How are the southern euro area countries doing in tackling their weaknesses?

Overall the experience of southern European euro zone countries has not been good since the euro zone was initiated in 1999 with Portugal, Spain and Italy all founding members and Greece joining two years later. Whether or to what extent this poor performance is due to the supposed structural flaw in the euro zone (an integrated monetary area but not an integrated fiscal or political area) or due to problems in the countries themselves is open to debate. The fact that performance was not very good also in the 1990s compared with previous decades supports the view that the problems lie within the countries themselves although two countries in particular were ultimately hurt by excess borrowing resulting from the mistaken view of markets that the lending within the euro zone was safe. When the 2008-09 financial crisis came from the US to the EU the southern euro zone was hit particularly badly. Initially the worst hit countries were Greece, Portugal and Spain plus Ireland. Ireland was the first to recover while Italy’s problems including those of its banks became worse so the ungainly acronym PIGS remained appropriate swapping Italy for Ireland.

From a societal point of view the biggest problem in all these countries is unemployment, especially youth unemployment. In Greece and until recently Spain youth unemployment is almost 50% (although this does not account for unregistered employment) in Italy and Portugal 40%.

International organisations including the European Commission, the OECD and the IMF constantly call for reform and stipulate a wide range of such reforms. Reforms are also called for by creditor countries notably Germany and the Netherlands and the European Commission has to take account of their views in its own recommendations. The creditors recommendations are inevitably informed by their own self interest. The IMF is also a creditor of Greece and is calling for debt relief but not of its own loans.  Such self-interest is reasonable up to a point. Irresponsible borrowing should not be encouraged. But there comes a point when the pain should be shared. Irresponsible lending which assumes that government loans will always be repaid also should not be encouraged.

The biggest problem with reform recommendations is that they tend to be so wide-ranging as to be telling supposedly sovereign and democratic parliaments how to legislate over a wide range of subjects. This has particularly been the case for the hardest hit country Greece but is also a live issue in the other countries. For this reason I want to focus on those l reforms which I think most important. First are reforms to the labour market, most importantly to modify protections to employees which are perceived by employers as very  burdensome and so discourage taking on employees. The second is the pressing need in several countries to simplify regulations and reduce the cost for starting new businesses and running small businesses.  Thirdly, there is the task of making the rule of law more effective, in terms of independence and impartiality of the judiciary, effectiveness in terms of sanctions and also the time taken to bring about justice. Finally, reforms may be needed to improve the management of public finances, not least in terms of collection of taxes. Decisions about how spending is divided and how much to tax should be left to free democratic choice unless expenditure is bankrupting the country or taxes are utterly crippling economic activity remembering that some countries can be economically successful with high levels of public expenditure.

The most important single reform which can improve the chances that more job opportunities are provided and one which more than most others can be done through a single piece of legislation from central governments is to limit the costs and legal procedures for companies to shed employees. The reason is simply that there is much evidence gathered by a range of organisations like the OECD that, if such costs are reasonable and predictable, companies will be much more willing to take on new employees. The model to be aimed at is one in Scandinavian countries and the Netherlands where redundant employees are given adequate welfare support and crucially access to retraining. However, there has been huge resistance to such reforms in countries like Italy and France from trade unions. Trade unions are a key ingredient in a plural society and should not be lightly over-ridden, but in this instance where they are giving priority to their hold on a diminishing membership at the expense of opportunities for young people, they should be over-ridden. The best example of a country that has reformed its labour market in this way is Spain which began introducing reforms early in the last decade and enacted a major labor market reform in 2012, while in recession.  This reform permitted companies in most cases to dismiss regular contract employees with 20 days severance pay per year worked, compared to up to 48 days previously. There were high levels of job creation in Spain during the boom before the 2008 crash, but during the recession and in the wake of a reform making it easier to fire workers, it went sharply into reverse. From 2014 the economy and employment have been recovering strongly. In Italy Matteo Renzi introduced significant reforms in employment legislation when prime minister between 2014 and 2016. There has been no major impact on job creation so far, though this may be due to the fact that the economy remains weaker than the euro area average.

Such a reform to increase flexibility should not be seen as a complete deregulation of the labour market.  The UK, which has long been one of the most flexible labour markets with high levels of job creation, has kept powerful employment tribunals to protect individuals against discrimination or victimisation, although they are now weakened by cost cutting. However, in Italy a law protecting individual employees was a long cause of controversy with employers accepting paying compensation if found to have dismissed an employee unfairly but arguing that having to take the employee back was disruptive.

Making life easy for people to start and run small businesses should not be controversial but is less easy in practice than might be expected. Two reasons may be postulated. One is that registration usually involves local governments, which are rightly autonomous. Secondly, some parts of southern Europe have a long established culture of non-co-operation and even antagonism between the private and public sectors. Private companies regard government as just a hindrance and don’t like paying taxes while government regards private companies as out to cheat. The resulting behavior of one side reinforces that of the other. Nevertheless there have been significant improvements according to the OECD in most OECD countries over the last eight years. In 2016 an OECD survey found that Scandinavian countries, the UK, Ireland and France were below average for both time and cost required to start a new business. Amongst southern European countries, Portugal seemed the best with well below average time and just slightly above average cost (just over 2% of income per capita). Italy was average for time but high for cost.

Another survey on overall Barriers to Entrepreneurship affecting small and medium enterprises also published by the OECD shows that both Italy and Portugal moved from being amongst the countries with the most burdensome regulations to being third and seventh best in terms of least restrictive legislation between 2008 and 2013. Spain, however, which has as noted done most to reform labour market legislation, retained in 2013 the second most burdensome other restrictions on entrepreneurship, having seen no improvement over the previous five years. Greece did improve but still scored only a little better than Spain.

