Euro zone must help Greece find a way to economic recovery

At least the Eurozone governments and the newly Greek government after two weeks of tense negotiations (which some described as a “game of chicken”) come to an agreement on policy parameters to tide them over a period of up to four months in which to discuss how Greece should approach its economic future on which its political future as part of the EU and NATO also depend. Germany’s finance minister, Wolfgang Schauble, who played a key part in the negotiations along with Jeroen Dijsselbloem, the Dutch finance minister, and chair of the group of euro zone finance ministers, said that gratuitous insults to today’s Germany comparing it to Nazi Germany did not help the Greek side. In itself this may be a reasonable point, but Germany’s most widely read tabloid Bild Zeitung has for the last six years been building up a picture in the German public of Greeks as feckless work-shirkers which has influenced the political debate and is indirectly reflected in the somewhat patronizing remarks about Greece by German (and also Dutch, Finnish and other) politicians who have never had to deal with in their generation anything like the Greek economic depression of the last six years, which is more comparable to the economic hardships of Europe between the wars than anything endured by any EU country since 1950.

The issue that should be discussed in the next four months is quite simple: how to enable the Greek economy to be start to provide employment and hope for its people, especially young people. That is how it is seen in Greece. Tragically it is not how it is seen in much of the rest of the euro zone although the political cohesion of the euro zone and the EU itself actually depends on a positive answer to the question.  Some of those who rebelled against agreeing with the Eurozone-Greek agreement in the Bundestag actually said that the agreement encouraged “moral hazard”, in other words implying that the Greek people had not yet suffered sufficiently from the policy mistakes made by their governments in the decade before the crisis to have been warned against making the same mistakes again. They imply that there should be no moral hazard for those who voluntarily made the foolish decision to lend money to Greece in the early 2000s, loans which created a bubble which was actually harmful to the Greek economy.

It is not fair to compare Germany’s present government with the Nazis as some Greeks have occasionally done, but it is fair to point out that six years after the end of the Second World War the countries which had formerly been Germany’s enemies were willing to provide the economic conditions for Germany to make a new start, consolidated by the 1953 London agreement which halved Germany’s debt. Surely if Germany deserved another chance in the early 1950s despite its earlier policies and their impact on its fellow Europeans, Greece deserves another chance now. However, although Germany  is seen as the main protagonist vis-à-vis Greece, it has to be said that there are many other countries whose agreement to a longer term deal with Greece cannot be taken for granted.

Whether Greece can recover depends on part on its fellow euro zone members but it does also depend on the new Greek government. First,  although right to resist ever-increasing primary surplus demands it will have to manage the public finances to maintain a primary surplus, and this is not compatible with fulfilling many of its promises. Secondly, although it understandably resists an unthinking continuation of the whole policy prescription imposed on it by the hated troika (IMF, ECB and European Commission), there are parts of the policy which are essential to providing the conditions for the private sector to generate new jobs, including reducing the costs to employers if they have to dismiss employees for economic reasons and opening up trades and professions to new entrants. Such changes are also encouraged by the OECD, an organization which the government refers to more than once in the policy outline it has given to euro zone governments. There are other parts of the prescription that the Syriza government is committed to, such as measures against corruption and tax evasion.  There are also some it can legitimately question. It has agreed to continue with privatisations in progress but should be entitled to question the benefits of further privatizations. The sale of assets can only make a modest contribution to reducing debt and takes away potential sources of future government revenue. Sometimes it can go badly wrong as for example in the case of Croatia’s privatization of Pliva to a foreign investor, which proceeded to close the company, which had a good track record of research and development of pharmaceuticals.

Germany risks losing EU moral leadership over handling of Greece

Germany, led by Angela Merkel, is at present the leading country in the EU and deservedly so. The standing of President Hollande though bolstered by his sure handling of the crisis caused by the shooting of Charlie Hebdo staff and Jewish hostages, is weakened by his having come to power on the basis of policies that could not work and have had to be reversed; the UK’s policy towards the EU changes day by day largely driven by the nationalist UK Independence Party and the rightwing of the governing Conservative Party; and, though Italy has a stronger than usual government under the youthful Matteo Renzi, that follows 20 years dominated by a politician in constant trouble with the judiciary for tax evasion and other illegal business practices, and Renzi acknowledges that the standing of Italy depends on the success or otherwise of a 1,000 day reform programme.

