With the German elections – which had held up EU policymaking for too long – behind us, it is high time to address the EU/Eurozone policy needs for the medium term. The following steps are necessary to get the EU/EZ finally out of the crisis. They are grouped relative to the time horizon (short-term, medium-term) and to the degree of “thinking out of the box”.
At the outset, I would like to emphasize that the overriding objective of EU policymaking must be enhancing the wellbeing of EU citizens, and not to placate or benefit financial market actors. This needs to be taken into account in all policy proposals.
A) Crisis mitigation – Budget Consolidation
It is clear from the data that the existing crisis strategy has been a failure. The EU/EZ are barely growing, GDP is still below the pre-crisis level by 3% (in Greece nearly 25%, in all crisis countries in the high one-digit figures), unemployment is rising to socially and politically unsustainable levels (EU 12%, Spain and Greece above 25%!), and the European banks are still burdened by high non-performing loans, too little equity and largely unreformed structures. The economic and social blight in the crisis countries threaten to topple governments and give way to non-governable conditions by moving the political spectrum to extremist parties and non-voting.
In this situation, the foremost necessity for the EZ is to desist from its demand-reducing austerity. As the European thinktank Bruegel has recently shown convincingly, for the past 3 years the Eurozone has reduced its (structural primary) budget balance by 1 percentage point each. And the same is true of surplus countries, like Germany, Austria, Finland, the Netherlands. These latter countries which are all running smaller or larger current account surpluses have ample leeway to postpone their budget consolidation, thus benefiting their own populations and those of the crisis countries.
Economics experience, if not theory, has shown, and the Great Recession of 80 years ago has proven devastatingly, that consolidating public budgets during recessions draw the economy into a downward spiral. While the need for the crisis countries to consolidate (more slowly than envisioned now) is clear, countries with “fiscal and current-account space” must add to total demand in the Eurozone. Only a growing Eurozone can alleviate the dire debt situation. Only positive growth prospects will induce private firms to invest (instead of hoarding cash) and consumers to increase their purchases.
European policymakers, both the Commission, the Parliament and the Council, in addition to the ECB, all need to look foremost at the Union as a whole and its growth prospects, and only then look at the individual countries to which appropriate policies are “allocated”. Now it is the other way round! The appropriate monetary-fiscal policy mix is not an expansive monetary policy and a contractionary fiscal policy. In this situation, both must be expansionary at the European level!
B) Crisis Mitigation – Banks
In addition, the finalization of the much-touted Banking Union needs to get under way. Up to now, there is no European plan/vision, how the financial sector in the Union should look ten years from now. Rather, each country is separately trying to “save” its own banks, disregarding the spillovers and the European picture. Europe is “overbanked”, some non-viable banks need to be liquidated or restructured. Only a truly “European” supervisory authority can do that, breaking the unhealthy link between national supervisors and “their” banks. Thus, the establishment of a European Resolution Fund and of a European Deposit Insurance System are urgently required.
The working of a European Banking Union could be enhanced by the introduction of “Eurobonds”, joint bond emissions with certain conditionalities attached. The German Sachverstaendigenrat and Bruegel thinktank have made pertinent proposals.
C) Crisis Mitigation – Growth Strategy
Both the surplus countries, much more so the crisis countries, need a directed growth strategy. The present EC position that growth will come automatically once necessary “structural” reforms (mainly in the labor markets, but also product and services markets) are completed, is wrong. While more flexible structures undoubtedly can enhance and pick up growth dynamics, coming from increases in demand, they by themselves cannot “generate” growth, unless, at the same time they are demand-enhancing. Most labor market reforms, most competition policies, initially at least reduce demand.
As the paltry growth rates of even “successful” EU/EZ countries, like Germany, show, their success in terms of structural policies has not brought about growth. Rather, it is their unit labor cost position which has given them a competitive edge. Investment data, especially for public investment, show that business investment has been lagging, instead of leading a growth dynamic. Public investment shares in GDP are below 3% in all EU countries and have fallen in most of them, including Germany. This may be the unhappy effect of neo-liberal thinking, touted by the German Prime Minister as epitomizing the “prudent Suebian housewive”, who does not spend more than she (preferably her husband) takes in. This primitive view ignores that the public budget – unlike the household budget of Ms. Merkel – has a significant influence on effective demand. Much of the European infrastructure, both physical and immaterial, is in need of rejuvenation, be it energy networks (see the German impasse of its “Energiewende”), transport infrastructure (France, England), as well as investments in education and R&D, which have fallen back.
Even budget consolidation is not inconsistent with a simultaneous growth strategy, but this requires tough political choices – from which also successful politicians shy away, to the detriment of their populations.
D) The Medium Term: Overcoming the Financialization of Our Economy
Today, nobody doubts that the vast spreading of financial products into ever more areas has been responsible for the decoupling of the real economy and the financial sector. The latter has taken on a life of its own, such that estimates show that only about 20% of all financial activities benefit the real economy, while 80% are within-sector trading activities. Money begets money! At present, there is no visible effort to overcome this pernicious situation. Rather, small tweaks are being effected in oversight of banks only. JP Morgan is in the dock for up to 20 bill $ for pre-crisis wrong selling, a larger number of major banks have been fined several billion $ for Libor manipulation, misselling products, fraud, etc. According to Global Financial Market Review, the six largest US banks, all S&P 500 listed, up to last month incurred litigation costs of 66 billion $, about one third of the more than 200 bill $ they made in profits during the past 3 1/2 years. While criminal procedures and pre-verdict settlements are necessary (how many bankers are in jail??), politics so far has ignored the need to shrink the financial sector down its socially useful size and quality.
