The Golden Rule : “He who has the gold makes the rules ”
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Transcript of The Golden Rule : “He who has the gold makes the rules ”
The Golden Rule:
“He who has the gold makes the rules”
Discourse on the Political Economy of the Eurozone29March 2012
Agenda
Part I. Politics - New economic governance in the EU• The “Sixpack”• The “Fiscal Compact” (“Begrotingspact”/”Pacte Budgétaire”)
Part II. Economics – Separating truth from fiction• The myth of excessive public spending• The myth of competitiveness
Part III. What to do?• The democratic deficit• Proposals
PART I : POLITICS
The Sixpack• Five regulations and one directive introduce a new framework for economic governance,
greatly extending the powers of the Commission and the Council• Approved in 2011 by the Member States and the European Parliament• Entered into force on 13th of December 2011• Includes the “European Semester” (recent policy initiatives frequently overlap)• Reinforces the Stability and Growth Pact of 1997 (rules on public debt and deficit)• The Commission determines and monitors macro-economic variables and makes binding
recommendations to Member States• Visbility and peer pressure is created through the “scoreboard”• In case of non-compliance the Commission may trigger:
1. Excessive Deficit Procedure (EDP)• As of March 2012 only four Member States are NOT in EDP
2. Excessive Imbalances Procedure (EIP)• Penalties in case of non-compliance
• Between 0,2 and 0,5% of GDP for violations of the EDP• 0,1% of GDP for violations of the EIP
• Only the Council may block the fine(s) through Reversed QMV (almost 75% of the votes needed)
Example Scoreboard
The Scoreboard• Reflect the real priorities of the EU• No social (except unemployment) or ecological variables• Nominal ULC• No lower limit• No academic references proving this variable to be problematic
• Unemployment• Constant unemployment levels of 9% are not a problem?
The Fiscal Compact• Is an Intergovernmental Treaty• Ratification is ongoing, will enter into force 1 January 2013 if by then at
least 12 Member States have ratified it• … hence a referendum in Ireland can not halt adoption (although the political
implications of a “no” would be substantial)• The United Kingdom and Czech Republic haven’t signed it (yet)• Perhaps a novelty: the Treaty is opposed by the European Trade Union
Federation (ETUC)• The Treaty reinforces the Sixpack:• Stresses the “Golden Rule”: structural deficit must be lower than 0,5% of GDP• Only those who agreed to the Fiscal Compact will be able to draw funds from
the European Stability Mechanism (ESM), the permanent “rescue fund”• Compulsory anchoring of provisions in the Constitution of Member States
• Penalties (European Court of Justice decision):• 0,1% of GDP if the Treaty is not embedded in the Constitution or equivalent
PART II. ECONOMICS
The Golden Rule• The Golden Rule: the structural deficit must be lower than 0,5% of
GDP, but this policy goal raises a number of questions1. The Golden Rule relies on “Potential GDP”, an elusive figure
• “As a measure of fiscal rectitude, [the Golden Rule] mandates use of a statistic that is unobservable and can be estimated only with a plethora of assumptions about cyclically adjusted revenues, expenditures and output.” – Prof. David R. Cameron (Yale University)
• Example: in 2007 the IMF estimated that Ireland had a structural deficit 0,1% of GDP, a number which was revised in October of last year to 8,4% of GDP
2. Public debt will be forced below 60%• The structural deficit limit is raised to 1% of GDP when debt is below 60%• According to Prof. Karl Whelan (University College Dublin) it follows that
in the long run, given a nominal GDP growth of 4%, public debt will tend towards 25% of GDP (one unit of debt for four units of growth)
Public Debt: Ireland
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20110
10
20
30
40
50
60
70
80
90
100
110
120
Public Debt of Ireland (1991-2011)
Public Debt: Greece
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
201160
70
80
90
100
110
120
130
140
150
160
170
180
Public Debt of Greece (1991-2011)
Public Debt: Italy
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
201180
90
100
110
120
130
Public Debt of Italy (1991-2011)
Public Debt: Portugal
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
201140
50
60
70
80
90
100
110
Public Debt of Portugal (1991-2011)
Public Debt: Spain
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
201130
40
50
60
70
Public Debt of Spain (1991-2011)
Comparing Government Debt
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201250%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
105%
110%
115%
120%
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
105%
110%
115%
120%
Comparing Gross Government Debt
From 2000 until 2007 the combined periphery was steadily decreasing its debt level. Increasing debt was clearly a consequence , not a cause of the crisis.