Germany has achieved not only political stability and economic strength, but also moral leadership resulting from a number of factors;

First, it has achieved what can rightly be called a social market economy. Its competitiveness is combined by company structures which give employees a large say through works councils and supervisory boards and a large proportion of companies are located in their communities and feel a social obligation to those communities particularly in providing younger ones with high quality training schemes. Trade unions though they come sometimes cause disruption through industrial action still have a respected role in large parts of the economy.

Second, Germany has a consistent foreign policy based on support for the EU, and for NATO as a defensive alliance, while taking a very cautious approach to military interventions elsewhere in the world. With regard to the EU’s largest neighbour, Russia, Germany has made strenuous efforts to achieve good and stable relations but has recongised that Russia’s incursions into Ukraine are unacceptable and have to be resisted by economic sanctions.

Third, Germany has in recent decades, become a country open to large scale immigration. Although immigration under the free movement principle from other EU countries is higher than to the UK it has not led to controversy and it has taken more refugees from Syria than most other EU countries (albeit little in relation to those in Lebanon, Turkey and Jordan). The anti-Islamic Pegida movement is a cause for concern but its support is still much less than for the UK Independence Party or France’s Front National, and it has been categorically condemned by Mrs Merkel.

However, although German policy under Angela Merkel and the finance minister, Wolfgang Schauble, has contributed to keeping the euro zone together since it was hit by crisis six years ago (first in Greece, but then spreading), the soundness of its policy has been open to question as has whether it is a genuine European policy or one designed to protect narrower German interests. In the early years of the euro, Germany, despite having strongly insisted that members of the euro zone must be underpinned by strong economic fundamentals as set out in the so called Maastricht criteria in the 1992 Maastricht treaty, failed to enforce these criteria. Countries were allowed to join the euro zone which only on a very generous interpretation of the rules met the Maastricht criteria, and most egregiously Greece joined two years after the others on figures which it was known had been manipulated by advisers from Goldman Sachs. While Germany was itself breaking the Maastricht rules in the early 2000s, investors poured money into Greek and other south European government bonds and banks with no effective warning of the dangers from the European Central Bank then still largely dominated by German thinking (its then chief economist, Otmar Issing is German).

Germany acknowledges that it made mistakes during this early period in the history of the euro, but the only lessons its policy makers draw is that fiscal discipline must now be imposed ruthlessly in very different times. They do not want to allow Greece,  after six years of economic and social turmoil, Greece should be allowed a new start and that even a small part of the adverse consequences of past mistakes should be borne by the richer countries. Unattributed comments from German government sources have suggested that Germany would be relaxed about Greece leaving the euro, if a new government  questions the policies being imposed on it and whether it can ever reasonably be expected to pay back its foreign public debt. If, after suffering more than any other EU economy has ever suffered since the beginning of the euro, in order with the aim of remaining in the euro, Greece were to be effectively expelled because of disagreements with a newly elected government, the economic contagion might be containable (as it would not have been in earlier years), but the political contagion resulting from a breakdown of EU solidarity would be unpredictable and irreversible.

It is understandable that Germany does not want to sign blank cheques for transfers to poorer EU members similar to those West Germany has provided and still is providing to other Germans in eastern Germany. The EU, Germans reasonably insist, is not a “transfer union”. But, with Greece now running a primary surplus (excluding interest payments) on its government accounts, demands that it should fully service and eventually pay back its 177% of GDP debt are in effect demands for transfers from Greece to richer countries in exchange for the poisoned chalice of inflows in the 2000s whose impact on the Greek economy was almost entirely harmful.