It may of interest that Italy according to the OECD had just over 3.5m enterprises in 2013 more in absolute not just relative terms than any other country apart from the US (and not much less than the US). A generation ago Italy’s local networks of enterprises both cooperating and competing were seen as a model. They have been less dynamic than hoped in the intervening period but remain resilient. In particular Italy is a (possibly the) world leader in design, particularly but not only clothing, and there has been a moderate return of clothes making to Italy for those willing to pay a little more.

On the general question of good government, a very interesting and still relevant book called Making Democracy Work: Civic Traditions in Modern Italy by Robert Putnam was published in 1993.  It takes as its starting point the major devolution of government reform which took place in 1970 following 100 years since unification of centralized government. It compared various survey measures of good government seen through the eyes of both individual citizens and businesses and measures of civic participation (partly actual participation in social groups and partly attitudes). It found that regions with a higher degree of “civicness” correlated surprisingly closely with better government performance both through objective tests and as seen by citizens. The higher degree of civicness itself was found to be linked to the history of the regions – ones that had been city states or with local autonomy hundreds of years ago showing much higher levels of civic participation than those that had been under autocracies – most notably in the south. But the book did not find that as a cause for fatalism. Both southerners and northerners were positive about the impact of devolution and improvements on the quality of government could be seen in the south as well as north between 1970 and the early 1990s. While the south remains poorer than the centre and north and with higher unemployment, its standard of living, which had remained very low during 100 years of centralised government, has increased hugely in the decades after 1970. The book is not only relevant to Italy. The differences between regions within a country are perhaps particularly strong in Italy but also exist in most other countries and should be a warning against sweeping generalisations.

Often taking for granted when it operates well, the effectiveness of a country’s legal system including the objectivity and independence of the judiciary, is essential to a good environment for businesses of all sizes to operate and so to economic development. Companies need to be able to enforce contracts and be able to operate without fear of criminals particular mafia-type organisations which have in southern Italy particularly conducted widespread extortion.  In Spain and Italy the judiciary is independent and has been a thorn in the side of allegedly corrupt politicians in both countries, including members of the governing Popular Party in Spain. On the other hand, the system can be very slow, especially in Italy. As is well known Sicily and southern Italy are where the word mafia originated and particularly in Sicily, Calabria and around Naples has had a vice-look grip on parts of the economy. Due to the dedication and bravery of police, public prosecutors and judges, and also the co-operation of businesses in resisting extortion, the power of the mafias especially in Sicily have been reduced though they remain a major challenge and have indeed spread into the north.

In overall terms, I think the four countries I have discussed are all making changes for the better albeit slowly and unevenly and subject to the normal political shenanigans of any democratic country. The devolution of power in Italy has been very beneficial, although inevitably it means differences in quality of government between the regions. It has also overall been beneficial in Spain, despite some bad examples of corruption associated with speculative building in some regions. Outright independence for any region would be a step backwards. Although independence is favoured by many in Catalonia, a geographically small but economically important autonomous community in Spain, I don’t think the majority exists to bring it about.

The issues here discussed are in my opinion more important for the countries’ future than whether or not they remain members of the euro zone, though leaving would cause a lot of disruption and no significant benefit. Criticisms made of euro area policies towards countries dependent on the backing of creditors and of the European Central Bank are mostly valid but their claim that a softer policy would have enormous benefits is exaggerated. Once country Greece is being unjustly treated by Germany and the Netherlands taken into account how much pain it has suffered in the last nine years, the fact that it finds itself host to more refugees relative to its population than any other EU member and the fact that lenders and EU decision makers acted just as irresponsibly as Greek governments, but even in this case the answers to Greece’s economic travails lie more inside Greece than outside.

 

 

2017 will be risky year for EU (less the UK) but there are also reasons for hope

 

The year 2017 will be an eventful and important year for the EU. The expectation that the UK will set in motion in March a process to leave the EU in two years is a blow – the first time that a full country has decided to leave the EU (Greenland an autonomous region with a link to Denmark had previously left) and one that might suggest the possibility of further countries leaving. The immediate aftermath of the UK according polls conducted by the German Bertelsmann Institute was a strengthening of pro-EU feeling in all other countries and there does not appear to be any country with a majority in favour of leaving the EU. Nevertheless there are strong movements in many remaining member states which are either in favour of outright departure or want to weaken the EU; there is also increased opposition to euro membership in Italy.

With the governments of all other major countries either weak or unstable and with many of their economies still struggling, Germany has in recent years played a leading role, and this will be even more the case in 2017 with the UK having decided to leave. The coming election there in September is likely to see the Christian Democrats re-elected as the largest party and therefore the leading party in a coalition, which could be again with the Social Democrats (SPD) or other parties. Whatever the criticisms made of her, Angela Merkel as the unchallenged leader of the CDU will very probably be re-appointed as chancellor.

 

Italy with caretaker prime minister faces election by March 2018

Within the euro zone Italy had since Matteo Renzi became prime minister in 2014 had a stronger and for Italy relatively long-lasting government. For a time Renzi seemed the most effective leader after Merkel, but he resigned in December as a result of a badly misjudged referendum on constitutional reform. If the overall aim of the reform – to change Italy’s costly and unwieldy bicameral system – was a good one, details were flawed and it became associated with a separate electoral reform, which could have given excessive power to the largest party even if it had well below majority support. In addition, having promised to resign as prime minister if he lost, Renzi had to do so. As a result Italy faces a new period of political instability with elections likely in 2017 and necessary by March 2018. There is a possibility that the Five Star Movement (M5S) might come to power. It can be described as populist but is not as anti-immigrant as other populist movements. It has said that it would have a referendum on euro membership. The leader, Beppe Grillo, is hyper-critical of the other main parties, particular the Democratic Party (PD), which is still led by Renzi, but M5S’s own performance in city governments has been mixed and particularly poor so far in Rome.

