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%