That said, it has to be admitted that a negotiated writedown of Greek debt will not in practice be easy or quick. The more aggressive stance of the victorious Syriza towards the demands of the Troika (IMF, European Commission and European Central Bank) can not be seen to be immediately rewarded in preference to New Democracy’s more cooperative approach.

Secondly, although Germany does to a considerable extent pull the strings of the Troika, it is not all-powerful. First the IMF cannot consider any forgiveness of its debt. It is not an EU institution and represents many other countries, mainly much poorer than the EU. The IMF can continue to offer advice from its wide experience on policy reforms but it cannot be part of the debate on fiscal obligations within the euro zone. The European Commission and the ECB with regard to its role in the Troika–,which is completely separate from its main function of setting monetary policy on which it is independent–are effectively constrained by euro zone member states, of which Germany is the most powerful, but not of course the only one. Through the European Stability Mechanism all other euro zone countries, both strong and weak, have stakes in Greek debt and would correspondingly share in any debt write-down. Logically opposition to such a write-down should come most from the weaker countries though that does not seem to be the case. The most hardline stance is that taken by the prime minister of Finland, Alexander Stubb. Finland presents a unique problem. It is an anomaly in the euro zone in that it is the only Nordic member and its original decision to join was taken by the government of the time against a much degree of opposition than in other member states at the time of joining. The government there is under pressure from the nationalist True Finns (as though other parties were not truly Finnish) which makes a big issue of providing “help” to allegedly profligate southern Europeans. Finland might have to be treated as an anomaly and excluded from any deal. Of more concern should be adding to the debt of weaker member states but given the relatively small size of the Greek economy, and that lending to it is shared between all the other euro zone states, a substantial write-down of the €320bn debt is not going to have a dramatic impact on any of the others.

A final concern is to what extent a write-down of Greek debt would lead to other indebted euro zone countries to demand their own write-downs. But the only other country which may need such a write-down is Portugal and this would be to a lesser extent than for Greece. Italy’s public debt to GDP ratio is 130% but the country has lived with a similar ratio for 20 years, since before it joined the euro, and a high proportion of its debt is held domestically. Ireland also has a high debt to GDP ratio, but is now coming out of its prolonged recession and has always despite cuts in living standards, been one of the richest countries in the euro zone. Spain’s public sector debt is lower  and similar to that of Germany’s.

Moves to tackle Greece’s unmanageable debt will take time and the new Greek government will have to ensure that its accounts remain in primary surplus, but after six years of painful measures, it would  be wrong to prevent it from taking measures to ease the hardship of the most vulnerable people or to push it into even deeper cuts in expenditure to meet the demands of creditors and even more wrong to remove Greece from the euro zone as an answer to an impasse in the negotiations.

EU partners must keep out of Greek election

The calling of a general election in Greece at the end of January poses a challenge to democracy in the euro zone.  The main challenger to New Democracy, the leading governing party, is Syriza, a left wing party which is challenging the economic policy which the government has adopted over the last three years. That policy has been largely in response to demands from the troika (European Commission, European Central Bank and IMF) in return for a loan programme which was needed to prevent a banking collapse which would have forced Greece out of the euro zone. New Democracy itself had in opposition challenged the policy imposed on the previous PASOK government by the troika but did a u-turn on winning the election which it to an extent has got away with in the eyes of a sufficient percentage of its voters to remain one of the leading parties. Syriza could not possibly implement its whole anti-austerity programme while staying in the euro zone as it says it wants to but it would have to implement some changes if it won to retain any credibility at all with those who had put it in office.

Spokespeople of the EU institutions and leading EU governments have a huge dilemma. On the one hand they may feel a need to state the realities of what it considers any Greek government has to do to stay in the euro zone. On the other doing so is likely to be seen in Greece as interfering in the election on the side of the government. Already Pierre Moscovici the new economy commissioner and the German finance minister, Wolfgang Schauble, have intervened in favour of continuing with the existing programme being implemented by the government as being the only one to return to growth while Mr Schauble has said that a change of policy would make it much more difficult to “help” Greece., though many in Greece would question whether the country is actually being helped. Immediate reactions to the announcement of the election are perhaps understandable but such people will have to restrain themselves during the campaign if the election is to look at all like a free choice for the Greek people between alternatives.