 

Spain with new minority government stages economic recovery

Spain, following a year with only a caretaker government, now has one led by the previously incumbent right-of-centre Popular Party (PP), which has been given conditional support by the opposition Socialists (PSOE) and opposed by the newer and more left wing Podemos, as well as being challenged by Catalan nationalism. In the last year the economy has finally, seven years after its collapse in 2008-09, staged an impressive recovery with over half a million extra jobs created in 2016. This seems likely to continue meaning that despite political difficulties Spain is no longer a weak link in the euro zone.

 

First 2017 elections to take place in Netherlands

Elections will take place in the Netherlands in March when the performance of the virulently anti-Muslim party the PVV led by Geert Wilders will be watched. Netherlands’ governments have always been coalitions but the other main parties have said they will not form a coalition with the PVV. Such a strategy may seem right in principle but has the disadvantage that the PVV has been becoming the main opposition.

 

French elections in May should lead to stronger president

The next major EU elections in 2017 will probably be those for the French president and parliament in May. At present there are three leading candidates each with about a quarter of likely votes according to opinion polls: Marine Le Pen leader of the Front National, Francois Fillon, the choice of the right of centre, and Emmanuel Macron, a centrist who was minister in the Socialist government before resigning to declare his independent candidacy. President Hollande is not standing. The Socialist Party is holding a primary to choose its official candidate but none of the potential official Socialist candidates looks likely to rival Macron. Macron has been making speeches emphasizing his difference with Le Pen by giving full-hearted support to the EU and declaring that France should be open and multi-cultural. Fillon on the other hand may try to win over potential Le Pen voters by being more sceptical of the EU (though not in favour of a referendum on it) and appealing to identity politics. He has also called for drastic cuts in the size of the public sector, one of the largest in Europe relative to the economy, by reducing state employment by half a million. As a declared admirer of Mrs Thatcher, he may also pursue policies which increase inequality. Even if these succeed in helping the development of private sector enterprise,they could increase the number of people who feel left out and so could be vulnerable to Le Pen.

At the moment opinion polls suggest that in the second round of presidential elections between the two leading candidates in the first round, assuming Le Pen comes first or second, that either Fillon or Macron would win by between 60 and 65% of the vote against 35-40% for Le Pen. Given the surprise Leave vote in the EU and the Trump victory in the US, there is no room for complacency that this apparently comfortable lead will be reflected in the final vote.

If Fillon or Macron can win by a reasonably strong majority his government will at least for a time have the potential to be a near-equal partner with Germany led by Merkel, a role that President Hollande has not been able to fulfill. Unlike Hollande, both Macron and Fillon argue that difficult and painful reforms are needed to revive the French economy and to strengthen the fiscal position. They are not therefore setting themselves up for a dramatic decline in support when it becomes apparent that they cannot meet promises made during the campaign as happened with Hollande.

 

Merkel likely to remain chancellor after September election

Germany’s election takes place, as is traditional there, in September. The far-right party, the Alternative fur Deutschland, at present polling at 13%, is less of a threat there to the mainstream parties than similar parties are in the many other EU countries, despite the bold decision of Angela Merkel to welcome over a million refugees in 2015. Still, the far-right will for the first time in post-Second World War Germany have seats in the federal parliament, and its presence there is likely to be quite significant.

If she can hold the far-right opposition to its present level of support, Merkel is likely to achieve another convincing electoral victory. Her ability to remain an authoritative but not authoritarian chancellor after 13 years in the post is remarkable but at present she faces no major challenge from any competitor for the post. Germany led by Merkel has been a lynchpin of stability and liberal multi-culturalism in the EU as a whole.

 

Criticism of Germany’s fiscal policy are valid but should not be exaggerated

On the other hand Germany’s finance minister, Wolfgang Schauble, has been accused of dictating harshly restrictive monetary and fiscal policies which have served its interests more than its euro area partners. Schauble is the second most powerful figure in German politics. His popularity means that Merkel would find it very hard to overrule him and risk provoking his resignation.

In fact the monetary policy of the European Central Bank, in promising if required unlimited intervention to keep key countries in the euro area and keeping interest rates close to zero has been highly criticized both by Schauble and by the Bundesbank. In fiscal policy Schauble has largely got his own way which has is in some respects been excessively harsh, especially in still refusing to write off un-repayable Greek and Portuguese debt and being unwilling to take into account the pressures on Italy’s public finances by the need to tackle the bulk of the cross-Mediterranean migrant flow in the last 12 months and suffering severe earthquakes. On the other hand, German policy has been consistent with holding the euro area together, and, whatever happened the post-2008-09 crash period would have been a difficult one inside the euro area as it has been outside the euro area. While some criticisms of German policy are justifiable it is not helpful to suggest that the difficulties of other countries should be solved more in Germany than domestically. Ireland has for several years shown that a euro zone crisis country could recover and in 2016 Spain recovered with the addition of over half a million extra jobs.

 

Role of EU institutions is important but likely to remain low profile

Given the upsets in the UK and the US in 2016 and the substantial support for right wing populist parties in many EU countries there are clearly risks that the cohesion of the EU apart from the UK. However, there are also grounds for hope that it can hold together despite both internal strains and unpredictable policies of the US and Russia, as well as the possibility of large new flows of refugees via Turkey or Libya. The ability to do so depends primarily on what happens in member states. The performance and decisions of the EU institutions, the Commission, Parliament and Court of Justice are important in the longer term but it is unlikely that they will do anything in the coming 12 months which has a decisive impact on the EU’s prospects. Following the departure of the Socialist Martin Schulz to return to German politics, the new president of the European Parliament, Antonio Tajani a member of the centre-right European Peoples’ Party is likely to have a lower profile. The European Commission, headed by Jean-Claude Juncker, has kept a generally low profile and is likely to do so.

One delicate issue is how far to go in criticizing authoritarian governments in Poland and Hungary for actions that seem to come into conflict with commitments made at the time of EU entry on principles like the independence of the judiciary. Overall, the EU institutions are unlikely to and should not push for more power since this could provoke a backlash in countries other than the UK  but they will still have important roles to play in keeping the EU functioning in very difficult circumstances.

