Eurozone Stagnation: Wrong diagnosis, wrong medicine, no recovery

 

By John Weeks

What the EC Doctors Said

If a doctor misdiagnoses a patient’s malady and prescribes an inappropriate medicine, we would not expect recovery to good health.  Should the doctor persist in the faulty diagnosis and prescribe further doses of the wrong medicine, the wise patient seeks a second opinion.  As evidenced by the experience of Greece last year, it is the misfortune of the residents of the eurozone that second opinions are not allowed.

In the early years of this decade the European Commission, fronting for governments powerful members, diagnosed eurozone members as suffering from lack of competitiveness in international trade.  The medicine implied by this diagnosis, controversial from the outset, included fiscal “consolidation” and “structural reforms”.

The first of these, summarized in the word “austerity”, dictated expenditure reduction and tax increases to reduce fiscal deficits.  The diagnosis implied emphasis on the former, because social expenditures allegedly harm competitiveness, as would higher taxes.  The most important “structural reforms”, vague enough to cover all policies to make policies more pro-business, involved reduction in worker and trade union rights, especially collective bargaining.

Governments of the putatively “uncompetitive” countries were lectured that obedience to the Commission’s prescriptions would eliminate efficiency-undermining maladies by “down-sizing” the public sector and directly reducing the production costs constraining wage growth.  In a more enlightened era this diagnosis and prescription would have been described as “mercantilist”, selecting government policies with the explicit goal of a trade surplus.

Ambiguous Fiscal “Consolidation”

The chart below shows that the Commission-fronted fiscal policies were associated with a decline in public sector deficits.  Fiscal deficits bottomed out in late 2009 (France, Italy and Spain) and late 2010 (Germany).  On average the Euro 15 (the foregoing four plus others adopting the euro in 2000-2001) reached its lowest point in early 2010 and subsequently rose.  Was this a success of austerity policies?

Dating the beginning of austerity policies involves considerable subjectivity.  As a programme implemented across the eurozone 2011 seems an appropriate date.  On the basis of when governments adopted European Commission approved austerity packages the BBC suggests late 2011 or early 2012.  If we accept this dating, the onset of deficit reduction preceded austerity policies by at least a year except for Spain.

Scepticism about the effectiveness of the EC prescription for deficit reduction increases by comparing the terminal years in the chart.  Though the German fiscal balance rose into surplus, after eight years France and Spain remained slightly below their 2008 values.   The Italian government achieved a very marginal deficit reduction (-2.7 to -2.5), and the contraction of the deficit for the Euro 15 disappears if we exclude Germany.

Overall Fiscal Balance Share of GDP, Euro 15, France, Germany, Italy & Spain, Quarterly 2008-2016 (4 quarter moving average)

0906weeks--fig.1

Source: Eurostat

Notes: Euro 15 is an EU category includes those eurozone members from 2001.

 

Mercantilism in Real time

Current account statistics provide more favourable results for the EC diagnosis and prescription (see chart below).  The German current account balance increased to over 8% of GDP in 2016, which according to the FT “boosted” the government’s popularity.  In Spain a deficit of almost -9% of GDP changed to a small surplus (net reversal of ten percentage points), with a less dramatic but strong shift in Italy from about -3% to +2%.  The French current account increased slightly (briefly positive), and all Euro 15 countries showed increases except Belgium and Luxemburg.

When assessing success in generating current account surpluses one must keep in mind that a decline in a country’s trade deficit implies a fall in domestic expenditure.  The most common form this takes is a decline in household consumption.  The striking case among the larger countries is Spain.

In 2008 Spanish per capita income was €24,400 and in 2016 will be slightly lower at 23,740.  Had it remained the same share of GDP, household consumption would have fallen by about 2.5% over the eight years.  Because of the large shift in the trade balance, private consumption per capita in 2016 was almost ten percent lower than in 2008.  In Ireland, one of the Euro 15, the trade surplus shifted by a massive 30 percentage points, leaving household consumption in 2016 almost 25% below its 2008 level.

These numbers demonstrate what until recently was a consensus across the economics profession – generating trade surpluses reduces the welfare of a population and in extreme cases impoverishes households.  This is especially the case when a surplus derive from depressing wages and output.

In itself a trade deficit need not bee a problem because short or long term money inflows can finance it.  Many countries, including EU members, have sustained trade deficits for extended periods, Britain being most obvious case.  A trade deficit does not necessarily indicate “lack of competitiveness” however defined.  In general it is not a problem that requires policy action even within a currency union.

Current Account Balance Share of GDP, Euro 15, France, Germany, Italy & Spain, Quarterly 2008-2016 (4 quarter moving average)

0906weeks--fig.2

Source: OECD

Note: numbers in legend average for entire period.

Was It All Worth It?

A recent article in the Financial Times cites the dubious Markit indices to tell the reader that the eurozone recovery has “weathered the shock” of the British vote to leave the European Union.  I stress “dubious” because the PMI for Germany showed an increase while the Munich-based Ifo index reported a drop in “business confidence”.

