Iberia and Italy send contradictory messages to EU policy-makers

 

Portugal cuts to the bone

The Portuguese government’s newly announced cuts of 30,000 government employees designed to replace the cuts in holiday pay and pensions that were disallowed in early April by the Constitutional Tribunal threaten to weaken key services like education, where Portugal is anyway weak, and healthcare, where a relatively well-performing service could be undermined. Portugal like other countries has already endured five years of declining incomes which in the last 12 months have been severely intensified. During this period its long-term external imbalance as measured by the current account deficit has finally been rectified which implies that exports of goods and services now exceed imports of goods and services by a margin sufficient to service the large external debt. But further government cuts threaten to wreak deeper and more permanent damage to the social fabric than has already occurred.

The same is true perhaps even more so with Spain where unemployment has reached a staggering 27% with well over 50% of young people unemployed. If some of these have precarious and low paid jobs in the grey economy such employment hardly provides a basis for their future.

 

Help out of debt-depression spiral is desperately needed

In both Portugal and Spain governments of the centre-right have been implementing harsh austerity policies prescribed by the European Commission and the creditor countries (Germany and the Netherlands being the largest of such countries) and also striving to put in place the kind of structural reforms to labour and product markets which they are being urged to take. Yet even the beginnings of economic recovery remain elusive. Portugal for example has seen a 20% increase in exports outside the EU but with the majority of exports being to an EU in recession this is insufficient to make a noticeable difference. They have a real need for some complementary action by the creditors and European institutions. This commentary does not believe there is any magic answer to the debt-depression spiral but Germany and others could ease fiscal policy a little and allow wages to rise slightly faster so boosting disposable incomes. They could move a little faster to a banking union which would gradually tackle the divided lending markets where businesses in southern Europe have to pay to banks double or more the interest rates charged by German or Dutch banks in their own countries. Germany and its allies in the ECB could take slightly more risks with the distant danger of excessive inflation.

Estimates of the EU budget required to oil monetary union before the actual plans where drawn up in the Maastricht treaty of 1992 were up to 5% of GDP, the actual budget has been held rigidly within a 1% limit. Loans through the European Stability Mechanism or otherwise are not transfers. They do entail the risk of default but such default could be more rather than less likely if southern economies continue their downward trajectory.

On the other hand the German fear, fed by the country’s own experience of massive transfers since unification to eastern Germany which failed to bring economic convergence, of pouring money into countries which use it to avoid rather than help necessary financial discipline and reform is also understandable. What is being done in Portugal and Spain (and even more so in Greece) should make Germany and its creditor allies see that such fears are now as justified as fearing that an anorexic could become obese by over-eatin.

 

But Italy sends another message

However the message coming to the creditors from Italy is very different from that from Spain, Portugal or Greece. Although Italy has a massive and chronic government debt its private sector has a low level of debt and huge financial assets so overall it is a wealthy country and not heavily indebted externally. It is less far off eliminating its government deficit than the other countries and its failure to do so is a result of politicians who in an effort to be re-elected have not taken feasible and necessary measures.

In November 2011, the financial markets and Italy’s partners (then President Sarkozy as much as Chancellor Merkel) lost confidence in the government of Silvio Berlusconi and the yields being demanded of Italian debt threatened to bring the country to financial collapse. As a result the head of state, President Napolitano who normally kept aloof from the country’s politics, intervened to appoint the academic economist, Mario Monti, as prime minister of a government of non-politicians to “save” Italy. Its first set of measures entitled “Salva-Italia”) included a tax on first homes (second homes were already taxed). Although similar property taxes are common in other countries, this was highly unpopular in Italy, and from late 2012 Mr Berlusconi staged a spectacular recovery from near political oblivion to almost winning the March election, a central theme of which was his promise to abolish this very property tax which had been necessary to convince external creditors including private bondholders that Italy was financially viable.

In view of such events in Italy, Germans would not be completely mistaken if they concluded that an easing of financial pressures on Italy would make it easier for politicians like Mr Berlusconi to return to power and use that power to entrench their privileges rather than make the reforms needed to allow Italy to perform adequately within the monetary union.

 

Italy’s problems are not just a result of the economic downturn

It is true that Italy is also suffering from prolonged recession and is offering its young people poor economic prospects but this predicament is more due to deep flaws in Italian politics and society than to the euro zone crisis. The success of Beppe Grillo’s Five Star Movement (M5S) which came from obscurity to 25% of the votes in the March 2013 election reflected a feeling amongst much of the population that Italy’s political class was self-serving. Unfortunately, though, this message was blurred by the simultaneous recovery of Italy’s most self-serving politician Silvio Berlusconi, helped by his control of much of the country’s television. Other flaws include the notorious organized crime clans which though being combatted seriously in Sicily remains rampant in two large southern regions, Calabria and Campania, where their impact on the wider economy is profound. The justice system includes many brave and dedicated public servants but remains appalling slow and is also over-politicised. Most professions remain encumbered by restrictive practices which makes entry even by well qualified young people difficult.

