new bank lending facility that in practice would work as back to back loan to the governments. There are various ways to structure such facility within the current lending practices of the ECB; and, as long as the loans would not feed back into the market, they would work.
Friday, 28 October 2011
Shameful European Leaders
In today’s news: “AP - The chief of Europe's bailout fund visited Beijing on Friday to discuss possible terms for a bond sale aimed at raising money from China and other non-European investors”.
After months of protracted squabbling over how to solve the Greek problem, all that Sarkozy and Merkel could come up with was a convoluted scheme that involves begging support from one of the remaining communist dictatorships – China.
To realize how outrageous their incapacity was, one must recall that the haircut or debt forgiveness that Greece, Ireland and Portugal needed at the start of the crisis was about 140 billion Euros, that is, the equivalent to the European Union budget for one year.
To understand how shameful it is to rely on the support of a non-democratic country, it is important to remember that China does not have a fully convertible currency, ranks 7 and 6 respectively in terms of political rights and civil liberties in the Freedom House index (a classification worse that of Iran and Rwanda) and according to Amnesty International is by far the country with the worst record in terms of executions which remain a state secret (again worse than Iran).
This is a dark episode in the history of European integration, and a shaking foundation for the future of the Euro as a currency.
After months of protracted squabbling over how to solve the Greek problem, all that Sarkozy and Merkel could come up with was a convoluted scheme that involves begging support from one of the remaining communist dictatorships – China.
To realize how outrageous their incapacity was, one must recall that the haircut or debt forgiveness that Greece, Ireland and Portugal needed at the start of the crisis was about 140 billion Euros, that is, the equivalent to the European Union budget for one year.
To understand how shameful it is to rely on the support of a non-democratic country, it is important to remember that China does not have a fully convertible currency, ranks 7 and 6 respectively in terms of political rights and civil liberties in the Freedom House index (a classification worse that of Iran and Rwanda) and according to Amnesty International is by far the country with the worst record in terms of executions which remain a state secret (again worse than Iran).
This is a dark episode in the history of European integration, and a shaking foundation for the future of the Euro as a currency.
Wednesday, 17 August 2011
A Merkel & Sarkozy’s Europe? No, Thank You!
Yesterday’s press conference of the German and French leaders to announce their vision of Europe was so dull, leaderless and uninspiring that in itself it was enough to put off any followers of their proposals.
However, their plans for an Euro Zone closer integration are so misguided and meaningless that they need to be denounced as such. They include: a) closer economic integration; b) enforcing compliance with budgetary targets; c) greater fiscal harmonization; and d) better European governance. Let’s examine them one by one.
Full economic integration in Europe has been achieved a long time ago with the implementation of the common market and the single market. All that lacks is a more efficient judicial system to punish attempts by member-states to circumvent the rules when it benefits domestic special interest groups. To have their economic ministers meeting regularly adds nothing. Instead it might increase their propensity to mess with the competition rules whenever it suits them.
Enforcing compliance with budgetary targets by inscribing debt limits in their constitutions is a major mistake as we show in a recent post and the recent history of the US confirms. In short, once you reach the limit there is nothing you can do except to increase the ceiling while creating a lot of uncertainty about the nation’s creditworthiness. The experience in enforcing the Maastricht deficit and debt limits has also shown that France was among the first to bend the rules.
Greater fiscal harmonization on corporate taxation may suit the two countries but it would be a disaster for the rest of Europe. The OECD Tax Database for 2011 shows that France applies a combined corporate income tax rate of 34.4% with a number of special exemptions, while Germany applies a general tax rate of 30.2%. Dividends in France are taxed under a partial inclusion system without withholding, with an overall personal plus corporate income tax rate of 57.8%, while Germany uses a classical system with a withholding rate of 26.4% and a combined personal and corporate income tax rate of 48.6%. Harmonization would give Mr. Sarkozy an electoral boost by reducing tax rates and would allow Mrs. Merkel to get away with a tax rise, but the final result would still be a very high level of taxation. Should other countries follow suit, all the remaining Euro Zone countries would have to raise rates and lose their current tax advantage.
Finally, on European Governance, the two leaders propose an elected president for the Euro Zone area with a mandate of two and a half years and the appointment of an economics minister. This double-headed European Union would aggravate an already messy situation in Europe about who is in charge. What would happen to the head of the Euro Group? Who remembers the names of the current European Union President and Foreign Minister? But, most importantly, it would institutionalize a de facto two-speed Europe that would endanger progress towards an ever closer union.
Overall the meeting of the two leaders was another missed opportunity. The other European leaders should politely say: no thanks!
However, their plans for an Euro Zone closer integration are so misguided and meaningless that they need to be denounced as such. They include: a) closer economic integration; b) enforcing compliance with budgetary targets; c) greater fiscal harmonization; and d) better European governance. Let’s examine them one by one.
Full economic integration in Europe has been achieved a long time ago with the implementation of the common market and the single market. All that lacks is a more efficient judicial system to punish attempts by member-states to circumvent the rules when it benefits domestic special interest groups. To have their economic ministers meeting regularly adds nothing. Instead it might increase their propensity to mess with the competition rules whenever it suits them.
Enforcing compliance with budgetary targets by inscribing debt limits in their constitutions is a major mistake as we show in a recent post and the recent history of the US confirms. In short, once you reach the limit there is nothing you can do except to increase the ceiling while creating a lot of uncertainty about the nation’s creditworthiness. The experience in enforcing the Maastricht deficit and debt limits has also shown that France was among the first to bend the rules.
Greater fiscal harmonization on corporate taxation may suit the two countries but it would be a disaster for the rest of Europe. The OECD Tax Database for 2011 shows that France applies a combined corporate income tax rate of 34.4% with a number of special exemptions, while Germany applies a general tax rate of 30.2%. Dividends in France are taxed under a partial inclusion system without withholding, with an overall personal plus corporate income tax rate of 57.8%, while Germany uses a classical system with a withholding rate of 26.4% and a combined personal and corporate income tax rate of 48.6%. Harmonization would give Mr. Sarkozy an electoral boost by reducing tax rates and would allow Mrs. Merkel to get away with a tax rise, but the final result would still be a very high level of taxation. Should other countries follow suit, all the remaining Euro Zone countries would have to raise rates and lose their current tax advantage.
Finally, on European Governance, the two leaders propose an elected president for the Euro Zone area with a mandate of two and a half years and the appointment of an economics minister. This double-headed European Union would aggravate an already messy situation in Europe about who is in charge. What would happen to the head of the Euro Group? Who remembers the names of the current European Union President and Foreign Minister? But, most importantly, it would institutionalize a de facto two-speed Europe that would endanger progress towards an ever closer union.
Overall the meeting of the two leaders was another missed opportunity. The other European leaders should politely say: no thanks!
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