Sunday, April 21, 2013

Back and forth in the Debt Statistics port.

The dream of a united Europe dates back in 1951 in the form of the "European Coal and Steel Community" (ECSC). 41 years later, on February 7, the 12 members of the EU signed the Maasticht Treaty probably a treaty with the most lethal omissions, lethal for the future of EU. During all the years following the Maastricht Treaty even more mistakes were made and are currently being made and more facts were neglected. Currently, we are playing down the spill-overs of austerity policies while we are concentrated in maintaining a "lower than, but close to, 2% inflation in the mid-term", like a ship being trapped in a port without the crew knowing that they have actually been trapped...

Decisions were made as if the only economic variables that could hamper economic growth and social prosperity are debt and inflation. Given that false, sometimes rather naive, perception and regardless the 5 year long inert growth of Euro area we are still focusing on "sound government accounts". I will not advocate for the non-necessity of a such policy, at least under the current economic outlook, I would like to make some remarks with respect to the rising long term employment in Europe and its possible implications instead. Given, additionally, that the problem is more intense in the 15-24 age tranche, human capital depreciates more and more as a result of its receding productivity. Technical knowledge, expertise and skills become stagnant and eventually fade away every moment that a used-to-be-a-worker spends in unemployment. Unless this problem is efficiently addressed soon, the long run effects of this kind of employment will be, primarily, a much higher equilibrium unemployment and, secondarily, the decline in the competitiveness of the Eurozone. That is the first omission of the latest period; a result of perceiving debt as the only threat.

In the chart below you may see the upward movement of long term unemployment which is a bit sharper for the youngest age interval.

Moving on, the process of integration has also neglected the economical and structural diversity of the member states. Each nation has its own modi operandi based on its intrinsic ethics, history and culture and hence has developed his own specific weaknesses and strengths. The lack of more tight supervision has led to the enlargement of these weakness and the responsibility for this outcome must be allotted among the nation that has neglected his own flaws and his partners for pretending that these flaws are either minor and negligible or nonexistent or market-healed. Take Greece for a example: rates went down, public deficit remained constantly derailed after the rigorous expansion of public sector both in terms of public servants (the result of the existing relationship between politicians and voters) and non-wage spending and growth was victualed through consumption; no word for innovation, science and technology. Until now, no measure has been announced nor even discussed for dealing with these conspicuous weaknesses efficiently.

At this point, claims that the only prevailing problem is the structural shortcomings of the economies of the EMU, would be naive. Starting from the 2008 turmoil, the government funding of liquidity and capital needs (bail outs, so to speak) of the financial sector and the cyclical component of budgets (unemployment benefits, lower income and profits tax revenues, decreased revenues from indirect taxation etc.) have been accumulated to debt, a scar that is deeper in the northern European Union. Please, note in passing that instead of stocking debt in order to boost aggregate demand and investment we borrowed to support the financial sector and now we are absorbing resources from economy (austerity...) to feed our low-debt-mania; ECB must had taken over the resurrection,
 in terms of regulatory capital, of the banking and the financial entities. Debt is now a concern and I shall avoid to examine whether these concerns are well-grounded or not and to what extent, for the shake of argument.

What happens now, that we are about to make big steps towards a more profound integration. Public-debt-to-GDP ratio in certain regions shall remain higher than that in others and austerity will only succeed in making the this figureo worse. If you ask me, there are no reasons to expect a resolution of this troubling matter should the current policies remain unchanged. Let us suppose, for now, that the government-debt-to-GDP ratio is identical for all member states. Fiscal administration then shifts from national governments to the European Parliament; necessary reforms with respect to the super- national authorities of the EMU are prerequisite. Briefly, national government budgets must be either approved by the European Parliament or aligned with a prototype budget voted by the European Parliament. It is essential that the national budgets are not subject to approval by heads of the other member states. In addition, supervisory authorities must closely monitor the budget implementation in each member state in order to prevent large deviations, both when they are positive and when they are negative, from the prototype budget. Single fiscal coordination must also allow for deviations resulted from the cyclical components of the budget and for Keynesian tactics which a nation might wish to follow in order to boost internal aggregate demand and investment.

In order to keep the debt of each nation of the Euro area under control, long-term borrowing needs has to be covered by Eurobonds issued by the entire EMU as a whole. On the other hand, short-term borrowing needs can be met by debt securities issued by each member individually. Such operation also requires reforms as far as issuing debt in common is concerned; 
in that case, the US might serve as a benchmark.

Disparities in current accounts balance exist among the member states, as well. In order to meet the challenge of persistent deficits or surpluses, policy should use both short term and long term measures. Brad DeLong states succinctly:

And why--given that one country's exports are another's imports--does the adoption of policies in deficit countries to reduce their imports and boost their export not automatically trigger the adoption of policies in surplus countries to boost their imports and reduce their exports? 
Limiting bureaucracy, innovation policy and reforms in the financial sector are part of the the long term orientation, as they need time in order to bear fruit. But again, all these aspects of European integration can only be observed if we zoom out our telescope...

I made a very reckless hypothesis earlier that government-debt-to-GDP ratio is similar for all member states. How can this be achieved? It is unquestionable that continuous austerity can only make things worse. On the other hand, gradual fiscal consolidation through gradual steps of cuts and reforms requires a lot of time and patience and Eurozone is running out of time. I do not know if you can see it but there are only two options left. Either default or redistribution of debt burden among all member states. Default? Nope! So, debt redistribution is the gambit. Starting from the point of equal public-debt-to-GDP ratio, there will be enough time to correct all the weaknesses mentioned above and instruments of adequate magnitude will have been developed in order to prevent persistent deviations.

Unless we radically alter our perception of the economic variables of the Euro area and of their respective challenges, we will remain trapped in the vicious circle of high public-debt-to-GDP, austerity, depression, higher public-debt-to-GDP, more austerity and so forth. For now, we are at a dead end and we are trying to move forward by going back and then forth...