Three years ago a significant policy shift would have almost certainly led to Greece leaving the euro zone. However the situation is now different, at least to some extent. The euro zone has stabilized though not recovered from its economic doldrums and crucially the Greek public sector has a primary surplus. The latter means that the Greek taxpayer is fully funding Greek public expenditure with a bit to spare except for the servicing of debt. Syriza has a point when it argues that the Greek taxpayer cannot afford to pay this debt which was incurred by previous government with the participation of lenders who foolishly believed the Greek economy can absorb and eventually repay such loans and with the tacit approval of the European Central Bank including its then German chief economist Otmar Issing. No-one suggests that debt should be easily renounced but when it proves to have been a disastrous mistake the pain of tackling the situation should be shared between creditors and lenders and it is evident that the Greek public has suffered far more over the last six years than the financial creditors or the other governments of the euro zone who now indirectly hold much of the debt.

Syriza may not win the election given that it leads New Democracy by only a few percentage points in the opinion polls a lead which could be reversed and even it emerges as the largest party it will still be well short of an overall majority and may not be in a position to lead a coalition government.

If Syriza does lead the next government and its leader Alexis Tsipiras is the next prime minister, he will not be able to fulfill his promise to end austerity since the financial resources are not available to do so and would not be even if the debt could be wiped out. The primary surplus is a small one and it would not be possible to move into deficit. He will in this and other ways be faced with a reality which cannot be changed by the rhetoric that he has used to attack present policies. But that is for the Greek electorate to judge. The rest of the EU needs to stay out of the campaign and let the Greek people make up their minds. After that if Syriza were to form a government they will need to work out how to deal with it.

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.

Greece’s coalition splits over closure of state broadcaster

The three party coalition government in Greece has broken down. The sudden decision on June 11th, of the New Democracy prime minister, Antonis Samaras, to shut down the state broadcaster ERT, with a promise to open a new state broadcaster in about two months, and his subsequent refusal to re-open it,despite an apparent, although ambiguous, request to do so by the Council of State, has been opposed by both ND’s coalition parties, the traditional socialist party, Pasok, and the newer Demcoratic Left. But Pasok is not taking any action to put pressure on the prime minister to change, while the Democratic Left, after ten days of indecision, resigned from the government on June 21st. This leaves the government with a majority of three but the Democratic Left has indicated it will not try to bring down the government.

 Motivation for sudden move is unclear

The motivation for the abrupt move of the prime minister to close ERT and his refusal to back down is unclear. A pessimistic interpretation could see it as a move to set up a new broadcaster as a New Democracy propaganda vehicle. An optimistic view would be that Mr Samaras decided to create a sense of crisis to push through expenditure cuts and reforms in one sector, which would act as precedent for radical change in other sectors such as the large array of state funded entities and the privileged professions which in spite of new legislation continue to restrict entry. But, with the troika (IMF. ECB and European Commission) breathing down his neck, it could be simply an emergency measure to save money and meet the troika’s immediate demands.

The first interpretation that he wants to control the media seems unlikely, at any right as a sole motivation, given that ERT has not taken an anti-government position, and an overtly pro-government and specifically pro Democracy stance would not be able to gloss over the actual situation of high unemployment and much reduced pay for most of those who have jobs. With regard to the second interpretation that he is deliberately creating a crisis in one sector in order to push through wider reforms, it is odd that Mr Samaras would choose the public sector broadcaster as the field in which to fight an iconic battle (its 2,900 employees are less than half a percent of total public sector employment) and unclear why he could not have just reduced the funding available to the broadcaster, so forcing it to make cuts but not to shut down. It could be that he deliberately wanted to provoke Democratic Left to resign because it had been difficult partner blocking reforms across the spectrum. Redundancies from the ERT or elsewhere in the public sector are likely to move people from the public administration payroll to the public welfare roll, with little chance of many finding new jobs. But the drastic measure of closing down ERT could create a few openings for the army of young people looking for their first job.

