The crisis in Europe and the need

for an alternative economic policy

package for the Euro area

Engelbert Stockhammer

Kingston University, UK

International Journal of Public Policy (2011) 7, 1-3: 83-96

International Journal of Labour Research (2011) 3, 2: 167-188

preview

• Crisis is a result of rapid growth of private debt rather than public debt

• ... a result of imbalances within the Euro area

• Imbalances are a characteristic of neoliberal growth regimes.

• Crisis gravely amplified by a dysfunctional economic policy regime.

• Alternative policy regime • Wage policy: higher wages in Germany and inflation!

• Speed bumps for finance

• Non-discretionary, public financial flows: a European welfare state

structure

• Economic policy regime of the Euro zone

• Deflationary bias

• Neoliberalism: rising inequality and 2 growth models

• The macroeconomics of rebalancing

• inflationary or deflationary rebalancing

• reform of the policy regime in Euro zone

• Wage policy: higher wages in Germany and inflation!

• Speed bumps for finance

• Non-discretionary, public financial flows: a European

welfare state

A dysfunctional economic

policy regime

The crisis in Europe and the need for an alternative economic policy package for the Euro area

Engelbert Stockhammer

Kingston University, UK

Budget deficits

Budget deficit (% of GDP) 2007

Germany 0.2 Ireland 0.1

Netherlands 0.2 Greece -5.4

Austria -0.5 Spain 1.9

Italy -1.5

Euro (12) -0.6 Portugal -2.7

Source: De Grauwe (2010)

Crisis

• Subprime crisis (from spring 2007)

• Financial crisis (from summer 2008)

• Economic crisis (from fall 2008)

• Sovereign debt crisis

• Euro crisis (from May 2010)

ECB Monthly Bulletin June 2010, p. 38

Europe’s Lehmann moment

• “on 6-7 May tensions in the sovereign debt markets of some euro area countries spread to other segments of the financial markets. Volatility in the financial markets increased sharply and liquidity conditions deteriorated significantly not only in sovereign bond markets, but also and to a critical degree in the money markets. Transactions within the interbank market declined rapidly and uncertainty among banks about counterparties’ creditworthiness increased.” (ECB Monthly Bulletin June 2010, 41)

• “heightened concerns about the probability of default of some European financial institutions. Indeed, the probability of a simultaneous default of two or more euro area large and complex banking groups, (...) rose sharply on 7 May, reaching values higher than in the aftermath of the collapse of Lehman Brothers.” ECB Monthly Bulletin June 2010, 38-39

• Sovereign debt crisis = (private) banking crisis

EMU policy package

• EU/EC has encourage financial integration

(FSAP)

• No central fiscal policy

• Restrained national fiscal policy (SGP)

• No bail out clause

• Monetary policy: inflation targeting

• Labour market flexibility

EMU. criticism

• Is monetary union a good idea to begin with?

• Post-Keynesians (Arestis, Sawyer), Euro-memo (Huffschmied), H. Flassbeck

• Relies exclusively on labour market flexiblity in case of asymmetric shocks

• Deflationary bias: the CA deficit countries have pressure to adjust

• No coordiation of wage policy: increasing imbalances + race to the bottom

• No plan B for crisis scenario

Neoliberal, unbalanced growth

regimes

The crisis in Europe and the need for an alternative economic policy package for the Euro area

Engelbert Stockhammer

Kingston University, UK

Neoliberalism

• External + internal financial deregulation

• Shift in power relations between capital and labour → rising inequality

• 2 growth models: debt-led and debt-led

• Both try to compensate for weak domestic demand

debt-led Export-led

Center US, UK Germany, Japan

Periphery PIIGS China

Declining wage shares

60

65

70

75

80

85

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

USA

UK

Germany

France

Japan

Personal income distribution USA

Growth regimes: economic structure

and distributional policies

Distributional policies

Other factors Pro-capital Pro-labour

Economic structure

Profit-led

Wage-led

Other factors

• Economic structure

• Wage-led vs profit-led growth

A profit-led growth process

Higher profits

investment

Economic growth

Productivity growth

A wage-led growth process

Wage growth

Growth of consumption

investment

Productivity growth

Distribution

Distributional policies

Other factors

Pro-capital

Pro-labour

policies “labour market flexibility” Abolish minimum wages Weaken collective bargaining

“welfare state” Increase minimum wages Strengthen collective bargaining

Changes in technology Globalisation financialization

results Weak wage growth; WS ↓

Rising real wages; stable (or ↑) WS

Economic structure

Demand regime Supply regime

Economic structure

Profit-led Investment very sensitive to profits WS↑ → I↓

Wage restraint leads to investment and productivity growth

WS↓ → YD↑ W growth↓→ I→ pdy growth

Wage-led

consumption propensity out of wage income higher than that out profit incomes

Wage growth has strong demand effects that cause investment

WS↑ → YD↑ W growth↑→ pdy growth ... →YD↑→ I→ pdy growth

Other factors

Other sources of demand: Gov’t policy Financial factors: asset price bubble ...

