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.

Italy’s referendum and the Brexit vote: a comparison

Parallels have been drawn between the June 23rd UK referendum on leaving the EU and the December 4th Italian one on domestic constitutional changes. Do such links have any validity?

Similarities:

Both attracted voters who wanted to protest specifically against the government and generally against the political class. As a result they both gave opportunities for tub-thumping anti-establishment politicians, such as Nigel Farage and Beppe Grillo to increase their profile.

The campaigns for the winning side in both cases included a very wide disparity of political opinions from the far left to the far right and many opinions between the two.

The result of both votes was a negative-not to be part any longer of the EU and to reject proposed constitutional reforms. Neither gave any idea of what the alternative might be, in the case of the UK what the future relationship with the EU would be, and in the case of Italy how the constitution might be reformed although there is widespread agreement that some reforms are needed.

Both led to the resignation of prime ministers and thereby created concerns over political stability.

Differences:

The Italian referendum was a domestic one, not one about its international relations. There are possible implications for Italy’s position in the EU as Renzi though highly critical of actual EU policies is fundamentally pro the EU and the euro, while one opposing group the Lega Nord is anti-EU while another the Movimento 5 Stelle is ambiguous about the EU and wants a referendum on euro membership. Nevertheless the euro and the EU were far from being uppermost in voters’ minds and any possible impact on these is only speculative at this stage.

The UK referendum was a voluntary choice of David Cameron whereas Matteo Renzi had according to the country’s 1948 constitution to get endorsement for his proposed reforms to that constitution because he only had simple majorities in both houses of parliament for the reforms. He would have needed two-thirds majorities to avoid the need for a referendum. However, Renzi did make the choice to package several reforms in one referendum and also to put his own job on the line thereby personalizing the referendum.

While Cameron chose subsequently to resign as a member of parliament and thereby to end his political career Renzi could still play an important role in the future.

Domestic repercussions of the vote will probably be less than those from UK referendum

We know that beyond the change of prime minister, the UK referendum has already had major implications for all political parties. It led immediately to a challenge to the leadership of the main opposition party, the Labour Party and although Jeremy Corbyn was subsequently re-elected by a large majority of the membership, the divisions within the parliamentary party have not been mended.

It is clearly possible five months after the UK referendum to know more at the political impact on the UK that two days after the Italian referendum. But there are at present no firm reasons to suppose that the consequences will go beyond the replacement of the prime minister. An election must in any case take place by March 2018. The result of that election was and remains highly uncertain but the departure of the prime minister could as easily help the Partito Democratico as hinder it since Renzi’s popularity had fallen sharply over the last 12 months. It is at present not known whether he will stay as leader of the PD. Even if he does his profile will be lower and he will have little choice but to adopt a more compromising approach. Renzi’s fall is indeed important but its impact on political stability is likely to be less dramatic than many commenters perceive. Italian governments have lasted little more than a year on average over the last 60 years.

 There is no direct impact on position in EU and any indirect impact is speculative

The referendum is only important for the EU insofar as it may prove bad for the pro-euro PD. At present its main competitor is M5S, which, if at the head of the government, could pull Italy out of the euro. Such a scenario after the next election is a possibility but that was so before the referendum. Because M5S proved able to motivate voters against the reforms and against Renzi does not mean that it will be able to motivate them to the same extent in favour of M5S and its leader, the comedian Beppe Grillo at a general election.

Some commentators have at times suggested that leaving the euro would imply leaving the EU but this would only be the case if the other leading members of the EU decided in effect to expel Italy, which is not likely. M5S is not calling for Italy to leave the EU.

What Future for the EU of 27?