This crisis one year into the government’s four year term comes as the economy moves deeper into the dark tunnel it entered four years ago with no reason to expect improvement in the foreseeable future.

How much is EU commitment to guaranteeing opportunities to young people worth?

 

Is EU tilting at windmills?

On April 22nd the Council of Ministers formally adopted a Commission proposal made in December that every young person leaving education or losing a job should have the offer of a job or training within four months. This is in some degree capable of being achieved in the more successful economies of northern Europe but in much of southern Europe looks like an aspiration divorced from the reality of youth unemployment ranging from 38% in Italy and Portugal to nearly 60% in Spain and Greece. The economies of southern Europe are now at or close to external current account balance so they are now longer consuming more than they produce and are, in addition, servicing high levels of foreign debt. But government deficits remain high leaving no extra finance for governments to fulfill the promise that they have made at EU level.

 

Southern Europe countries can not meet guarantee on their own

The emergency has to be treated as an EU one and its resources put into the struggle to make its commitment more than empty words. The EU budget at 1% of its GDP is small and 40% is still taken up with agriculture where employment can only continue to decline. But the regional fund should be re-directed from physical infrastructure which in southern Europe is mostly now adequate after decades of EU funding to human and enterprise development.

Good work by the European Investment Fund, which specialises in finance for small and medium businesses, and the European Investment Bank, should be supported by increased financial resources.

Ways must be found, by the European Central Bank, the national central banks and the banks themselves, to eliminate the huge difference in the cost of bank finance that is being charged to businesses in Spain and Italy compared with Germany and France. This may require risks being taken by the ECB in increasing its exposure but the risks of its exposure to southern Europe are already high and the risks to inflation of unorthodox policies have to be set against the risk to social and political cohesion and also the ability of the southern European economies to recover and so be in a position to raise the revenue to meet the stability requirements to their government finances.

Newspapers and politicians have insisted that Germany and its partner creditor countries are not prepared to subsidise southern European who retire early and lead leisurely lives. But that should not mean an unwillingness to act against the enforced leisure afflicting so many young people and others at present.

A meeting of minds did take place on May 10th between the new Italian prime minister, Enrico Letta and the president of the European Parliament, the German socialist, Martin Schulz. The latter said he was in complete agreement with with Letta’s statement that “Europe must respond to the greatest problem of today, the rising level of youth unemployment to unsustainable levels”. Specifically Schulz said that the €6bn provided for youth training in the 2014-20 EU budget be brought forward. He added that the problem was too urgent to wait for the result of the German election in September 2013. His proposal could if taken up be a start but would be far from enough to solve the problem but would give an indication of serious intent. Letta has proposed that youth employment measures be seen as an investment in the future and so justify financing like investment outside the normal budgetary rules. That means any measures could only be temporary otherwise they would add permanently to budgetary costs. Moreover Letta’s government has yet to show that it can manage the normal budget successfully replacing the lucrative property tax Imu which it is committed to abolishing with other revenue or spending cuts. But the challenge is not just for the southern member states but the whole EU or at least the whole euro zone.

Budget negotiations are key to future image of EU

On February 5th Herman Van Rompuy put out a video message (http://tvnewsroom.consilium.europa.eu/event/video-messages-of-herman-van-rompuy/eu-budget-negotiations-the-bigger-picture-must-not-get-lost) which made an admirably concise plea for a budget to focus on jobs and particularly jobs for young people and also insisted on moderation, which he surprisingly defined as a real terms cut. This would imply that the demands of the UK, Sweden and the Netherlands in terms of expenditure discipline would be met or even exceeded.

Budget is small in relative terms,but high in absolute terms

As a percentage of national budgets (about 2%) the EU budget is much smaller than implied by the claims of over-centralisation of power. It has remained at around 1% of gross national income (considered a fairer measure than gross domestic product) over the last 20 years well below its allowed maximum of 1.24% of GNI. To have done this during a period when the EU has expanded to include 12 new countries almost all well below the 75% of average income threshold which entitles them to substantial funding to help catch up, and when a monetary union has been created for 17 member states, an embryonic diplomatic service has been set up and effective measures for criminal justice have been put in place is a significant achievement.