Viability of growth models

Distributional policies

Pro-capital Pro-labour

Economic structure Profit-led

Profit-led growth process

Stagnation or unstable growth

Wage-led

Stagnation or unstable growth

Wage-led growth process

Viability of growth models

Distributional policies

Pro-capital Pro-labour

Economic structure Profit-led

Profit-led growth process

Stagnation or unstable growth

Wage-led

Stagnation or unstable growth

Wage-led growth process

Classifying growth strategies

Distributional policies

Pro-capital Pro-labour

Economic structure

Profit-led

‘Neoliberalism in theory’ - Trickle-down growth

Wage-led

A profit-led growth process

Higher profits

Growth of investment

Economic growth

Productivity growth

Distributional policies

Pro-capital Pro-labour

Economic structure

Profit-led

‘doomed social reform’

Wage-led

Distributional policies

Pro-capital Pro-labour

Economic structure

Profit-led

Wage-led ‘actually existing neoliberalism’ –

unstable and has to rely on exogenous growth drivers: • credit-led growth • export-led growth

Actually existing Neoliberalism

• Has resulted a in polarisation of income

distribution

• But has not generate a sustainable growth

process

• Has relied on finance-led growth

• Or export-led growth

• It has proven socially unjust

• ... and economically unstable.

Neoliberalism

Neoliberalism

Wage suppression

Finance-led growth

crisis

Demand effect of changes in income

distribution • Q: What is effect of wage cut on demand?

Keynesian answer: that depends … • neg effect on consumption [Kalecki]

• pos effect on investment [Marx/Goodwin]

• pos effect on net exports [European Commission]

• Overall effect of dYD/dWS is ambiguous (Bhaduri and Marglin 1990)

• Substantial post-Keynesian/Kaleckian literature

• Estimate consumption, investment and net exports

• decompose + identify the effects of functional income distribution

30

The effect of a 1%-pt. increase in the wage

share (Stockhammer et al 2011 CJE)

Effects on private excess demand

EU 12

(openness <15%)

Austria

(openn. 50%)

Consumption 0.37 0.36

Investment -0.07 -0.15

Domestic sector 0.30 0.21

Net exports -0.09 -0.39

Total effect 0.21 -0.18

Overview. Results on distribution-

led demand regimes

Domestic D Total D

wage-led Profit-led wage-led Profit-led

Euro area SOE09 SOE09

Germany BB95, NS07, HV08, SHG11, SS11

NS07, HV08, SHG11

BB95

France BB95, NS07, ES07, HV08, SS11

(SO04), NS07, HV08

BB95, SE07

NL NS07, SS11 HV08 NS07 HV08

Austria SE08, HV08, SS11 SE08, HV08

UK BB95, NS07, HV08 SS11 BB95, NS07, HV08

Japan BB95 NS07 BB95, NS07

USA BB95, HV08, OSG11, (SS11)

NS07 BB95, HV08, OSG11

(SO04), NS07, BFT08

Growth models in last 25 years

• Race to the bottom: declining wage shares

• Fall in wage share has led to a stagnation of domestic demand

• 2 growth models in response: credit-led and export-led growth → international imbalances

Credit-led Export-led

Center US, UK Germany, Austria,

Japan

Periphery Greece, Ireland,

Portugal, Spain

China

A wage-led growth strategy

Distributional policies

Pro-capital Pro-labour

Economic structure

Profit-led

Wage-led Wage-led growth strategy

European imbalances and

rebalancing

The crisis in Europe and the need for an alternative economic policy package for the Euro area

Engelbert Stockhammer

Kingston University, UK

0 = BS + SF + SHH – NX

• One sector‘s financial asset is another sector‘s

financial liability

• BD = SF + SHH – NX

• Currant account deficit = capital inflows

• What‘s the active variable? Capital flows or trade

flows?

Neoliberalism

Financial

deregulation

Polarization of

income distribution

internal

External Temporary relaxtion

of BoP constraint

2 growth models

Stagnant domestic

. demand

debt-driven

consumption

Export

orientation

CA surplus

Capital

outflows

CA deficit

Capital inflows

Asset + housing

price bubble

The build up of the crisis

Germany: GDP, priv. cons., adj

WS (1994 = 1)

0.92

0.93

0.94

0.95

0.96

0.97

0.98

0.99

1.00

1.00

1.05

1.10

1.15

1.20

1.25

ad

j. w

ag

e s

hare

GD

P, co

nsu

mp

tio

n

Priv cons.Ger

GDP.Germany

Adj WS.Ger

ULC (2000 = 100; AMECO)

90

95

100

105

110

115

120

125

130

135

140

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Germany

Netherlands

Austria

Ireland

Greece

Spain

Italy

Portugal

Growth of ULC 2000-08

ULC 2000-08

Germany 3% Ireland 33%

Netherlands 19% Greece 26%

Austria 9% Spain 30%

Italy 27%

EA12 16% Portugal 24%

Real GDP growth 2008-2000

GDP 2000-08

Germany 10% Ireland 40%

Netherlands 17% Greece 35%

Austria 19% Spain 28%

Italy 7%

EA12 15% Portugal 8%

Increase in household debt (% of GDP)