Considerably more informative than these methodologically problematical attempts to capture subjective sentiments is that the FT considered annual growth rates less than 2% to qualify as “recovery”.  This is a textbook case of redefining failure as success.  Productivity growth plus growth of the labour force represents the lower limit to the potential growth rate when a country’s economy operates near full capacity.  When below full capacity, the case for all eurozone countries with the possible exception of Germany, growth rates can rise considerably above this.

Across the eurozone countries private sector labour productivity growth slowed after the financial crisis of 2008-2010, but was well above one percent annually.  This number implies that taken together the eurozone countries must growth at least by 1.5% to prevent a rise in unemployment.  As the chart below shows, since 2012 only the Spanish economy sustained an annual rate of growth substantially above 1.5%.

Over the four quarters through June 2016 the German and French economies grew at rates just sufficient to prevent unemployment increasing, while the Italian rate fell far short.  On average across the eurozone GDP expansion was insufficient to lower the unemployment rate.  No rational person would call this “slow recovery”.  It is stagnation.

Annualized GDP Growth Rates Euro 15, France, Germany, Italy & Spain, Quarterly 2008-2016 (4 quarter moving average)

0906weeks--fig.3

Source: OECD

Note: numbers in legend average for entire period.

Fiscal deficits have fallen across the eurozone and most countries have passed from current account deficits to surpluses.  So slow has been progress on the former that the hypothesis cannot be rejected that initially larger deficits due to fiscal stimulus would have brought deficits down faster.  Similarly, the current account surpluses in most countries may reflect depressed domestic demand rather than greater competitiveness.

The German Chancellor described the British referendum result a “deep break in European history”.  At the meeting in Bratislava in mid-September she will face a range of complains and challenges, many of which have their source in the region’s economic stagnation.  One can speculate about the political health of the EU had she and her finance minister spent the last six years stimulating the European economies rather than “consolidating” and “reforming”.

Labour Party Leadership:  Fight for Policies Not Souls

By John Weeks

A Yawning Divide

Those following the internal conflict in the UK Labour Party repeatedly read that  it is a fight for the “soul” of the party.  This metaphysical reference to the contest between Jeremy Corbyn and Owen Smith comes as part of the concerted campaign to depoliticize and divert from the basic issues at stake.  It may be that some or most of Jeremy Corbyn’s opponents within the party believe that the unfolding leadership contest involves something analogous to religious conversion.  The use of this evangelistic metaphor consciously to avoid policy debate is considerably more likely.

As I wrote is my last post, “the Corbyn Phenomenon”, the deep division in the Labour Party results from one major fissure, social democracy on the left of the crack and neoliberalism-lite on the right.  Initially narrow enough for a few politicians to straddle, over the last year the crack widened to breech and now a deep chasm for which the famous US union song “Which side are you on” applies in spades.

Almost thirty years ago Tony Blair and his supporters undertook a spectacularly successful conversion of official LP policy to neoliberalism.  Why, suddenly it seems, can a social democrat lead the party he made his own and none dare speak his name except to denounce him?

Therein lies the explanation for why the center-right of the Labour Party refuses to debate its political differences with the social democrat progressives, focusing instead on allegations of Jeremy Corbyn’s lack of leadership qualities including incompetence, lack of charisma and being “out of touch”.

A serious and frank discussion of policies would destroy Corbyn’s opponents within the party.  The social democrats at the party base that Blair disenfranchised have reasserted control of party policy.

How the Labour Party got here

Until quite recently the Labour Party (LP) functioned in a strictly hierarchical manner.  For decades LP members of Parliament selected the party leader.  A change in rules that assigned MPs, trade unions and members at the constituency level each a one-third share brought the victory in 2010 of the more progressive candidate (Ed Miliband) over the center-right candidate (his older brother David, now living in the United States).

Ed Miliband’s parliamentary party (PLP) had supported his opponent by a considerable majority and set out consciously to undermine his leadership.  He proved unable to shift the PLP toward social democratic policies.  This was obvious in the general election of May 2015 when official party policy endorsed a balanced fiscal budget.  However, he achieved one change that would undo the power of the center-right in the party.  He introduced one-person-one-vote for the party’s leaders.

The failure to block this change indicates out out-of-touch was the center-right with the grass roots.  However, the Miliband voting reform still required that a leadership candidate obtain the endorsement of at least 35 MPs.  So marginalized were the social democratic MPs that the late-day Blairites assumed that 35 would be an insurmountable obstacle to a progressive leadership challenge.

In every leadership contest for a generation the “far left” (aka committed social democrats) of the party put forward a candidate.  In May 2015 this small group of social democratic insurrectionist MPs (no more than a dozen) faced a serious constrain.  Their most prominent members had either served as the sacrificial lambs previously or were not available (one that I had the honor of knowing, Michael Meacher, would soon die of a sudden illness).

Jeremy Corbyn received one more than the minimum endorsements, making the cut literally at the last minute before the deadline.  At least two of his endorsers came from the center-right after much pleading from progressive MPs that the contest should have at least the appearance of inclusiveness.  The campaign proved remarkably policy focused.

