The bailout of Spain’s banks over the past weekend was necessary, but it may not be sufficient.
Spanish banks are carrying a lot of bad debt from the construction bubble there. The banks have not properly acknowledged this debt in their books, and this has sapped investor confidence in them.
Spanish banks are carrying a lot of bad debt from the construction bubble there. The banks have not properly acknowledged this debt in their books, and this has sapped investor confidence in them.
House prices in Spain have not adjusted downwards as much as they have in Ireland, and Spanish competitiveness has not improved as much as Irelands’ has. Unit labour costs remain high, although Spanish exports have been fairly buoyant.
The new Spanish Government has introduced sweeping labour market reforms that will improve Spanish growth potential in the next few years, but that is not immediate enough to kick start the Spanish economy today. The true financial position of many Spanish regional governments is obscure, and that saps confidence too.
Greece, despite all the austerity, still has a big balance of payments deficit. In other words, Greeks are buying more abroad than they are selling there. Until that is tackled, nobody will want to lend to Greece. It seems Greek banks are using cheap ECB money to lend to some Greek consumers who are spending it abroad.
Meanwhile, other Greeks have experienced big wage cuts, but, because the distribution system in Greece is riddled with monopolies and restrictive practices, Greek prices have not come down along with wages. This is why many Greeks are angry.
The new Spanish Government has introduced sweeping labour market reforms that will improve Spanish growth potential in the next few years, but that is not immediate enough to kick start the Spanish economy today. The true financial position of many Spanish regional governments is obscure, and that saps confidence too.
Greece, despite all the austerity, still has a big balance of payments deficit. In other words, Greeks are buying more abroad than they are selling there. Until that is tackled, nobody will want to lend to Greece. It seems Greek banks are using cheap ECB money to lend to some Greek consumers who are spending it abroad.
Meanwhile, other Greeks have experienced big wage cuts, but, because the distribution system in Greece is riddled with monopolies and restrictive practices, Greek prices have not come down along with wages. This is why many Greeks are angry.
It is not so much that Greece has had too much austerity, it is that it has had the austerity in the wrong places. So far, that problem has only been tackled on paper, because the Greek system of public administration is weak.
Portuguese banks have a big exposure to a possible Greek collapse. Total Portuguese exposure to Greek debt comes to 7% of Portuguese GDP, as against a comparable exposure of 5% for France, 4% for Germany, and 2% for Ireland. Relative unit labour costs in Portugal have hardly come down at all since 2007, whereas they have come down substantially in Ireland and Greece. All this makes Portugal particularly vulnerable to a loss of confidence that might come, if Greece defaults again.
The recent decline in voter confidence in the government of Mario Monti in Italy is also a big worry. His reform programme is only beginning to take effect, and the fear has to be of a return to populist politics, of a kind that would stop long overdue action Monti is taking to clear the arteries of the Italian economy, and lift its growth potential .
Two issues, growth potential and political capacity to implement decisions, are at the centre of our present dilemma.
The OECD has done some calculations on the growth potential of various countries from 2016 to 2025, making assumptions based on growth or decline in the working age population and likely productivity growth. These estimates show huge differences between euro area countries. OECD thinks Ireland has a growth potential in that period of 2.7% per year, whereas Germany only has a growth potential of 1.2%! This is explained by the likely decline in Germany’s working age population.
Interestingly, Spain has a growth potential of 2.3%, whereas Greece and the Netherlands are deemed to have a potential of just 1.4%, and Italy 1.5%, almost as low as Germany. These figures, if valid, may explain why Germany is emphasising productivity and is unwilling to underwrite the debts of other countries, unless and until it is first fully convinced that those countries will achieve or, better still, improve their growth potential.
Portuguese banks have a big exposure to a possible Greek collapse. Total Portuguese exposure to Greek debt comes to 7% of Portuguese GDP, as against a comparable exposure of 5% for France, 4% for Germany, and 2% for Ireland. Relative unit labour costs in Portugal have hardly come down at all since 2007, whereas they have come down substantially in Ireland and Greece. All this makes Portugal particularly vulnerable to a loss of confidence that might come, if Greece defaults again.
The recent decline in voter confidence in the government of Mario Monti in Italy is also a big worry. His reform programme is only beginning to take effect, and the fear has to be of a return to populist politics, of a kind that would stop long overdue action Monti is taking to clear the arteries of the Italian economy, and lift its growth potential .