Can Spain’s new parties bring new vigour to Spanish politics or will there be deadlock?

 

On January 13th, the new Spanish Parliament, the Cortes, met for the first time following the election of December 20th which gave significant numbers of seats to two completely new parties formed since the previous election, the left wing Podemos (“We can”) and the centre-right anti-corruption Ciudadanos (“Citizens”). The emergence of one, let alone two, new nationwide parties winning substantial numbers of members of parliament, is a rare event in Europe (or outside Europe). The only other example in a large European country this century is the Movimento 5 Stelle (M5S) in Italy. The formation of new parties, despite making government formation more difficult is in the opinion of InsightEU, a positive development which has the potential to re-invigorate democracy. The ability of the two parties to continue to flourish is therefore important for Spain and indeed for the EU as a whole. To do so they have to steer a difficult passage between being simply a protest party determined not to sully itself with real life compromise and treating the pilloried establishment parties with the modicum of respect needed for any negotations and being sucked into coalitions where they have to share responsibility for government and its inevitable failures and in a worst case scenario come to be seen as complicit in a system which they have been able to do little to change. M5S has avoided the latter but at the cost of remaining essentially a protest movement. But the Italian electoral system has meant that M5S is in any case an opposition party. In Spain the electoral result on December 20th and the refusal of the leader of the established Socialist Party (PSOE) to form a coalition with the party governing Spain until the December 2015 election (and still the provisional government) the right-of-centre Popular Party (PP), mean that the two new parties’ choices will be key to determining whether a government can be formed and win a vote of confidence or whether as must happen if no government is formed within two months of parliament reconvening, another election is called. In the latter event it would be likely that voters would move towards the PP as the largest party and therefore the one most likely to provide a majority government.

 

Sub-plot in Catalonia could prevent progress in Madrid

Pedro Sanchez came back from an early Janurary visit to Portugal extolling the recently formed coalition there between the Portuguese Socialist Party and two parties further to the left including the Portuguese Community Party. Sanchez has called for a left wing coalition in Spain, as was suggested as a likely outcome in our post of December 24th, but this now looks very difficult. The Catalan nationalist parties, which have just formed a new regional government, are set on their demands for a referendum on outright independence. Podemos favours such a referendum but the PSOE has promised to oppose it. Thus a coalition including the PSOE and the Catalan parties is impossible, while one including both the PSOE and Podemos looks very difficult. Not only is there the inevitable mistrust between two parties competing for the left wing vote, but there is also the whole issue of the future survival of Spain as a nation. Moroever, without the Catalan parties, Ciudadanos would have to be included to make a majority in the Cortes.

 

Can Podemos compromise enough to allow for new government?

It is to be hoped that Podemos is willing to modify its position on a referendum in the near term. It would be very unfortunate if a new party formed to combat the injustices of a 21st century economy were to be diverted onto the path of supporting nationalism of a kind little different in essence from the 19th century nationalist movements. There is some right and wrong on both sides of the referendum argument. On the one hand, the Spanish establishment needs to understand that if the majority of Catalans feel over a long period that they are not respected in Spain and are thwarted from fulfilling reasonable expectations as resulted from the constitutional court’s overruling of an agreement with the previous PSOE government for increased devolution, this will undermine the legitimacy of Spain. On the other hand, where pro and anti independence opinion is quite evenly divided and also volatile, a referendum which gave a little over 50% to a pro-independence question on one day but could be different if held a few years earlier or later, is a very flimsy basis on which to overturn the 524 years of unity since the merger of the Kingdoms of Aragon and Castile in 1492.

Whatever the pros and cons of the argument for Catalan independence it is almost irrelevant to the issues of inequality and lack of opportunity which affect all parts of Spain (as indeed many other countries).

Ciudadanos appears more willing to take the risks of entering a coalition government than Podemos. A possible way forward, though not one likely to guarantee a government to last the four-year parliamentary term, would be a minority coalition between the PSOE and Ciudadanos backed from outside government by Podemos, in return for meeting the two immediate demands that Podemos has made: a halt to banks repossessing homes from those unable to meet mortgage servicing commitments and free medicines for the elderly. Such demands should be possible to meet without endangering the credibility of Spain’s fiscal policy.

Spain’s Christmas election: what does it mean?

The results of the Spanish election on December 20th are not clear-cut. Four parties, two old –the centre-right Popular Party and centre-left Socialists (PSOE)—and two new, the left wing Podemos (We can) a movement of local groups which grew out of the 2011 street protests by the Indignados at the time that government cutbacks, and the centrist Ciudadanos (Citizens). The new parties have mounted a significant challenge to the old parties, but unlike Greece failed to dislodge them.

 A fragile lefty-wing coalition may emerge

There does appear, however, to be the possibility of a narrow margin in favour of those who want a change of from the PP, a party whose government in the last four years has succeeded, at considerable social cost, in turning round the economy, but whose moral authority has been weakened by the revelation that the party had for a long time ran a dual bookkeeping system, one above board and one for illegal contributions and illegal payouts. The PSOE is also tainted by corruption but mainly in its regional stronghold, Andalusia. Moreover the PSOE leader, Pedro Sanchez, is relatively new and not seen as tainted by past malpractice. The PP leader, Mariano Rajoy, has by contrast been party leader since 2004 and cannot convincingly claim that he new nothing about what was happening, unless by deliberately turning a blind eye.

The election of 69 MPs to Podemos and 40 to Ciudadanos (out of 350 deputies in the lower house) from none in the previous national election in 2011 are major breakthroughs but ones that were fully expected. Indeed the result for Ciudadanos was in comparison with opinion polls during the campaign the most disappointing of all four main national parties. One reason may be that polls seemed to be pointing towards a centre-right coalition of Ciudadanos and the PP. Some potential Ciudadanos supporters may have moved to other parties on the left because they did not want to prop up the PP.