Corbyn opposed austerity, and his three opponents endorsed it with varying degrees of enthusiasm.  Corbyn opposed renewing the UK nuclear program; the other three endorsed renewal.  Corbyn advocated renationalization of the railroads and eliminating university fees.  His opponents ridiculed both policies.  Corbyn endorsed union rights without qualification, while his opponents adopted various degrees of equivocation.

The rest, as the cliché goes, is history.  At a meeting in September 2015 the results were announced.  Corbyn came first among four candidates with 59.9%, far ahead of his runner-up at 19.5%.  The most blatantly Blairite candidate came last with less than 5%.  Over 400,000 voted, three-quarters of the membership.

The Labour Party, social democratic at the base, elected a social democratic as leader for the first time in over thirty years with overwhelming support from unions and working class members.  The PLP remained overwhelmingly center-right.  The social democratic MPs had begrudgingly, if passively supported the party leadership under Blair and his short-lived successor Gordon Brown (even as the purge of progressives continued).  The leaders center-right quickly made it clear that Corbyn would find no loyalty or even civility from them.  The intra-party war began immediately upon Corbyn’s election.

Deposing Corbyn without an Election

Corbyn’s overwhelming victory among Labour Party members left center-right opponents with no obvious strategy for deposing him.  They did not accept his leadership, but they could not remove him through established party procedures.  By necessity they sought a combination of strategy and tactics that they hoped would force him to resign.

They could not force his resignation through debate over political issues because his policies reflected the views of the grassroots.  This left the anti-Corbyn MPs with only one tactic, to discredit Corbyn personally.  The tactic would prove an extremely difficult to implement successfully.  While Corbyn has faults as all humans do, like Bernie Sanders he suffers from none of those flaws that usually discredit a politician.

He lies modestly without a hint of corruption.  The closest his enemies have come to a case of corruption was the revelation that Corbyn supporter t-shirts were made by sweatshop labor, which he quickly denounced.  In one of those ironies no one could make up, Britain’s most right-wing newspaper burst with outrage over “poverty-stricken workers” (the support group distributing the shirts quickly changed supplier).  Try as they might, Corbyn’s opponents have found no evidence of sexual misconduct, that other variety of politician-slaying scandals (except in France).

The discrediting campaign shifted focus to allegations of “unelectability”.  This proved ineffective across the Labour grass roots, because electoral outcomes during the Corbyn months have been sufficiently ambiguous to produce no clear message.  However, the aggressiveness of the person attacks took a quantum leap after the English and Welsh electorates (but not the Scots or the Northern Irish) voted “out” in the referendum on EU membership.

Guardian columnist Polly Toynbee, who had bolted the Labour Party in the 1980s as part of a right-wing exodus, denounced Corbyn as “dismal, lifeless, spineless”.  A few days later prominent economist and editor-in-chief of the Guardian Sunday edition (The Observer) Will Hutton informed his readers that Corbyn was not a social democratic, but an ideologue committed to the overthrown of capitalism, not to its reform.

Various decisions by Labour Party’s politically split National Executive Committee make it unclear as to the number of eligible voters in the unfolding leadership contest.  None-the-less, polling suggests that Corbyn will achieve re-election with a strong majority.  Whether this is true, his opponents appear to believe it a strong possibility.  In response a major donor to the Labour Party funded a court case to have Corbyn excluded from the leadership race, a case being heard as I write (see discussion on the putatively neutral website of Labour MPs).

End of an Era?

The current leadership contest is not a re-run of 2015.  During last year’s leadership contest no one in the Labour Party realized the revolutionary impact of the Miliband voting reforms.  The surge of enthusiasm for Jeremy Corbyn and his overwhelming victory came as surprise to opponents and supporters.

For an early campaign appearance his major strategist (John McDonnell now his shadow chancellor) urged booking a small room of less than 50 chairs to avoid embarrassment should few arrive.  Over 500 Labour Party members appeared at the provincial university venture, which required Corbyn to speak outdoors with a megaphone.

This time both sides come prepared for the conflict that will solidify in the Labour Party the new era of resurgent social democracy, or re-establish center-right leadership of the Blair period.  Should the later occur, on the surface British politics will return to a neoliberal consensus across the parties of England and Wales (but not Scotland where the social democratic Scottish National Party rules like a colossus).

On the assumption that legal challenges do not exclude Corbyn from the contest, the center-right campaign will be slanderous, venal and petty.  The fundamental source of this political degeneration is not the character failings on the anti-Corbyn forces (though these are many).  The center-right campaign will take this form because it cannot on peril of certain defeat enter into political debate, its fatal weakness.

In contrast, the Corbyn campaign will take the cliché-ridden “high ground”, stressing policies, not personalities.  Many of Corbyn’s devoted supporters have and will launch savage tweets against his opponent Owen Smith.  Corbyn himself and those in his campaign will avoid such trivialities.

Corbyn has the winning card and will play it repeatedly: that he and his shadow cabinet are social democrats.

John Weeks is a professor emeritus at the School of Oriental and African Studies of the University of London and author of The Economics of the 1%: How Mainstream Economics Serves the Rich, Obscures Reality and Distorts Policy. Follow him Twitter: @johnweeks41.