The Legacy of Hollande

In 2011, after the election of Hollande, I published a post with a table depicting 13 OECD social and economic indicators on which I would judge his presidency. I also made a bet that 77% of them (10 out of the 13) would get worse. Meanwhile, the OECD abandoned some of the indicators and changed others. So, for consistency, I publish below a new table with the existing indicators before and after Holland to evaluate his mandate.

Out of the initial 13 indicators, the OECD now publishes only 8 but I added the debt/GDP ratio which is equivalent to the previous indicator to end up with 9 indicators to compare the pre and the post Hollande.

First, I lost my bet. Hollande was bad, but not as bad I had forecasted. Only 55% (or 67% if I count the current account evolution as negative) of the indicators worsened during his mandate.

Actually, the breakdown of the indicators to see where there was improvement and deterioration is more interesting.

The French economy did not do too bad under Holland, with the productivity gap in relation to the USA substantially reduced, the current account deficit kept at a low level and inflation substantially reduced.

In terms of public finances, Holland continued the socialist tradition of increased public spending. Its rise of 2.6 percentage points, to reach 57.9% of GDP, was partially financed by a higher tax revenue. However, it was not enough to prevent a 20% increase in public debt, which rose from 100% to 120% of GDP.

What is more significant is that in relation to social policies, which the left traditionally claims to be its priority, Hollande’s score was quite negative. With the exception of youth unemployment which fell from 20 to 18 per cent, the other social indicators worsened. Employment declined slightly to 63.8% of the working age population, while unemployment rose significantly from 8.3 to 10.3%.

Overall, one may say that Hollande’s zigzagging between traditional socialist policies and some forms of timid liberalization offsetted each other so that his legacy was not as dire as I had anticipated.

Let me comment briefly on his political legacy.

At the international level, Hollande’s performance was reasonable and aligned with the promotion of traditional western values.

The same cannot be said at the national political level. Apart from his matrimonial adventures and other minor internal affairs which may had weighted on his presidency ending with the lowest approval ratings of any previous president, his legacy will certainly be remembered by the eclipse of the socialist party and the emergence of Macron’s new centrist party.

To be fair, Hollande made some modest contribution to the victory of the new President.

So, his final political balance will depend on the failure or success of his successor to stop France from falling into left (Melechon) and right wing (Le Pen) anti-European extremisms.

The 60th anniversary of the EU does not need to mean decadence

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.

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.

We can’t all deleverage at the same time

We can’t all deleverage at the same time. That would be equivalent to everyone moving to the same spot in a sinking ship. It would capsize immediately. To see why, imagine this nightmare scenario: everywhere and everybody – banks, firms, governments and families – think that they are overleveraged (i.e. is excessively in debt) and decide to reduce debt (deleverage) simultaneously. Regardless of whether they are right or wrong about their excessive level of debt (in a previous post we explain why this is difficult to define); the simultaneous deleveraging could start the following fatal spiral.

Banks reduced excessive leverage by not renewing their lending facilities to firms; these add misery to injury and reduce further their leverage by firing workers and trying to sell assets. Braced with lower tax revenues and higher calls for unemployment insurance, governments answer by reducing public debt through higher taxes and massive cuts in spending; which reduce the revenue streams of banks, firms and families. Families, affected by higher unemployment, loss of revenues and fearing the future, decide also to deleverage by saving more or defaulting on their loans and by massive cuts in spending. This would reduce further the revenues of banks, firms and governments. Thus, to pursue their debt reducing objectives all would initiate a new round of cuts. This would cause a downward spiral of spending cuts that would stop only after the economy was brought to a complete halt and widespread defaults.

Wait, there must exist some break point on this spiral. After all, debts are owed to someone and those receiving the debt repayments must use their surplus money. Yes, but what if, fearing that same spiral, they decide to hoard it by holding cash, exchanging it for some remote currency (e.g. the Swiss Franc) or buying some relic from the past (e.g. gold). The first, if not offset by the Central Bank, would cause a major liquidity crisis accelerating the depression. The other two may lead to absurd bubbles whose anticipated bust would hang on the heads of enterprising people. So, not much hope here.

What if there is somewhere an unleveraged entity willing to finance an orderly sequence of deleveraging through saving and inflation? To a large extent that was the situation at the end of World War II, when the US played that role. Can’t China and other emerging nations play that role now? Probably not, because they do not have the economic size needed to face a much bigger problem. Moreover, by accepting a rescue from a dictatorship, the Western democratic nations would risk losing their freedom.