Two issues, growth potential and political capacity to implement decisions, are at the centre of our present dilemma.
The OECD has done some calculations on the growth potential of various countries from 2016 to 2025, making assumptions based on growth or decline in the working age population and likely productivity growth. These estimates show huge differences between euro area countries. OECD thinks Ireland has a growth potential in that period of 2.7% per year, whereas Germany only has a growth potential of 1.2%! This is explained by the likely decline in Germany’s working age population.
Interestingly, Spain has a growth potential of 2.3%, whereas Greece and the Netherlands are deemed to have a potential of just 1.4%, and Italy 1.5%, almost as low as Germany. These figures, if valid, may explain why Germany is emphasising productivity and is unwilling to underwrite the debts of other countries, unless and until it is first fully convinced that those countries will achieve or, better still, improve their growth potential.
These figures also imply that some of the countries receiving help today, might be the ones having to help others in 15 years time! They should also be taken into account by the outsiders who are offering so much self interested free advice to Germany
The other part of the problem is capacity to make and implement decisions at EU level. A currency depends on confidence, and confidence comes from knowing that quick action can be taken in a crisis.
The other part of the problem is capacity to make and implement decisions at EU level. A currency depends on confidence, and confidence comes from knowing that quick action can be taken in a crisis.
Although the European Union has done a lot, in the past three years ,to remedy the original design flaws in the euro, it still has a very long way to go, and the markets may not wait another three years.
For example, a banking union in the euro zone would need strong capacity to close down banks in individual countries, to require agreed bail ins by bondholders, as well as the provision of funds to guarantee depositors. The difficulty is that the decision making system of the European Union is not designed to make, and implement, complex and controversial decisions like this, quickly.
The EU system is designed for deliberative and consensual legislation, not speedy crisis management.
To make decisions, the EU has to bring along countries that are in the euro, countries that are not yet in the euro, and also countries that never want to be in the euro at all but want to share in all the benefits of the single market.
If an unforeseen problem comes up, the EU has to amend its treaties, and that requires ratification in 27 countries (and a referendum in at least one of them!).
The EU system is designed for deliberative and consensual legislation, not speedy crisis management.
To make decisions, the EU has to bring along countries that are in the euro, countries that are not yet in the euro, and also countries that never want to be in the euro at all but want to share in all the benefits of the single market.
If an unforeseen problem comes up, the EU has to amend its treaties, and that requires ratification in 27 countries (and a referendum in at least one of them!).
The EU has to cope with a decision making process that emphasises the national, over the collective European, interest.
Not only is the Council of Ministers structured to favour the pursuit of national interest, even the European Parliament still allocates its own big jobs on the basis of national quotas, something it would be quick to condemn if it happened anywhere else in Europe!
Increasingly, because no European leader, like the President of the Commission, has a direct mandate from the European people, the really important decisions are being made by the 27 heads of Government, who each do have such democratic mandates in their own countries.
Increasingly, because no European leader, like the President of the Commission, has a direct mandate from the European people, the really important decisions are being made by the 27 heads of Government, who each do have such democratic mandates in their own countries.
But each of these women and men are “part time Europeans”, so to speak. Their day job is running their own countries (and getting re elected if they can). They meet less frequently together than national cabinets do, and when they do meet, there are 27 of them in the room. That makes it difficult to get into the depths of any question, or to look beyond the immediate problem.
I believe the crisis is of a seriousness that it requires us to step outside the conventional ways of thinking, and tackle the economic and political problems of Europe together in one package. If necessary, leaders should continue meeting until they have worked out a global blueprint, covering the present banking crisis, the Greek issue, structural reforms to lift growth potential, and enhancing democratic decision implementation. Sometimes, the more issues are in the mix, the easier it becomes to find balancing compromises.
I believe the crisis is of a seriousness that it requires us to step outside the conventional ways of thinking, and tackle the economic and political problems of Europe together in one package. If necessary, leaders should continue meeting until they have worked out a global blueprint, covering the present banking crisis, the Greek issue, structural reforms to lift growth potential, and enhancing democratic decision implementation. Sometimes, the more issues are in the mix, the easier it becomes to find balancing compromises.
We do not have much time, and we need to remember that we could lose, in five months, something it took over 50 years to create.