Source: IMF2011 and 2012 are projections
Economy Absolute debt increase (2000->2011)
AAA eurozone 73%Periphery 76%AA eurozone 86%US 176%
Private Sector Debt
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 201050
100
150
200
250
300
350Private sector debt (as a percentage of GDP)
Perc
enta
ge o
f GDP
Household debt
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 201020%
40%
60%
80%
100%
120%
140%
160%
180%
200%
220%
Household debt-to-income ratio
Conclusions on the Deficit• The claim that “soaring government debt” caused the crisis:
• Has no validity for any of the peripheral countries• … although the persistently high level of debt made it more difficult for Greece to react• Overlooks the important fact that rising private debt was far more problematic
• The macro-economic scoreboard does not take into account different levels of economic development of the member states and imposes a one-size-fits-all framework
• During the run-up to the crisis the ECB kept interest rates low, which was helpful for the struggling German economy, but caused overheating in the peripheral countries
• Soaring yields on government bonds in peripheral countries have a lot to do with the fact that Eurozone members borrow in a currency they do not control (“original sin” syndrome), not with the fact that the overall public debt level is high
• The United States currently borrows at 2%, despite debt and deficits levels that are higher than in a lot of Eurozone countries that are currently in trouble
• Reliance on fiscal policy alone in times of financial turmoil significanly increases risk of default and investors (speculators) know it
• Recent decreases in bond yields are a consequence of the LTRO rounds more than anything else• Austerity has proven deadly to Greece while the economies of other peripheral countries have also taken a
dive and are currentely stalling• The “golden rule” depends on an estimate of Potential GDP which is an elusive figure• If applied consistently the “golden rule” implies the debt-to-gdp ratio will fall way below 60%
Current Account Imbalances
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
-15
-10
-5
0
5
10
Germany Greece Ireland Netherlands Portugal Spain
Wages in Germany
Germany – Sources of NCO
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20120.000
50.000
100.000
150.000
200.000
250.000
Germany - Potential sources of increasing Net Capital Outflow since 2000The blue line represents capital that became available as a consequence of reduced gross fixed capital formation (i.e. reduced domestic investment) since 2000.
The red line represents the "extra" exploitation surplus as a consequence of wage repression, especially since the "Hartz reforms" that started under the Schröder-Fischer coalition in 2003.
The purple line adds up the blue and the red line.
The green line represents the increased Net Capital Outflow since 2000.
Source: Ameco Online
Competitiveness problem?
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201290
100
110
120
130
140
150
160
170
180
190
200Exports of Goods & Services: the Periphery vs the AA(A)s
Current Account Imbalances• Scoreboard thresholds: -4% < CA/GDP < +6%• The Netherlands and Germany were both above 6%• CA imbalances are a zero-sum game !• … but according to the Commission surplus issues are to be dealt with in the mid-
term while deficits require immediate attention, hence all the burden is on the deficit countries
• The debate is not new; for example at Bretton Woods in 1944 J.M. Keynes argued that both deficit and surplus countries ought to change policies in case of imbalances
• According to the International Labour Organization (ILO), wage repression in Germany is one of the main causes of the current crisis
• … but competitiveness as such is not the main channel through which trade imbalances came about, because
• … if salary increases in the peripheral countries were such a problem, how come their export volume grew faster than in many core countries?
• Liberalization of capital markets and high savings in Germany as a consequence of disinvestment and wage repression lead to the Current Account imbalances and overfinancing of peripheral countries
PART III. WHAT TO DO?
The Democratic Deficit• The new treaties, regulations and directives leave the European Parliament (EP)
completely out of the picture• The EP can not determine what macro-economic variables are monitored, what the
thresholds are, what the recommendations to the Member States will be or whether a Member State will receive a fine
• Everything is in the hands of the Commission with limited power to the Council to block a fine (Reversed QMV, almost 75% of the votes)
• The EP still has no right of initiative:• This renders elections meaningless because the EP can’t overturn any of the new
regulations or directives• The European Parliament can not pass any directive the Commission doesn’t agree with
• Motion of censure by the EP against the Commission requires a two third majority
• The European Council is the most powerful of EU institutions, but this is the seat of European “realpolitik” (large member states are in control)
• When push comes to shove the European Council moves around the treaties at will (cfr. the “no bail-out clause” or the Fiscal Compact)
Proposals• On Current Account Imbalances:• Monitor debt-driven growth• Have surplus countries carry the burden• Re-introduce capital controls to alter the composition of capital flows
• Minimum stay requirements• Prefer Foreign Direct Investment (FDI) over debt
• To reduce dependency on volatile financial markets, keep 75% of public debt national, even if that implies higher interest rates
• On financial stability:• Keep banks small, have public and support cooperative banks• Separate savings from investment banks• Let the EU take responsibility for systemic risk • Have an EU system for orderly bankruptcy of financial institutions
• Have a macro-economic scoreboard that monitors social and ecological variables: inequality, poverty, carbon emissions, etc.
The Confidence Fairy
Off-topic: the 1%
19131916
19191922
19251928
19311934
19371940
19431946
19491952
19551958
19611964
19671970
19731976
19791982
19851988
19911994
19972000
20032006
20090%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100% 8%
10%
12%
14%
16%
18%
20%
22%
24%
26%
US Federal Income Tax & Share of Income for the 1% (1913-2010)
Federal Income Tax (highest bracket) Share of income for the 1%