Indeed, despite some double counting, the following table shows that the net international investment position of the Western countries is less than 3% of their GDP, largely because of the high level of savings in Japan. Yet, Japan has the largest government debt as a percentage of GDP (226%).

Unfortunately, a deleveraging spiral may start without all countries being overleveraged. A debt crisis in one sector (e.g. the Government) may easily infect the remaining or be started off by a generalized downgrade by the rating agencies. In fact, some fear that the leading Western nations (US, European Union and Japan) may be in the brink of getting into such a depression spiral started by deleveraging in the sovereign debt sector. So they desperately need to find an alternative solution.

First, they must plug once and for all the holes emerging in the weaker economies of the Euro Area. Second, they must mobilize the spending power of the few remaining sectors with borrowing capacity. Finally, and most importantly, they must acknowledge that at least one entity must be allowed to continue to increase its leverage while the others deleverage.

Here the obvious choice must be the Government (except in Japan), due to its policy powers, but mostly because it is the only one that can borrow with very long maturities.

Thus, although we live in a peacetime period, sovereign debt limits in the US and Europe can be increased to levels close to those observed at the end of wars. That is, countries with national debts around 60% of GDP could borrow close to a 100%, while those already above the 100% should be allowed to borrow up to 180% of GDP.

The process, relying on multilateral facilities, should be sequential with an agreed calendar and coordinated at the level of the G3 group of countries (not the G20, which should only have a consultative role).

The Euro Zone Bond Debate: Can we have a common treasury without a common budget?

The debate on whether an European Agency (some kind of Euro Area Treasury department) should replace the Euro Zone countries in financing a substantial share of each country’s public sector borrowing requirements (some suggest a minimum of 60%) has gained new momentum since leading German business groups called for the issuance of Euro Zone bonds in defiance of the official German position.

The centralization of the debt issuing function in the Euro Zone is seen by many (including George Soros) as a solution for the current sovereign debt crisis as well as a way out of the intrinsic weakness of a Monetary Union built without a corresponding budgetary policy. Indeed, the later is the only convincing reason to argue for joint Eurobond issues and the debate should focus on its pros and cons.

Indeed, the European Union has already a long history of joint debt issues. Through the European Investment Bank it finances a non-negligible share of infrastructure projects in Europe. Through the European Commission it has also made several issues to finance specific programs of industrial restructuring and balance of payments support, the most recent being the EFSF mechanism to support the adjustment programs in Greece, Ireland and Portugal. However these issues were for limited purposes and for limited amounts. The centralization of the public sector borrowing requirements is an entirely new game.

In principle, a central Treasury Department for the Euro Zone makes sense. Indeed, that is what happens within national governments where debt issuance by local, state or regional governments is often supplemented by grants, borrowing and guarantees provided by the Ministry of Finance or National Treasurer. However, the later are usually granted under nationally agreed budgetary policies and often require the setting of borrowing limits. These are often the source of frequent disputes between national and sub-national governments that occasionally end up in blackmail by separatist movements.

In a Union like the Euro Area, which is taking the first steps towards a future political unification, a simple setting of borrowing limits by a central Treasurer (no matter how well designed they are) is more prone to such separatist threats because there is no national solidarity. These separatist threats would be a permanent risk undermining the credit standing of the central Treasurer and would become a burden for the remaining members.

To some extent national solidarity can be substituted by common interest in joint spending. For this reason, tying a large share of joint debt issues to the financing of centralized spending in common policies needs to be considered as an essential part of a monetary union package.

Although the experience of common policies in the EU is nothing to write home about (e.g. agriculture) it does not mean that it cannot succeed in areas like transport infrastructure, security (defense and policing), research and population policies (health, education, migration, etc.).

The only certainty is that, like a stool, a solid monetary union also needs three legs – a monetary authority, a treasurer and a spending authority.

Bond swap plan is for Greece and Greece only, but it won’t be enough.

The FT just published a few details of the bond swap agreement in the new bailout for Greece. The swap agreement is only for Greece, and “All other euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature”.