Echoes of UK anti-EU opinion are found in the 27

The UK was never a lynchpin of the EU and the immediate effect of its vote to leave has been to strengthen pro-remain opinion in other countries. However, there are strong anti-EU sentiments in many member states and there is a notable lack of solidarity amongst the 27 in facing current issues, so there is no room for complacency. The British desire to blame the problems of modern life on “Brussels bureaucrats” has echoes in many other countries and there are strong parties which like UKIP play on nationalism “we against them” in France, Netherlands, Germany and many other countries. But at present emotions in the 27 are stirred almost entirely against would-be immigrants or asylum-seekers from outside the EU, particularly Muslims, partly because except in Germany there is less movement of intra-EU labour into any of the 27 than into the UK. Moreover no other country has any equivalent of the UK’s anti-EU press (Sun, Daily Mail, Daily Express and Daily Telegraph).

 

A divide remains between east and west

There are two fault lines through the EU-27, that of the former divide between communist eastern Europe and western Europe and that between north and south. The one between east and west reflects the fact that there is much less ethnic diversity in the east and consequently a fear of the consequences of any immigration from outside Europe and the ability of their societies to cope. This explains why there has been such strong resistance to any refugee quotas despite the fact that the numbers being asked of them are tiny compared with the million refugees taken in by Germany in 2015.  Two eastern European countries, Hungary and Poland, have also witnessed a worrying retreat from principles such as independent judiciary and a free and diverse press, which were part of the criteria for their entry to the EU, although the Polish Law and Justice Party is having to contend with a loss in popularity.

 

Another is between north and south

The second divide is across the euro zone where southern countries are struggling with high debt and stagnant economies, while Germany and some smaller countries are doing much better economically and have their public finances under tighter control. (France is only partly a southern country but does have some of the same problems.) It may well be the case that some of their difficulties would have been mitigated had southern countries not joined the euro zone at the start as this led to rising public and private borrowing from 2000 to 2008 encouraged by low interest rates and excessive confidence. But that does not mean that anything would be gained by breaking up the euro zone now. Croatia which is not in the euro zone has similar problems to countries that are in the zone. Short term growth might be achieved by currency depreciation and monetary accommodation of the consequent inflation but at some inflation would have to be brought under control. The labour market problems notably in Spain and Portugal existed before joining the euro. In Spain there was a big rise in employment after 2000 but much of the increase was due to the excessive boom particularly in construction backed by private sector borrowing. The recession in Spain brought about a big rise in public borrowing to a country whose public finances had been exemplary. In contrast Italy, Portugal and Greece were all crippled by high public debt already before the introduction of the euro.

 

Germany has taken role of disciplinarian

Germany has acted as a strict disciplinarian, not because it is trying to exercise power but because it believes that is the right policy for all countries and essential for the stability of the euro zone. It acknowledges a mea culpa in breaking the fiscal rules which Germany itself had insisted on as a foundation of the currency union in 2002-03 which undermined efforts to promote fiscal discipline in other countries during years of relatively strong demand. It has reacted by trying very hard to impose very tight fiscal discipline on itself, perhaps excessively especially in prioritising such discipline over infrastructure repair and improvement. It has a point in not excluding investment from fiscal targets since this can result in unnecessary investment, which will not lead to increased revenue in the future. It should, however, engage in debate on prioritising investment that is either going to become essential soon in the future or which can bring in revenue through fares, road tolls or other charges.

 

Renzi would like more flexibility

At present, the government of Matteo Renzi in Italy can claim to be the main spokesperson for southern Europe, given that his government has by Italian standards lasted a long time (just over two and a half years) and the next largest country, Spain, has been without a parliamentary-backed government for the whole of this year. But he is holding a referendum on December 4th on major constitutional reforms designed to produce a less costly and more effective parliament. He had earlier said he would resign if the reforms are defeated although he has recently been reticent about this. The reforms can be criticized in detail but are part of a wider reform programme that is trying to bring about changes that have long been recommended by organisations like the OECD, IMF, the European Commission, and indeed Germany, to reduce the cost of public sector administration while safeguarding key services like health and education, reduce regulatory and tax disincentives to establishing new businesses or increasing their size by hiring more employees. Renzi is straining at the leash of the fiscal rules to, on the one hand, try to help companies take on more employees by reducing labour taxes and the other to boost public investment; one need is to rebuild after the earthquake around Amatrice in August with buildings able to withstand future earthquakes.