The gains in terms of both political stability and prosperity from the single market are not possible to measure but surely hugely outweigh the costs of the EU. Nevertheless when expressed in absolute terms, the amounts are large enough to become politically contentious, at a time when all countries are having to make cuts which are causing large scale public redundancies, closures of hospitals, and other public services like libraries. The UK, France and Italy are currently spending about €16bn (£13bn) in gross terms and €6bn (£5bn) in net terms in contributions to the EU budget.

Some but not all is all is well spent

Some of this money is very well spent. There is huge over-demand for the 11% of the total EU budget spent on boosting collaboration between EU countries (and sometimes also other countries) on scientific research and the development of new technologies. This is money well spent on boosting the EU’s economic potential and ability to thrive in the face of competition from rapidly growing economies like China and India. A strong plea for this spending to be maintained was made on February 5th in a letter to the Financial Times by leading British scientists. Another area of money well spend is co-operation on justice mainly criminal justice, which takes up just 2% of the budget. According to the British Association of Chief Police Officers (ACPO) if, as is being considered, the UK were to opt out of the European Arrest Warrant (EAW) just one of about 20 important EU measures in the field of criminal justice, the result would be “fewer extraditions, longer delays, higher costs, more offenders evading justice and increased risks to public safety”.

Slightly lower in terms of money well spent is the category of administration which absorbs 6%. At 0.06% of national income this is good value for underpinning the benefits of a rules-based single market with a level playing field evened by the enforcement of rules on competition. Yet at a time of austerity the pay and privileges of the upper tiers of the Commission which exceed those of leaders of national governments look excessive.

The largest items of spending are agriculture and regional policy. Agricultural spending, narrowly defined to standard income support for farmers amounts to 27% of spending. If the EU were starting from scratch this might see excessive, but there has been a continuing decline from about 70% when the UK joined the EU in 1973 and most of the spending no longer supports (ie increases) prices as it used to. There is however an additional item called rural development environment and fisheries which absorbs 10% of the total. This is almost as much as is spent on research and innovation and yet its purpose. It includes the very different objectives of environmental conservation or improvement and diversification to non-farming economic activities. It is a category which at least merits careful scrutiny.

Focus of regional spending should be on job creation

But the category which needs most attention is the 37% spent on helping the poorer or most economically troubled regions. This spending has in the past been heavily focused on infrastructure, which does not necessarily bring fundamental economic development. What is most needed is to foster the development and expansion of new micro, small and medium businesses which having already  been responsible for the great majority of job creation across the EU in recent years have the best potential to provide employment opportunities in southern European regions where rates of youth unemployment often exceed 50%.

 

Peace prize is for more than avoiding war but achievement is under immediate threat

The award of a Nobel Peace Prize to the EU comes at a crucial time. Some critics of the EU regard the reward as absurd because war between its member states is inconceivable and would, the critics say, remain inconceivable even if the EU broke up. The contrary argument is that the EU has been so successful that it has not only prevented war but made it seem inconceivable; and this despite the fact that brutal wars were fought just outside EU frontiers in the 1990s. In addition to avoiding war, the EU has hitherto enabled conflicts to be sorted out within an institutional framework, becoming a possible model for areas of conflict.

However, though there would be no immediate or foreseeable danger of war even if the euro zone breaks up, the EU’s status as model for the institutionalisation of peace is under immediate threat from a possible break-up of the euro zone, particularly if such a break-up occurred in a chaotic way and was accompanied by an increase in the acrimony between EU member states that has already been seen between Greece and Germany in particular. The visit of Angela Merkel to Athens on October 9th, to meet members of the Greek government, appeared to have been constructive despite hostile demonstrations, but whether it actually was so will only be confirmed if the next tranche of the euro zone/IMF financial facility is soon released (although Germany is crucial this also requires the agreement of other countries).