As it is neither the two national parties of the centre-right nor the two national parties of the left, the PSOE and Podemos, can quite muster the 176 seats needed to hold a majority. The other parties are mainly regional ones, some of whom are on the left, others in the centre. However, because the PSOE and Podemos are more sympathetic to the ambitions of the regional parties (though not as far as wanting to concede outright independence to Catalonia or the Basque Country) they will probably support a left wing government enabling it to have a fragile majority.

 

Meeting the hopes of its voters will be an uphill struggle

Such an alliance might be portrayed as an anti-austerity coalition but if it tries to live up to such a name it will be wasting precious time. Investors in Spanish government paper have to be kept happy that the government will keep the deb from rising rapidly, otherwise they will charge higher interest rates leaving less available for other government expenditure or in extremis force the government to seek a full scale bail-out (they at present have limited support to help prop up illiquid savings banks) from the European Stability Fund (ESM), thus leading them from the frying pan of the need to keep investors happy to the fire of being told what to do by the Quadriga (the old Troika of IMF, European Central Bank and European Commission plus the ESM).

What the government may be able to do is to distribute the burden of austerity more fairly between the privileged on the one hand and the less privileged and public services on the other. That means higher taxes, and crucially a drive against tax avoidance and evasion. An exception should be made to the relatively small proportion of private wealth going into small and medium businesses. To successfully make significant moves to a more equal society while also promoting continued economic recovery, will require single-minded determination, skill, patience and the willingness of competing parties to work together. At the time of writing this looks a tall order, and the left can be sure that the PP will exploit any weakness or failures.

 

 

 

 

Anti-system parties adapt to opposing forces

The agreement reached between the Greek government, led by the leftwing Syriza coalition, and representatives of Greece’s creditors on August 11th for a third loan to avoid default, following those in 2010 and 2012, increases the chances that Greece will stay in the euro zone, despite uncertainties over whether the government will be able to implement what it has agreed to and as to whether the creditor governments from the rest of the euro zone will be willing at some point to make the debt manageable.

It means that – apart from a significant dissenting minority—the formerly anti-system Syriza has succumbed to the rules of the euro zone. This development can be looked at negatively as the denial of democratic hopes of the Greek people but there is still the chance that the new government can prove to be radical in the Greek context.  It can remodel the administration to work for the public rather than in its own interests or those of privileged clients as has often been the case; it can reform the tax system to enforce payment of taxes, but for this to be possible it will have to ensure that payment of taxes is compatible with Greece’s large number of small businesses thriving and expanding. Despite this proviso it cannot act to reduce inequality. There is still scope to hope that a government not formed of one of the two that have governed Greece since the end of military rule in 1974 will be able to do what the others failed to do, namely transforming the enduring Greek view of the state as opponent of the individual citizen to one of a state serving the citizen.

 

Spain’s Podemos likely to make gains but will also have to compromise

In Spain two new parties, Podemos (We Can) and Ciudadanos (Citizens), will at the end-November elections in similar manner challenge the longstanding hold on power over 30 years of two established parties of centre-right and centre-left.  While Ciudadonos is a centrist party, Podemos is very similar to Syriza, except that Syriza is a coalition of formerly existing small parties, while Podemos has emerged as completely new since the 2008-09 crisis. It achieved considerable breakthroughs when local groups supported by Podemos won sufficient seats on the town councils of Madrid, Barcelona and some other cities, to appoint mayors. The new mayor of Barcelona, the 41-year-old Ana Colau was previously running a campaign group against evictions of families unable to pay mortgages while the new mayor of Madrid, the 71-year-old Manuela Carmena, had in the past been a leading member of a law firm focusing on employment law, who had seem some of her colleagues in the firm assassinated by right wing extremists soon after the restoration of democracy in 1975.

Creditor institutions are now claiming that a Greek recovery was beginning at the time of Syriza’s election victory in January 2015, but any such recovery was highly tentative and had not had any impact on the great majority of the Greek public. The Spanish government of Mariano Rajoy (Popular Party) can point to expected 3% growth this year and half a million extra jobs in the year to mid-2015. The opposition, which includes the traditional socialist party (PSOE) as well as the two new parties, can point to major corruption cases implicating the PP and continuing near 50% youth unemployment. Despite Podemos’ success in major cities, the two new parties, alone or together, are not likely to win the election. But they should become a significant presence at national level and could be part of a coalition of the centre-left.

 

Portugal prepares for a traditional two party contest

Portugal is holding general elections in early October. Remarkably, despite the severe austerity the country has experienced, there is no sign of any increase in support for non-traditional or existing far-left or far-right parties. The elections will be a close contest between the governing parties –the Social Democrats  and  Christian Democrats – which have recently united to fight the election– and the opposition Socialist Party. One reason may be that, despite government cuts and high taxation reducing living standards unemployment at 11% is much lower than the rates of 23% and 25% in Spain and Greece. Another could be that an active and independent judiciary has gone so far as detain the former Socialist prime minister, Jose Socrates, in prison since November 2014 awaiting trial for corruption and Ricardo Salgado, the head of the country’s largest failed bank, Espirito Santo was put under precautionary house arrest in July pending trial on a range of charges connected with his leadership of the bank. The public may therefore not feel the establishment is able to act with impunity.

 

Real change may still be possible

In Greece and Spain, anti-system parties have made gains and are likely to do so again in the November general elections in Spain. But they have been and will continue to have to compromise with internal and external forces they oppose. Even so they bring new energy and challenge vested interests. Some real change could be achieved, although it will fall well short of their ambitions.

After five years depression Spanish employment rebounds

Employment jumps dramatically

After five years of depression, the Spanish economy is growing again. Employment rose by 402,000 in the second quarter. In the second quarter of 2013 employment rose by 98,000. The underlying economy was then still declining but not very steeply so no more than 150,000 of the extra jobs in the second quarter of 2014 are likely to have been for seasonal reasons, leaving 250,000 new jobs because of a recovering economy. This could imply a million jobs in a year if the recovery continues at the same rate.