The only interesting feature of the agreement is the voluntary exchange of bonds maturing before 2019 by 15 and 30 year bonds, paying 5.9 and 6.8%, as a compensation for the banks accepting a 21% “haircut” on the value of the existing bonds. IIF, the Banker’s designer of the plan, estimates a participation rate of 90%.

The Greek government will have to use the new funding to buy European AAA bonds to post as collateral for the new bonds. The cover ratio was not specified, but if it is close to one the “haircut” will be meaningless. Even at 50% and with a take up rate of 90% the effect of the effective haircut would be only “9.45%”.

As been amply demonstrated in last few years the Greek problem is not one of liquidity but of solvency. We and many other observers have estimated that to get out of insolvency Greece needs a debt pardon of about 50%.

All the other measures announced to support Greece are not enough to fill the gap between these 50% and the expected “haircut” of 9.45%. So, it is only a matter of time before Greece needs another bailout, probably as early as 2013.

True Democracy ≡ Representative Democracy

Los indignados (the indignant) sit-in by young people in central Madrid and other European capitals is not just one more “youth protest”. The true grievance expressed by many protesters is not simply an adulthood ritual.

Every generation of teens and youngsters needs to affirm their adulthood by contesting their parents. This is usually done by adopting different life styles, entertainments and clothing or by endorsing naive political views. This is a positive process promoting creativity and carried out mostly in peaceful ways (despite the occasional brawl by a few thrilled by violence).

However, the indignant complaints have more to do with failed job expectations and unemployment and what they see as the lack of hope. They feel betrayed by elected politicians who pay only lip service to their concerns. Traditionally left wing parties and anarchists capitalize on this discontent to recruit members and cause some havoc. Ironically this has been a key reason why many youngsters have kept away from such protesters.

Although on the background those parties still try to manipulate the protesters, in general, these have been led by genuine non-partisan leaders. So why are the protesters still embracing revolutionary utopia falsehoods and anti-capitalist propaganda?

Some in the Democracy Camp in Madrid’s Puerta del Sol demand a “Real Democracy Now through neighborhood assemblies”. This amounts to direct democracy, which throughout history has always failed to provide democracy and led to dictatorships. This idea of direct rule by the people is populism based on a false view of early forms of democracy in ancient Greece. Rule by the majority, subject to a constitutional limitation of power to protect minorities, is the true democracy. And that is representative democracy.

Still, youngsters are right in questioning why elected representatives fail to act on their concerns. They need a clear answer to: a) they do not care; b) there is nothing they can do about it; c) the problems are transitory and the labor market will recover soon; or d) that the measures they are taking will work but take some time.

First they need to dispel the first perception. Second they need to fight the main source of anxiety – uncertainty.

This means that classical liberal progressive politicians cannot entrust the young generation to some kind of anger therapy provided by left wing revolutionaries and hope that anxiety dies out soon. For a young person who has been unemployed for more than two years it is not enough to hear that the market will solve the problem some day.

They need hope, and need it now. So, whether politicians believe in demand or supply measures they need to demonstrate action now.

Such action must also include education on why representative democracy together with constitutional liberalism and market capitalism are not the cause but the solution to their problems. They are in fact the only solution that can give young people hope in the future.

The IMF/EU/ECB bailout of Portugal: Fiscal Stabilization

In our preliminary reaction to the IMF/EU/ECB €78 billion bailout for Portugal we thought it looked like too little, too late and too soft. We promised then a full verdict once the details of the program were known. This is the first part covering fiscal consolidation.

In contrast with Greece, at the outset, the Portuguese program has only two criteria of quantitative performance – a General Government deficit of €10.3 billion in 2011 to be reduced to €7.6 billion in 2012 and a ceiling on the overall stock of General Government debt of €175.9 billion in 2011 and €189.4 billion in 2012. With nominal GDP forecasted to decline by 1.1% it will be only €170.6 billion in 2011.
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Under the IMF projections the program of fiscal stabilization will cut the deficit from an average of 9.6% of GDP (€16.5 billion) in 2009-2010 to 3% in 2013. This is achieved through a projected growth of revenues equivalent to 0.8% of GDP and a reduction in spending equal to 5.4% of GDP. The increased revenue target of €2 billion will be achieved mostly through VAT rises and reductions in tax benefits. The bulk of the €9 billion in expenditure cuts will be achieved by freezing the nominal wages of civil servants until 2013, an average cut of 3% on pensions above €1500 (a similar cut was already made to civil servants wages), downsizing the central government, saving in healthcare and education, cutting public sector investment and reducing transfers for loss making state-owned enterprises.