 

New prime minister Letta has to square the circle

Enrico Letta, deputy leader of the Democratic Party (PD) which just emerged as the largest party in the March election, but performed much less well than seemed likely at the start of the campaign, leads a new grand coalition between the PD and Berlusconi’s People of Liberty (PdL) having failed to persuade Grillo to enter constructive discussions. The government states that it wants to ease austerity but sis committed to maintaining the budget projections of the Monti government including a 2.9% of GDP deficit in 2013, but will have to remove the property tax if it is to retain the support of Berlusconi. It will somehow have to find expenditure cuts or other tax increases to meet this commitment. Neither are likely to be possible without taking on entrenched interest groups linked to one or other of the two parties in the coalition. Hard-nosed German and Dutch policy-makers will be watching.

 

 

Greek crisis is no side-show

While much of the news in the second half of September has been bad news involving Spain, where the prime minister, Mariano Rajoy, has floundered despite the strong political position given him by a decisive victory in the late 2011 election, there is reason for even more concern over what happens in October over Greece. The decline in the standard of living of huge sections of the population in this country over the last five years is an order of magnitude worse than in any other country in the euro zone, or than the experience of any other OECD country since the Second World War, and is comparable with the effect of the economic depression which hit Europe and the US in the 1920s and early 1930s. Real take-home earnings in the public sector and of pensioners have declined by nearly a half, taking into account both pay cuts and tax increases on the pay itself on the sale of goods and on property. A walk through Athens will show that much of the private retail sector has closed down, with an inevitable impact on other private sector companies further down the supply chain. The only obvious growth sectors are soup kitchens and similar charitable or voluntary activities such as improvised health centres to relieve the suffering. Although the economies of the more popular tourist areas remain in tolerable shape and greater social and economic cohesion in smaller towns has in many  cases kept their economies going, the economic and social situation of Athens-Piraeus and Thessaloniki, where more than half the population live, is dire.

Following the political instability of the first half of 2012, the June election—the second in three months—just produced a majority for the three “pro-Memorandum” parties which were willing to accept the need for the continuation of the swingeing austerity necessary to prevent financial chaos and keep Greece in the euro. These parties have accepted further expenditure cuts and tax increases of €13.5bn, about 6% of GDP, on top of the unprecedented austerity already in place but are asking for a spreading out of the timing for some of the measures to 2016 instead of 2014. As tense negotiations with the troika (European Commission, European Central Bank and IMF) take place, it looks as though the governing parties find themselves in a position where their remaining domestic political credibility could be broken by giving in to the rigidly hard line which the troika are taking. If this were to happen, the withholding of the next tranche of lending and consequent inability of the Greek state to service its debt might cause Greece to be the first country to exit the euro.

Earlier this year, the euro zone institutions and the other member countries, in effect told the Greek population that a vote for the anti-Memorandum political parties would lead to the withdrawal of the financial support necessary for the Greek economy to function within the euro zone, and that the rest of the euro zone was ready to withstand the shock waves that would result. However, if Greece were to be forced out of the euro now, the shock waves would be even greater because it would be unexpected and because it would have happened despite a hard-won parliamentary majority in favour of the Memorandum, the document committing Greece to continued austerity. A country, where a majority wanted to stay in the euro, despite having suffered the most severe economic pain of any developed country in recent times, would have been broken by the ever harsher conditions being imposed. The message to other troubled euro zone countries would be that even political support for harsh austerity is not sufficient to keep a country in the euro, with the result that the existing reluctance of financial markets to provide support for these countries would intensify and public scepticism over the ability of apparently moderate and responsible political leaders to keep these countries in the euro would weaken, and support for other parties, including those supporting leaving the euro, would  rise.

The negotiators of the troika in Athens are international civil servants, technocrats with a low public profile, but what they are willing to agree is likely to be influenced by the politics of the euro zone and in the creditors countries, of which Germany is the most important, though not necessarily the most hardline. The newly chosen German chancellor-candidate in the scheduled September 2013 general election for the main opposition party the SPD, Peer Steinbruck, has called for a degree of flexibility to be allowed to Greece. This shows political courage given the still prevailing stereotype in Germany of the Greeks as lazy, feckless and pampered, but it remains to be seen whether it will lead to any change on the part of the government of Angela Merkel, which has hitherto taken a hard line with Greece, and even if it does it would remain to be seen whether such a change will be sufficient to prevent a potentially catastrophic breakdown in the negotiations between the troika representative in Athens and the Greek coalition.

Can labour market reforms boost plight of young people without jobs?

The euro zone’s southern countries fiscal and banking problems have exacerbated an underlying social challenge, one facing all countries, but most acutely those of southern Europe, namely that of providing job opportunities for young people. Even when their economies were performing better, Italy and Spain had developed dual labour markets, in which a large number of established employees enjoyed a high degree of job security, together with relatively good wages, while most young job-seekers could only obtain a succession of short-term jobs which provided little or no training. Now that these countries are in the second part of a double-dip recession, the opportunities for young people are even worse: half of those not in education under 25 in Spain, and a third in Italy, are unable to find a job at least other than completely unregistered jobs in the shadow economy.