 

On refugees Germany is closer to Italy and Greece than to many other countries

Despite tensions on fiscal policy, Germany is actually closer to Italy and to Greece in that both southern countries are like Germany struggling to take a degree of moral responsibility for the migrants risking their lives in crossing the sea. In the case of those coming to Italy a substantial number are from sub-Saharan Africa. In some cases they are fleeing from war or terrorism instigated by Boko Haram or other insurgents but where only a limited part of a country is so affected they should in theory be able to be returned to another part of the country. However, the process is costly and difficult and should perhaps be accompanied by financial aid. In Greece most migrants are from countries to which return is impossible. Germany is provided some financial aid to Greece to help it make living conditions bearable its many asylum seekers who are no longer able to continue to another country.

 

In the end EU will survive only if it can act as a community

Although aspects of the EU involve a legal framework of rules and enforcement, an equally important aspect is that it is a community of nations trying to act together and share political and ethical objectives. In a way it is a pity that the word Community was replaced by Union in the organisation’s title by the 1992 Maastricht Treaty. In any case, the EU’s leaders should not forget that acting as a community remains essential to its effectiveness and possibly its survival and that not everything can be done through rules or joint institutions, for which there is little appetite amongst public opinion in most member states.

 

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.

Success of Youth Guarantee will test credibility of new Italian government

From May 1st, the Italian government led by the youthful Matteo Renzi, now in office for two months, has committed to implementing the EU proposed Youth Guarantee of a job or training place for everyone under 25 within four months of leaving education or another job; and moreover to extending the guarantee to all those under 29. As the EU Youth Guarantee was supposed to come into effect on January 1st, the job or training opportunity should be provided very soon for most of the 900,000 estimated to be without employment or training. Directly responsible for implementing the guarantee is a not previously very well known man of 62, Giuliano Poretti, whose career had been in the co-operative movement, whose national association, Legacoop, he had been president of since 2002.

The challenge is the most tangible test of whether Renzi can fulfil the high expectations which he has built up of his ability to transform the Italian economy, which has been stagnant for over a decade and whose most glaring failing is its inability to provide career opportunities for young people, for whom the unemployment rate is 40% while most of those who have work are in limited duration contracts. As a result many young people go abroad in search of work opportunities. In March the government passed a new Jobs Act partly in the form of a decree with immediate effect whose main features were a a simplification of fixed term contracts up to 36 months and clearer rules designed to encourage apprenticeships. Other parts of the Jobs Act including one to encourage companies to offer more indefinite contracts by making them  less potentially crippling for those needing to make redundancies if facing a downturn in demand, is being steered through parliament with the hope that it is passed by the end of 2014 and comes into effect in the first six months of 2015.

Organisations like the OECD have long argued that the countries with the kind of labour market legislation which is less burdensome for employers as the Jobs Act tries to bring about is associated with much higher employment rates than those with restrictive labour market legislation as Italy’s used to be (the Jobs Act is the latest but not the only reform in this direction in recent years). However, the main body of the Jobs Act will not be operative till 2015 and, in any case, it is difficult to point to any clear cut time frame a change in labour market legislation and any beneficial effects on the demand for labour. Beneficial effects  are at best likely to be in the longer term if the economy remains weak and nothing else is done. In the meantime the public could quickly become disenchanted with the government which is formed by an uneasy coalition and does not yet have a direct popular mandate.

It is thus important for the credibility of the government that the Youth Guarantee proves effective and does so quickly. This will require a much greater degree of co-operation between central and local government and the private sector than has been normal in Italy, particularly in the south. Italy’s success or otherwise in creating jobs is also important for the euro zone. The euro zone has against the expectations of many observers, survived nearly five years of crisis, but the imbalance between job opportunities in Germany and smaller countries close to Germany and southern Europe has so far shown no sign of easing.