In June, Greek voters gave a narrow but clear majority to the three political parties that not only wanted to stay in the euro but also committed themselves to continuing with the most severe programme of austerity imposed in any EU country since the Second World War. It would be a tragic failure if Greece’s euro zone creditors cannot agree with the government on a moderate alleviation of the extent of continuing spending cuts over the next two years. This surely is the moment where tightening the squeeze on Greece could just fall slightly short of the current harsh demands. That does not mean that the troika and other euro zone countries should not put pressure on Greece to introduce other measures, such as radical clampdown on tax evasion, effective laws and sanctions against corruption, privatisation of state assets where feasible, compiling a land registry, and action against restrictive prices which have kept prices high while wages have drastically fallen. But it is partly the fault of the troika and the creditor countries that these issues have not been addressed with the same urgency as expenditure cuts and tax increases; and proof of effective action will necessarily have to wait until after the next tranche of  the loan facility is released.

There is also increasing cause for concern about what is happening in a much larger country, Spain. Generally in Spain, the large demonstrations, and the encampments in Madrid, have been more peaceful than in Greece. The near 25% rate of unemployment (double that for youth unemployment) has been regarded as less alarming than the headline indicator would suggest because of large scale unregistered employment and the fact that similar unemployment percentages were recorded in the 1990s. However, signs of social stress have recently increased, one being that the Spanish Red Cross is this year for the first time devoting funds collected on Red Cross Flag Day (October 10th) mainly to helping support the destitute in Spain, rather than in developing countries.

As worrying is the rapid development of a crisis affecting the future unity of the country. Until recently, the regional Catalan political parties, unlike the Scottish National Party (SNP), had not demanded independence but this has changed quite dramatically in the last two months. The main reason for the change is the question of how to share the pain of austerity. Unlike Scotland in the UK, Catalonia as one of the richer regions makes a substantial net contribution to Spain’s overall budget. It estimates that it sends the equivalent of 4% of its GDP more to Madrid than it receives back. While it is true that Catalonia is richer than the Spanish average it is also very severely affected by unemployment and despite having to make severe expenditure cuts, the regional finances have plunged into deficit. Because the deficits of Catalonia and other regions are the main reason why Spain is likely to overshoot its 6.5% of GDP general government deficit target this year, the Popular Party government led by Mariano Rajoy, has been putting pressure on all regions to cut their deficits. By effectively treating Catalonia which makes net contributions (without which its budget would be in surplus) the same as Andalusia which is a net beneficiary it has riled opinion in Catalonia, which in the present economic circumstances feels that Catalonia would be better off on its own.

No country has yet broken up while being a member state of the EU (although several broke up or broke away before becoming members). If a settled majority of public opinion in a region comes to demand independence, there is a strong case for allowing that such democratic wishes should be fulfilled but that independence should take place in well-planned way in agreement with the country it is leaving with the minimum of economic disruption. But a sudden lurch to independence in defiance of the central government, both resulting from and exacerbating an economic crisis would be serious blow to the political stability which the EU member states have hitherto been able to claim.

It might be desirable that EU institutions or a team from other EU countries should try to mediate between Madrid and Barcelona.  The Spanish government should recognize that both the historical and cultural status of Catalonia and its net contributions to the Spanish budget mean that its government should be treated with diplomatic respect, rather than on the same level with Murcia or Andalusia. For its part, the Catalans should appreciate that the post-Franco order in Spain has provided the region with the conditions to become prosperous and to restore the cultural identity. It would be highly irresponsible rapidly to abrogate their financial contributions deriving from the position as a richer part of the Kingdom of Spain at a time of crisis.

Equally important, however, is that the euro zone countries in less dire financial straits stick to what they agreed at the June European Council, rather than trying to backtrack the moment the financial market pressures on Spain and other countries look a bit less threatening in the short term, as they have done in early October.

Writing from the UK, a country of which not very much is being asked, it should be said that it would be helpful if the prime minster, David Cameron, could be a little more consistent instead of berating his euro zone partners for not acting and as soon as they do act, veto the agreement, whether on a fiscal pact as last December or a banking union now under discussion.