Labour market reform is therefore rightly high on the agenda of these countries. Many economists and other commentators believe that, if job security were reduced, employment would increase, pointing to Denmark and the Netherlands, two countries which have achieved not only low levels of unemployment but high rates of participation by bringing into the labour force those, especially women, who in southern Europe do not seek jobs. These countries models are described as “flexicurity” since those who lose jobs have both relatively good unemployment benefits and a labour market which provides opportunities for re-employment. Unfortunately there are huge obstacles towards moving to this model. Allowing the easier dismissal of existing workers would certainly increase redundancies, but despite the evidence from countries like Denmark and the Netherlands that it would increase opportunities for new jobs, this cannot be proved and, from the perspective of trade union members remains a  matter of speculation, and under existing economic circumstances the prospects do not look very good. Moreover, it has to be pointed out that Spain and Italy already do have a large section (the second tier) of their labour markets which are highly flexible – some would say excessively so—and although this second tier has led in Italy at least to the creation of jobs which were not there before, they have by no means produced north European levels of employment even when economic conditions were better.  An obstacle particular to Italy is that this country at present only provides an adequate cushion of unemployment benefits to a limited group of the work force through the so called Cassa Integrazione. Those not covered by this fund receive negligible benefits. Efforts are being made to fill this gap in the social security system but these are limited the need to bring the public finances into surplus so as to begin to reduce the 120% of GDP public debt.

More fundamentally, the functioning of labour markets is dependent not just on the legal framework but on patterns of industrial and social relations which have developed over generations. The experience of countries with well-functioning labour markets should be given prominence and lessons should be learned but applying those lessons is not as easy as just tearing up excessive regulation. Labour markets are highly political and it is not easily possible to impose common euro zone rules that over-ride domestic politics on top of the increasing severity of fiscal rules needed to address the sovereign debt crisis.

Nevertheless Spain has brought about a significant reform which should limit dismissal costs for standard contract employees to a month’s pay for every year worked, ending the uncertainty over costs which had been such a disincentive previously, although this applies only to newly taken on employees. Those already employed before the reform retain existing rights. The reform has not yet resulted in any beneficial effects on job creation but this is likely to have to wait till the elusive economic recovery takes place.

Negotiations over a bill to reform labour markets in Italy put forward by Mario Monti’s employment and pensions minister, Elsa Fornero, was the major domestic policy preoccupation between March 2012 and the end of June when, after amendments by parliament, the bill was passed into law. It has been severely attacked by the employers’ organization, Confindustria, and by some Italian commentators. On one of the government’s objectives, the simplification of legislation, it certainly fails, running to nearly 100 pages of dense text. However it does make some significant changes, which should be for the better. With regard to the highly contentious Article 18 of the 1970 Workers’ Statute, regarding individual dismissals, it makes these considerably easier if they are for economic reasons. Protection against dismissal for disciplinary reasons can rightly still be contested in the courts. If the employee is vindicated he or she has a right to compensation but will no longer have an automatic right to be re-instated, the latter now is dependent on the judge.

Controversially, the new law makes some changes, which increase the rights of employees on short-term contracts. The law also increases the obligations of employers towards the training of apprentices, an aspect where the ministry claims to have the support of both sides of industry.

With regard to bringing young people into the labour force, an example that southern countries could benefit from looking at is that of Germany. Its latest youth unemployment rate in May 2012 was 7.9% compared to 37% in Italy and 50% in Spain. Of course the recent overall performance of the German economy has been much better than those of Italy and Spain, which clearly provides a more favourable background to taking on young people. But the German youth unemployment rate has throughout the cycle kept much closer to the overall rate—youth unemployment peaked at just over 15% in 2005. A likely reason for Germany’s better performance is the longstanding priority in German business culture to apprenticeships, backed up by a system of days released for external vocational education. Apprenticeship programmes are supervised and monitored by local chambers of commerce. Although the German system is an old one it has adapted to changed needs by introducing 43 (out of total of 344) new types of apprenticeship in the last ten years and changing many others. In other countries, employers often complain about the quality of school education, but results for German 15 year olds in the OECD’s comparative studies known as PISA have not compared favourably with other EU countries which reinforces the likelihood that low German youth unemployment is linked to the apprenticeship system.

The German labour market also benefits from reforms introduced in the mid-2000s under the heading Agenda 2010, although the reforms were incremental rather than consisting of a radical sweeping away of regulations.  Indeed in some ways it increased regulation. For example, employees serving notice now have a right to time off to seek new employment. An important change was a radical reform of the federal labour market agency, incorporating elements of a private job agency and integrating its work with the provision of benefits.

Arguably more important than government-driven reforms has been a decentralization of bargaining over wages and conditions, which has taken place over the last decade. This has increased the role of existing works councils, which have long been provided for by German law and have gradually come to be seen as a valuable tool by company management and owners for concerted approaches to competitive challenges. They have allowed greatly increased flexibility within companies for tackling changes in demand and between companies depending on the performance of companies.

Italy and Spain should likewise strive to increase the say of employees at company and local level, where large national trade unions cannot be expected to know the conditions. National agreements may continue but, as is the case now in Germany, they should be increasingly open to adaptation at company and local levels. However this does require central union organisations to be willing to devolve some of the powers.