This fact alone would be bad enough, but this development of 30 years of deregulation and debt-building has increased the volatility of the whole system and has brought 3 deep crises to the European economy during the past 10 years (dotcom bubble, Lehman crisis, Eurozone crisis).
Several steps are needed to reverse this pernicious trend:
a) Separate commercial activities from trading activities, such that the latter are not – implicitly- cross-subsidized by the deposit guarantees for the former. This would not outlaw trading, but would have it bear its own risks fully.
b) Enforce “too-big-to-fail” which in essence is also “too-big-to-save”, by breaking up large financial conglomerates into “manageable” groups.
c) Subject all financial products to a “utility” test, a check which investigates their social and economic utility. Products which do not pass this test, should be forbidden.
d) Introduce rapidly a Financial Transactions Tax as widely as possible on a European scale
E) Medium Term –Two Radical Proposals.
a) Institutional: The Eurozone needs a “Unitary Fiscal Authority”, similar to a national finance minister, in order to effectively coordinate the fiscal positions of the member states, with a view to achieving the appropriate fiscal stance. This fiscal authority must take over the pre-national budget coordination and have the authority to induce member states to adjust their national budget proposals in a way that they correspond to the desired EZ fiscal position. This then needs to be coordinated with the monetary policy decisions of the European Central Bank.
b) Restructure government finance: Government finance, i.e. debt issuance, should be taken away from the private sector banks and turned over to a publicly accountable European institution. This could be the ECB or the ESM.
Since government expenditures are done in the public interest, its financing should not be subject to the whims of private profit-making calculus. The evolution of the present crisis – from banking crisis to government debt crisis – has shown that the irrational movements in private investors (and rating agencies as their agents) assessments of government activity have been instrumental in the eventual crisis. A more sober and stable assessment of government policies by e.g. the ECB would be in order.
Government debt then would not be traded, but held by the ECB, or by private savers, who in general would also hold them to maturity. If the latter wanted to redeem their bonds (because of a private financing need), they could resell them to the ECB at an ECB-determined price.
In this way, all financing of government expenditures, both by taxes and by bond issuance, would be subject to public accountability.
This model would also require to make the debt-holding institution publicly accountable, subject to the EU Parliament.
All this would require a change in the European Treaty.
F) The Long Term: Combining Growth with Social and Environmental Objectives
The objective of economic activity is human wellbeing, consisting of both material, immaterial, social and environmental services.. The EU predominant emphasis on GDP growth does not take account of that, even though elements of a wider concept of wellbeing are contained in the Europe 2020 Strategy. At present, the “WWW4Europe” project of 30 European research institutes, led by the Austrian Institute of Economic Research (WIFO), aims to underpin this and a wider strategy.
The European demographic points to a likely decrease in the European population. This relieves some pressure on growth, since per-capita incomes could still rise with overall stagnant GDP. Social objectives would demand more employment, better wages, less unequal income distribution, a reduction in poverty, gender equality, diversity, taking care of the ageing societies. Environmental objectives would focus on preventing and mitigating the effects of climate change, of the loss of bio-diversity and other environmental “capital”. The project explores where the tradeoffs between these 3-pronged bundle of objectives are, where potential synergies can be exploited and which instruments the European Union needs to employ, in order to safeguard its populations’ increase in wellbeing.
Crisis mitigation needs a macroeconomic perspective at the European/Eurozone level which then, in policy terms, is broken down for individual EU member states: Basically, surplus countries need to participate in crisis mitigation by using their fiscal and current account space, in order to strengthen total demand for the EU/EZ. Some crisis countries may need some debt forgiveness, all need to combine a (slower) budget consolidation with a stronger emphasis on a growth strategy. Growth also needs a policy in the surplus countries.
Banks need to be restructured, recapitalized and be put to primary use of the real sector. The European Banking Union needs to be completed, Eurobonds introduced, a transactions tax at the European level installed. Their excessive trading activities must be curbed. Even the business-friendly IMF has most recently urged Europe to go this way!
Government finance should – because of the societal value of expenditures – consist of only publicly accountable sources, i.e. taxes and debt from a European accountable institution. The latter should in principle not be traded, but its value evaluated by the ECB on a regular basis. This would determine its pricing and conditions of emission.
A longer term Development Strategy for the EU needs to combine economic, social and environmental objectives. Again, the overriding objective must be the wellbeing of European citizens and its enhancement, and not the profitability of private investors. European institutions must be adjusted towards a stronger Union which is able to address European problems at a European level.
Last, but not least, EU/EZ institutions need to be restructured, in order to be able to implement the above (and other) proposals: Banking Union, Fiscal Authority, Coordination Fiscal/Monetary Policy Mix, accountability of the ECB, and more.
Much needs to be done, time is running out. ECB Draghi’s “unlimited support” announcement of a year ago has gained extra time, but this window is closing fast.