 

Boom and bust still a danger

It is important that the recovery is not creating a new external debt burden as happened in the boom in the early to mid 2000s. Here the evidence is mixed. The development of the current account deficit from €3bn in the first quarter of 013 to €10.4bn in the first quarter of 2014 (there was a surplus of €8.0bn for the whole of 2013) looks alarming. But there was also a big, and rising, positive errors and omissions item of €8.0bn. The so-called capital account which consists mainly of EU grants for investment showed an inflow of €3.5bn. This left the financial account with a moderate outflow (implying reduced net liabilities) of €1.0bn. There was a net outflow of direct investment – the part of the financial account, which does not add to debt—of €3.8bn, but this reflected an unusually strong outflow from Spain  in the first quarter. In most recent quarters there has been a substantial net inflow of direct investment. Therefore, though there was an increase in net debt liabilities of the Spanish economy of €2.8bn in the first quarter, the trend still appears to suggest an ongoing reduction in net debt. However, the figures will require careful monitoring.

 

Export performance and reduced import dependence are key

In some ways recovery should generate further recovery as the incomes of the newly employment (although they are likely mainly to be relatively low incomes) enable the newly employed to spend more. They should also pay more in tax and receive less in benefits so helping government to reduce the still high government sector deficit. However, it will also tend to pull in more imports so recent moderate rises in exports of goods and services (3.4% in 2013) will need to continue and, if possible, expand, if new imbalances are to be avoided. Reducing import dependency also could help, not least by investing in increased energy efficiency, which would also help address the fact that 69% of Spaniards, a higher percentage than in  most other EU countries, are worried about the cost of utility bills.

 

Spain has demonstrated high degree of social resilience

Unemployment reached 26% and youth unemployment has been over 50% for several years. Although there is a significant amount of employment in the informal economy this is very unsatisfactory particularly for young people trying to enter the labour market. The fact that Spain has been through a five year depression without destabilizing social unrest or the rise of extremist parties is a tribute to the resilience of its social fabric. The rise of the new party, Podemos (We can) which won 7% of votes in the May European Parliament elections follows from the peaceful protests and encampments of Indignados is encouraging.

 

The one major concern is the demands of the Autonomous Community of Catalonia to hold a referendum in November calling for Catalan independence. Such a referendum would not be binding and it is claimed by the Spanish government that it would  be illegal under the Spanish constitution but strong calls for independence cannot just be ignored. This is one matter on which the government of Mariano Rajoy has shown little tact, seeking to browbeat rather than persuade the Catalans that there interest remains in staying in Spain.

After five years, is the era of extreme austerity in southern Europe coming to an end?

The  southern countries of the euro zone, Ireland and France have experienced nearly six years of extreme austerity since the economic crash in North America and Europe at the end of 2008 exposed many weaknesses in these countries’ economies and their banks. At last there has been the beginning of an easing of austerity with the possibility of more measures to come. The reasons for austerity have been the high public debts and deficits of the countries concerned, excessive household and business debt in some of the countries, bank losses and inadequate bank capital ratios compounded by lack of transparency, and average inflation across the euro zone had stuck at close to the ECB target of just under 2%, which meant that the ECB could not within its policy mandate to take very substantive measures to loosen monetary policy, although its interest rates have for a long time been very low and it has provided easy short-term financing to banks.

Herculean efforts have meant that some of the affected countries, notably Italy but also even Greece, have managed to bring their deficit ratios (though not their debt ratios) to levels at which they have a little room for manoeuvre which they are exploiting even if without the approval of the troika (European Commission, ECB and IMF) or the ultimate authority, the German government itself dependent on  German voters. Less optimistically, household debt remains high especially in Spain, Portugal and Ireland and the condition of most banks remains weak, while at least until the new round of ECB supervised stress tests to be published later this, they are also lacking in transparency so there are fears that some banks may be still weaker.

The biggest change is that average inflation in the euro zone has fallen to 0.5% which means that the ECB is having to take action to boost the economy to allow inflation to rise towards its target and to avoid actual deflation. It did so on June 5th, with the first negative interest rate of 0.25% on bank deposits with the ECB and €400bn made available as targeted long term refinancing operations (TLTROs) provide banks onlend the sums at reasonable interest rates to non-financial companies. A further move which is being prepared and debated in the ECB is its purchase of asset backed securities (ASBs) of loan packages to small and medium enterprises. The TLTROs and, if they are introduced, ASBs, are the first real effort to tackle a major distortion in the euro zone, namely that it is far more difficult and more expensive for SMEs in southern Europe to borrow than in Germany or other north European countries.

Another significant development is the declared intention of the chair of the euro zone group of finance ministers, the Dutch finance minister, Jeroen Dijsselbloem, that some countries in the euro zone be given a little more flexibility in regard to the harsh imposition of rigour over the public finances. He made a distinction between countries with still relatively high  deficits which require a full focus on “corrective” measures, ie standard austerity measures to cut spending or raise taxes and those which have brought their deficits below the magic 3% threshold and for which “preventative” measures could be accepted in exchange for more flexibility on fiscal targets. These would be unlikely to include raising the 3% threshold but could imply flexibility of the goals for debt reduction and moving towards surplus. It may be helpful that it is Mr Dijsselbloem is suggesting such flexibility given that his provenance, the Netherlands, is seen as a country like Germany committed to fiscal orthodoxy at home. Nevertheless he and the countries, including most notably Italy which hope to be given more flexibility, will have to marshal their arguments cogently to challenge the severe belief in the merits of fiscal orthodoxy amongst the German establishment and German public opinion and not least, the view of the German finance minister, Wolfgang Schauble.