 

Is Citizen Berlusconi now equal before the law?

Senate moves to expel former prime minister

The ongoing process in the Italian Senate to expel Silvio Berlusconi from the Senate and to deny him the right to stand in subsequent elections in the face of threats (now abandoned) by Berlusconi and his supports to bring down the coalition government, is a historic milestone. It does not mean the end of Berlusconi as a major influence on Italian politics. Beppe Grillo, the leader of the Internet-based Five Star Movement who has insisted that its members of parliament vote against any government including the any of the other main parties despite being excluded from sitting himself because of a manslaughter conviction resulting from a road accident 30 years ago. Similarly, Berlusconi will certainly try to dictate what members of his party do from outside parliament. Despite his 76 years and probably not ideally healthy life style, he remains like a cat with nine lives. Moreover, his daughter, Marina, who has successfully taken over his main media and business interests, might well—despite denials—move into politics when he finally does step down.

However, the move does mark a move to tackle the deep flaws in Italy’s democracy. It has not been a country in which all are equal before the law. Berlusconi had been able to use political connections to establish a near monopoly in the emerging private television sector in the 1980s but at the time of the “Clean Hands” judicial investigations which brought down the two leading government parties the Christian Democrats and Socialists and in particular Berlusconi’s close friend Bettino Craxi, he risked losing these privileges and was threatened by prosecutions launched against him for business practices which gave a low priority to compliance with the law. Although Berlusconi has clearly liked excercising what proved to be a flair for politics in the television age, there can be little doubt, in view of the proportion of legislation enacted by governments he led which was designed to reduce the risks of being sentenced for the crimes for which he was being prosecuted, that a powerful contributory motivation to his political career has been to ensure that he and his businesses remained free from the need to comply with laws like transparent accounting and payment of taxes.

His main opponent was a party which, despite being actually very moderate, had only dropped the word Communist from its name a few years earlier. It could do little to exploit his problems with the law. His claims that the prosecutors were part of a leftwing conspiracy which were already given some credence by the fact that the judiciary was excessively politicised, would have been given more credence had former communists given more prominence to his judicial problems. Moreover, at the time to have denied office to a leader who had built an alliance able to win a majority in parliament, would have been even more anti-democratic than breaching the principle of equality before the law.

The situation now is very different. Berlusconi has been the leading personality in Italian politics for almost 20 years and been prime minister for about half the time. He has clearly had his chance to govern Italy, which ended in his resignation in late 2011 because Italy was bankrupt and national and international investors would not lend at affordable rates as long as he remained prime minister. Insofar as he subsequently regained some support it has been by promising to reverse the measures that had regained confidence.

Future of Italian democracy remains unclear

Berlusconi is finally being treated more like an ordinary citizen who has transgressed. Although commutation of the four years prison sentence given in July to one year’s house arrest or community service is a lenient one, it is still humbling as will be the expected ban on standing for election.

There is little of the hope that existed 20 years ago for a new era and better era in Italian politics.  But changes are possible. The electoral system manages both to favour excessively one political grouping that achieves a plurality by giving it a majority in the Chamber of Deputies while not allowing it to govern effectively because of a different system for the Senate. A reform is needed but no agreement can yet be found on how to replace it.

There are three main political groupings: that around Berlusconi’s recently relaunched Forza Italia, including the xenophobic regionalist party Lega Nord; the Five Star Movement which led from outside Parliament by Beppe Grillo has so far determinedly resisted any form of political negotiation with other parties and remains a purely protest movement; and the left of centre Partito Democratico (PD) which is deeply divided between traditionalists–like the leader until his resignation in April, Pier Luigi Bersani—and the mayor of Florence, Matteo Renzi, who wants a modernized more youthful party. All of these groupings could look very different, assuming they still exist, in a few years time.

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.