The program of fiscal consolidation must be judged on three fronts – compliance probability, future sustainability, burden sharing and macro-economic impact.

The targets seem to have been set deliberately low so that they can be met. We have estimated that only to roll back the excess spending of the Socialist Governments Portugal needs cuts amounting to at least 8% of GDP. Yet, there are still some uncertainties that are worth noting. On the revenue side the fiscal neutrality of the cut in payroll taxes is not certain. However, it is on the expenditure side that the resistance is going to be greater. In particular, in terms of downsizing the government, controlling health costs and reducing transfers to state-owned enterprises.

In terms of future sustainability the targets are not only timid but uncertain. For instance, the program of privatizations is targeted at raising only €5.5 billion. So, the IMF forecasts still assume a significant rise in public debt to 115% of GDP in 2014 in an economy that is not expected to grow at more than 2% in the post-recession period. In the context of continuing speculation against the weak links in the Euro Area this will not allow Portugal’s return to the market at reasonable interest rates. Moreover, three of the major public finance problems (unknown payment arrears, off-balance sheet debt and guarantees to banks and PPPs and the need for a full fiscal reform) are only left for further study.

In what concerns the fairness of burden distribution, the program is clearly biased against the lower and upper middle classes and the civil servants. Moreover, it barely touches the subsidization of privatized monopolies and other special interest groups. Again, these are only left for further study.

Finally, the macro-economic consequences of the fiscal adjustment point to a negative contribution to growth of 1.4% in 2011 and 1% in 2012. This seems a little optimistic especially when compared to a 2.9% negative contribution of private consumption (which includes civil servants and pensioners). The IMF attempt to avoid a sharper recession is reasonable, but it is unlikely to succeed given the foreseeable slowdown in the global economy and the generalized lack of confidence in the long term growth prospects of the country.

In conclusion, a timid program of fiscal consolidation in a context of global uncertainty might allow the country to get by in the next two years. Whether it will be enough to avoid the need for another future bailout and or debt restructuring is doubtful.

Reasons for the demise of European films: television, subsidies or Cannes?

During my childhood cinema-going was still the top form of entertainment and I witnessed its decline, which was superbly described in the film “Cinema Paradiso”. Indeed, Portugal like most European countries had their golden age in the movies industry during the 1940s.

It is well known that when a major industry declines due to the emergence of a new technology that creates a stronger competitor (in this case Television) there is an inevitable consolidation in the declining industry. What is not so well understood is the reason why the major survivors concentrate in specific regions (USA or India) and almost vanish in others (Europe).

The historian Tony Judt examined the fall of the European movie industry in his Postwar book and claims that “domination of post-war European cinema did not come about through the vagaries of popular taste alone… there was a political context”. Hollywood films flooded Italy and other countries encouraged by the State Department to support the anti-Communist vote.

In contrast European governments (left and right wing) tried to protect their declining industries from the so-called “American dumping”. The usual combination of barriers (quotas) to the entry of foreign films and subsidization of European movie producers were used to no avail. By confusing a technological shift with dumping they created the wrong incentives and facilitated the decimation of the few producers that could have survived through consolidation.

Worst, in the 1960s this fed a subsidized cottage industry which was taken over by (mostly) left-inclined and auto-proclaimed intellectuals; dominated by Directors such as Truffaut and Jean-Luc Godard and their followers that today gather around the Cannes Film Festival.

To be fair, the decline in the cinema-going activity meant that the production of movies for a domestic market is no longer a commercially viable activity; despite the widespread ownership of DVDs and a recent rise in the number of smaller theatres in shopping malls. For instance, in Portugal the most popular film can hardly attract 100 thousand viewers. This means that it can earn only 300 thousand Euros and this hardly covers half of the cost of a low-budget film. So only politically-minded “intellectuals” could be attracted for this type of business.

Now that the industry of broadcasted-television is also being challenged by a new technology based on the internet the inevitable consolidation will also to take place. How, the television and film producers will be affected by the emergence of Youtube and similar distribution channels? Before embracing a new round of protectionism European governments would be well advised to learn from the mistakes of the past.

It will be a missed opportunity if once more the Europeans are left behind in a major creative industry as is the film-making industry.