European Parliament election results, outside of France and UK, are positive for EU and euro

The European Parliament election results were much better in most countries than expected from the point of view of those who favour the survival of the EU, and also the survival of the euro. The only two, admittedly important, exceptions were the UK and France where anti-EU, anti-immigration parties won the most MEPs, as had seemed likely. In two euro area countries, the Netherlands and Finland, there were significant setbacks for similar parties. In Austria the Freedom Party which has stirred controversy for decades remained stable with 20% and in Hungary right wing nationalist parties did well but not more so than in previous elections. Elsewhere in central and eastern Europe the great majority of seats continued to be won by strongly pro-EU parties, although this was also in line with expectations.

Encouraging results were recorded in most of the countries at the centre of the euro zone crisis of the last five years. Germany voted overwhelmingly for parties that support its membership of both the euro, highly controversial both at the beginning and, more recently, over supporting measures to bail-out weaker members and particularly the European Central Bank’s preparedness if necessary to save the euro to make unlimited purchases of their government debt. The anti-euro (but not extreme and not anti-EU) party Alternative fur Deutschland won a very modes 6.7% of the vote, while the extreme NPD won %.

In Greece, Italy, Spain and Portugal, all of which have suffered severe losses of living standards and high unemployment during the last five years, there were overwhelming majorities in favour of parties committed to remaining in the euro and the EU. The highest anti-euro vote was in Italy, for Beppe Grillo’s Five Star Movement which has called for a referendum in euro membership and is anti the whole of the rest of Italy’s political establishment received 20% of the vote, but while a year ago it came close to the vote of the largest established party the left-of-centre Partito Democratico,this time the PD, led by the young new prime minister, Matteo Renzi won double the vote of Grillo’s party with just over 40%, well above that achieved by any left-of-centre party in the history of the Italian Republic. In Greece, the leading party in the EP election was the more left wing Syriza, led by Alexis Tsipiras, which calls for an end to austerity but not for leaving the euro area or EU. The governing New Democracy still held on as the second largest party despite direct responsibility for draconian economic measures needed to cut the public sector deficit. The extreme and sometimes violent right wing New Dawn won 9.6% of the vote which is disturbing but not an increase on previous elections. In Spain there was virtually no votes for parties against membership of the euro or EU despite one of the deepest economic depressions after Greece and unemployment of young people over 50% according to official figures. The two parties which have governed Spain since its entry into the EU in 1992 and into the euro in 1999, and were responsible therefore together and in roughly equal measure both for the austerity policies of the last five years and the mistakes in earlier years that contributed to the crisis, the Popular Party (PP) and the Socialist Party (PSOE) together won 49% of the vote which in the circumstances was a reasonable performance, although it led the leader of the PSOE which came behind the PP to resign. The rest of the vote was widely divided. Not at all surprisingly the established party to the left of the PSOE the United Left (IU) increased their vote somewhat to 10%. More interestingly a new party, Podemos, formed out of the Indignados movement of peaceful city centre protests by young people won 7%. Podemos like the Greek Syriza wants an end to austerity policies but does not call for exit from the euro. Another new party is the centrist Union for Progress and Democracy which won 4.7%. There were increased votes for regional parties, which in Catalonia and the Basque Country are calling for full independence within the euro and the EU. These do represent something of a problem since a fragmentation of the already large number of member states would make EU governance more difficult and there would be controversy over admitting new countries formed out of member states as EU member states. In Portugal there was also an increase in opposition to austerity policies but not towards the euro and EU.

There clearly was a move against existing economic policies in southern Europe but that is part of a healthy democracy. The question is whether their voice will be heard. The southern member states have had little choice over the last five years because of the need to either keep the support of bond markets or, where these are lost, to meet the conditions for loans managed by the troika of the IMF, ECB and European Commission. With government accounts now moving into primary surplus (income less expenditure excluding debt servicing) which gives a little more room for manoevre at a domestic level but policies at the EU level remain important for them. Given his strong position domestically and the fact that Italy will take on the presidency of EU Council of Ministers’ meetings in the second half of 2014, Renzi is likely to try to push for more expansionist policies. However, fiscal policies of countries without difficulties in borrowing are decided at a domestic level, while monetary policy is conducted by the ECB, which is strictly independent of governments. Nevertheless the ECB is now considering the controversial idea of quantitative easing and doing so by encouraging banks to lend more at reasonable interest rates to small and medium enterprises, given the huge imbalance in lending conditions between the member states of the supposedly single monetary area, the euro zone. Renzi or others could risk a backlash if they try to push the ECB in this direction but they are entitled to argue against any efforts at the political level to support the Bundesbank which may resist monetary loosening but be outvoted on the ECB board. No-one should be complacent over the situation in euro zone states with high unemployment, but the euro zone does at present look to be a going concern, and to have political legitimacy in most of its member states.

EU structural budget should aim to make a bigger impact

Final agreement between the Council (ie member state governments) and  the European Parliament, for the Multiannual Financial Framework (MFF) for the years 2014-20, is close. The budget ceiling in relation to GDP has been gradually reduced from 1.18% in 1993-99 to less that 1% in the coming seven years[1]. Parliament has accepted with reluctance a reduction in real terms compared with 2007-13 but has won some concessions on flexibility to increase the scope for sums not used in one year to be spend in subsequent years, and, more importantly, to allow some switching of spending from one area where demand may turn out less to another which becomes a high priority.

 

EU budget is small but still important

When the single currency was being discussed as a theoretical project, an independent report, the McDougall Report of 1977, recommended that the budget for a more integrated EU, but still without full monetary union, should be 2-2.5% of GDP and that monetary union itself should involve a federation with expenditure of 5-7% of GDP, so as to manage the imbalances between participating states that could occur. In contrast, although the budget increased in the early 1990s, it has actually fallen following the introduction of full monetary union.

Nevertheless, the budget is significant both in terms of contributions and expenditure. Net payments to the budget are close to 0.5% of GDP for major countries like Germany, France, the UK, the Netherlands, Sweden and even Italy. This is not much less than the 0.7% OECD target for total foreign aid to less developed countries and as much as most are actually giving in such aid.