Increase in HH debt (in % GDP) 2000/08

Germany -11.34 USA 26

Netherlands 32.83

United

Kingdom 28.13

Austria 7.91

Ireland 62.72

Greece 35.46

France 15.75 Spain 33.84

Portugal 27.38

Source: Eurostat, except USA: FoF

Current account (% GDP)

Current account (% GDP), avg. 2000-07

Germany 3.8 Greece -8.5

Austria 1.7 Portugal -8.9

Netherlands 5.6 Spain -5.8

Italy -1.3

Ireland -2.1

Neoliberalism

Financial

deregulation

Polarization of

income distribution

internal

External Temporary relaxtion

of BoP constraint

2 growth models

Stagnant domestic

. demand

debt-driven

consumption

Export

orientation

CA surplus

Capital

outflows

CA deficit

Capital inflows

Asset + housing

price bubble

The build up of the crisis

How can the €-zone re-balance?

• One sector‘s financial asset is another sector‘s financial liability

• BD = SF + SHH – NX

How much rebalancing is necessary?

• ULC 25-30%

• German wage growth has to be 2.5%-pts. above mediterranean wage

growth for 10 years!

How can the €-zone re-balance?

• 1 deflationary adjustment in deficit countris

• Big contraction in PIGS to bring down GDP and ULC and thus, ultimately, CA-deficit

• But: that means rising debt ratios!

• 2 inflationary adjustment in surplus countries

• Expansion and/or wage inflation in Germany

Wage coordination

• European system of coordinated wage bargaining

• As part of a new policy economic policy mix

• Aim: • ensure that living standards of the working class are

growing

• Prevent excessive inflation

• Prevent/counteract imbalances

• wj = xj + pT + a(ULCEU – ULCj) • w..wage growth, x..productivity growth, pT..inflation target,

ULC..unit labour costs,

• Subscripts EU and country j

• pT would have to be set such as to avoid deflation in all countries, while allowing rebalancing

obstacles

• No one wants it • EC, ‘mainstream’, employers seeks to get rid of collective

bargaining

• Unions are afraid of loosing their field of influence

• ...but • The present system is not working

• Would allow more direct control of wages (and inflation)

• Internalization of externalities

• Can it be done? • Requires institution building at European level

• Goverments try to influence wages all the time: Schulten (2004) lists 29 wage pacts in 12 European countries

• Would have to give unions some say in other policy areas: coordinated macro policy

EMU reform: actual

• Fiscal policy: further tightening • Monetary policy: half-hearted

• Initially made things worse by putting pressure on Greece

• Then bent its rules to back Greek gov‘t bonds • No indication that ECB will change inflation target

• No bail out clause: effectively suspended (EFSF) • But like standard IMF austerity program • Without devalution, without restructuring

• Wage policy: pressure on wages, no indication of coordination

• Assessment: barely survived first suicide attempt

Has it worked?

(Source: OECD ECO 89)

2009 2010 2011

Real GDP growth. Ireland

-7.6 -1 0.0

Real GDP growth. Greece

-2.0 -4.5 -2.9

Real growth. Portugal

-2.5 1.3 -2.1

Inflation. Ireland -1.7 -1.6 1.3

Inflation. Greece 1.3 4.7 2.9

Inflation. Portugal -0.9 1.4 3.3

Inflation. Germany 0.2 1.2 1.6

Has it worked?

Conclusion

The crisis in Europe and the need for an alternative economic policy package for the Euro area

Engelbert Stockhammer

Kingston University, UK

Conclusion

• Imbalances are results of neoliberal growth models; interaction of financial liberalization and the polarization of income distribution.

• Policies to fix the broken accumulation regime have to address financial regulation (internal and external) as well as wage policy.

• Crisis amplified by dysfunctional economic policy regime.

• More egalitarian destribution of income is not luxury that can be taken care of, once the crisis has been resolved – distributional issues are at the very root of the crisis

• Wage policy: wage growth is precondition of consumption growth without exploding debt

• Wealth: equal distribution of wealth comes with less speculation

Wage policy: coordination, higher

wage growth in Germany! • Wage policy so far has relied on wage flexibility and

effectively encourage beggar-thy-neighbour via-wage-moderation policies

• Results: • Falling wages shares across Europe

• Rising divergences

• If the Euro is to be saved, EU needs to rethink wage policy: coordinated collective bargaining • → higher wage growth in Germany (surplus countries)

• Higher inflation in Euro-land

• Wage policy as means of rebalancing

• To get there need social partnership and a greater say of unions in other policy areas (social and monetary policy)

Conclusion (finance and gov’t)

• Financial sector – introduce speed bumps for financial flows • private financial flows have fuelled imbalances

• Regulating the shadow banking system

• FTT: fiscal income

• Not-for-profit financial sector

• Fiscal policy: tax policy to decrease wealth inequality • Wealth

• Effective taxation of the financial sector

• Closing of tax loop holes, offshore financial centres

• Systemic public financial flows across Europe – A European welfare state • European unemployment benefit system

• Pay-as-you-go pension scheme

• Public housing