In terms of expenditure to poorer countries such as Greece and Portugal it is 3-4% of GDP and about 1% in Spain. Although Italy is actually a net contributor, expenditure in southern Italy, as well as in poorer regions of Spain, could make a contribution to boosting economic activity.

With all these southern countries in great economic difficulty, the question of whether EU spending is being used to best effect is an important one. There are two aspects to this question. One is a negative one: to impose sufficiently rigorous financial controls to ensure the money is spent as intended and not diverted into the hands of individuals or businesses for whom it is not intended. In reducing fraud the Commission claims to have been successful despite the fact that control of the funds still lies to a great extent at national and local levels, although sometimes the result is that not all allocated funds are used.

With regard to positive impact, the Commission claims that research shows that regional funding has had a positive impact on growth[2] in the regions concerned but whether right or wrong such studies are only of interest to experts. EU spending, especially structural spending in disadvantaged regions, should make a noticeable contribution to the inhabitants of those regions. At present and almost certainly over the next few years the most immediate need for these regions is to improve the prospects for young people after leaving formal education.

 

Youth guarantee is in danger of failure

The EU Commission won agreement by all EU member states at the beginning of 2013 that they would commit to a guarantee of training or paid work for all under-25s within four months of leaving education or losing a job. But the resources to put this into practice even with the political will is not available to the many countries struggling to meet fiscal commitments agreed with the Troika (IMF, ECB and Commission) for those under rescue programmes, or for others like Italy which are also being monitored by the Commission with a view to avoiding the need for rescue programmes. EU funding should therefore be made available with urgency for the purpose. Such funding should be possible under the remit of structural spending on economically-disadvantaged regions, which is provided with a third of the total EU budget.

 The reality does not show this urgency or commitment. So far only €6bn over the period 2014-20 is to be made available for helping young people find employment, which is less than 1% of the total EU budget. And it is not starting until January 1st, 2014.  A degree of caution is understandable on new forms of spending given the need to prevent fraud but there should be room for much more ambition than to spend only 1% of a modest budget on this challenge.

More broadly, the structural funds should be redirected from infrastructure to promoting vocational education and the creation and expansion of the small and medium enterprises which are the dominant providers of jobs, especially new jobs, in the better performing countries and regions. This switch should be particularly emphasized in southern Europe where infrastructure is now good.

Help to SMEs can be largely through help in providing affordable credit in association with the European Investment Bank (EIB) and the European Investment Fund (EIF). The latter’s JEREMIE programme, which leverages the structural funds, is a good example which could be built on. The aim should be to promote networks of business activity.

 

 



[1] The measure now used for the budget is the marginally different Gross National Income (GNI).

[2] This is, with qualifications, supported by EU Structural Funds: Do they lead to more growth? CAGE-Chatham House Series of Policy Briefing Papers, December 2012.

Much talk on youth unemployment and just a little action

Youth unemployment moves up the agenda

Recent weeks have seen increased traction to the perception that youth unemployment across the EU, especially the euro zone, has to be treated as a major—indeed the major crisis, if one is reassured that financial meltdown of the euro zone has been relegated. Of course the danger of the latter cannot be treated as though it had been eliminated but rising unemployment, especially of young people, could undermine the political support needed to sustain the kind of policies in southern Europe, and even in France, that are required to prevent financial meltdown, as so clearly indicated by the result of the Italian election of March 24-25th where huge swings in votes to the rightwing PdL and the internet based protest movement M5S, must be interpreted as protests against the well intentioned policies of the previous government led by the respected academic Mario Monti, to comply with the desiderata of the EU institutions.

 

Situation in southern Europe cannot be ignored in the north

This means not only that youth unemployment must become the top priority of governments in the peripheral countries most affected, and of the European institutions, but also of the countries like Germany the Netherlands and Finland that are doing much better in terms both of overall economic performance and specifically in providing opportunities for young job-seekers. If these countries are committed to the survival, let alone deepening, of the process of European political integration that goes back to 1951, as the great majority of political parties in all these countries claim to be (with the exceptions of Geert Wilders’ Netherlands Freedom Party and Timo Soini’s True Finns), then the employment crisis in fellow member states has to be taken as a serious challenge to their own credibility.

Recently some members of Germany’s government have shown signs that they are aware of this challenge. In mid-May the German employment minister, Ursula von der Leyen signed an agreement with her Spanish counterpart, Fatima Banez,  to facilitate the availability of apprenticeships in Germany for Spanish nationals and for German experts to provide advice to Spanish companies willing to learn on how aspects of the successful German apprenticeship system, whose roots go back centuries and which has been a major feature of the post-Second World War German economy, might be implemented in Spain. This would build on existing Spanish government efforts to promote apprenticeships. The  scheme has been supported by Wolfgang Schauble, the formidable German finance minister who has said “we must be faster and more definitive in fighting youth unemployment”. He also agreed on May 22nd with the Portuguese finance minister, Vitor Gaspar, that the German state development bank, KfW, should help set up a Portuguese institution to promote work or training for young people. On June 3rd the KfW signed a deal to lend €800m to its already existing Spanish counterpart, ICO  (with an extra €200m once agreed by parliament for “mezzanine” financing). On July 3rd, Angela Merkel is to host a meeting of EU employment ministers in Berlin.

 

But measures so far are mere drops in the ocean

However, the measures mentioned above are no more than drops in the ocean. While the subject of youth unemployment has risen dramatically in the field of international discussion across Europe, as seen in the OECD Forum at its headquarters in Paris on May 28-29th, there is as yet no policy measures which are likely to be make a significant impact. The €6bn of EU funds structural funds which are frequently mentioned are over the whole 2014-20 period so amounting to less than €1bn a year, which is 1% of the EU’s modest budget and 0.01% of EU GDP. It can be argued that larger sums if made available might be mis-spent given high levels of corruption in parts of southern Europe but that means that the rapid use and of EU funds to provide job and training opportunities, followed by rigorous assessments of their success with a view to applying any lessons to further funding, are urgently required.