John Bruton

Opinions & Ideas

Category: Austerity

WHAT HAPPENS IF GREECE DEFAULTS? HOW DISHONEST “ANTI AUSTERITY“ RHETORIC MAY LEAD EUROPE TO AN AVOIDABLE DISASTER

If Greece defaults on its debts, and leaves the euro, the effects will be very hard to calculate. 
Nobody really knows what will happen. Nobody even wants to talk about it.
But a very serious precedent will have been established.

That precedent, that of a euro zone country defaulting on its debts and leaving the euro, will eventually place upward pressure on the interest rates charged to small euro zone countries with substantial debts. Financial markets are emotional and erratic and often fail to make distinctions that should be made.

The effect of a Greek default may not, of course, be felt immediately, thanks to quantitative easing, but the underlying precedent will tend to corrode of confidence in government bonds generally and confidence in the irreversibility of the euro, and confidence is the basis for all money. 

Maintaining confidence, and doing what is just and rational in an abstract sense, are not always the same thing.

Just as in the private sector, a risk of not being repaid in full usually leads to a higher interest rate…a risk premium.

For example, if , for legal political or cultural reasons, banks  have difficulty getting hold of properties, given as security for loans that are no longer  being serviced by  borrowers,  they will tend to charge a higher interest rate on such loans. The gap between the rate of interest banks charge, and the rate they pay for funds, will be wider than it would be if they knew they could easily realise their security, if a borrower defaults.

The rules for capital adequacy of banks, set by global banking regulators, have treated government bonds held by banks as risk free, and this has meant that banks buy a lot of government debt. If, thanks to a Greek default, government bonds are no longer risk free, this will call these rules into question. That , in turn, would make government  borrowing more difficult.

The present Greek crisis was not inevitable. It is the result of a decision by Greek voters.

A few months back, it looked as if the Greek economy was about to start growing again, admittedly from a low base. For example, as recently as August 2014, Deutsche Bank forecast that the Greek GDP would grow by 2.2% this year. This was to be almost twice the forecast growth for the euro zone as a whole, and second only to the forecast growth for Ireland of 2.3%, which has proved to be a big underestimate in the Irish case. 

Greece had put in place a lot of structural reforms, under the previous Greek government, more than almost any EU country by some measures. The labour market reforms improved the competitiveness of the Greek economy, but the full benefit of these reforms was not achieved because of cartels protecting some professions and services. The reform programme of the previous government was not a “failure”, but it was delivering results too slowly for an impatient electorate in Greece.

40% of loans in the Greek banking system were non performing, but the banks were not dealing with this. Greece was suffering a brain drain.

That prospect of 2.2% growth in the Greek economy was blown away by the uncertainty caused by the Syriza election victory, and the nationalistic rhetoric and grandstanding that surrounded it. This led to a flight of confidence, and money, from the Greek banking  system and an unwillingness of foreigners to invest in Greece as long as the political uncertainty persisted. It did nothing to slow the brain drain.

The new government threatened to undo the labour market reforms and to make it more difficult for Greek banks to deal with non performing loans.

The  structural reforms, put in place by the previous Greek government, had begun to work, when they were derailed by politics. 

Syriza won office on a false platform which asserted that the previous structural reform programme had been a “failure”. It had not been a failure, it had  brought Greece to the pont where its forecast growth rates for this year were second best in the euro zone. It had simply taken longer to work than it would if international conditions were more favourable, and if it had been extended as vigorously to  the professions, and to tax evasion, as  it had been to employees.

Syriza  convinced Greek voters the “austerity” was a “failure”, without saying what those terms meant in practice, but implying instead that others should pay Greece’s debts for it, as part of some sort of moral obligation the rest of the world had to Greece. This was naive. Greeks forgot that other EU nations have electorates too!

If one is spending more than one is earning, “austerity” is inevitable, sooner or later, unless you can achieve a rate of economic growth that is faster than the growth in your state’s obligations. That was always going to be difficult for an ageing society like Greece, with an under funded  pension system, and a  disproportionate amount of early retirement.

The tragedy is that modern election campaigns have become shouting matches, that do not lend themselves to the sort of informed discussion that would have  led voters to see, in time, the fallacy of policies that imply that one can persistently consume more than one is earning, without eventually facing  “austerity”.

There is some ground for hope. A deal can be reached.  Because of the nature of  its support base, Syriza may have more freedom to tackle tax evasion and  cartels in the professions, than the previous government. This could get Greece back on a growth path, so long as  Syriza does not attempt  to reverse  the reforms  the previous government HAD put in place.

RESPONSE TO SUNDAY TIMES

Your correspondent, Justine McCarthy, in your edition of 17 August, gives a classic example of why it is  so difficult to find serious discussion of real choices in the Irish media.   Instead of dealing with the points I made she just wants me “remove the silver spoon and button my lip”.

Because of what she considers to be my personal financial circumstances, apparently I should not express any views at all about current economic choices facing Europe and the rest of the world.
  
I served as an elected representative for 35 years, much of that at a time when the country was poorer than it is today, so I fully understand the difficult circumstances many families face. I also care about this country.

If we want to preserve our welfare state, we must face facts. 

In the long run, the numbers do not stack up, unless we change things.

Arithmetic is not “right wing”. Burying one’s head in the sand is not ”progressive”.

By facing facts now, one can mitigate hardship, and generate confidence. By maintaining the “tactful silence” that your correspondent favours we do no service to anyone.

When I spoke in New York in 2013, I had in my mind the European Commission Report entitled “2012 Ageing Report…Economic and Budgetary projections for EU 27 (2012-2060)”. 

It had been requested by the EU Summit of March 2011.

It covered the sustainability of pension, healthcare, long term care, education and unemployment transfer policies in the 27 EU countries up to 2060, based on current trends and unchanged policies.
It pointed out that the proportion of the population over 65 would rise from 17% to 30% by 2060. Life expectancy would increase from 76 years to 84. But  the working age population in the EU would peak in 2022, and decline thereafter.

In other words, fewer workers would be paying in to support health, long term care, and pension systems for an ever larger number, of increasingly elderly, retirees.

That growing gap could be bridged either by extra taxation, by reduced services, or by extra borrowing. Borrowing would be the best course. But the more one loads up with debt now, the less  one will be able to borrow later on, when this ageing gap will have to be bridged. 

That is why EU leaders focussed on this problem at their 2011 Summit. It is also why Keynesian stimulus is difficult when society is ageing. 

If EU states acknowledge the existence of these looming long term problems in good time, they  can adjust policies gradually. This is the best way to mitigate hardship would certainly come about if the problem is ignored, and then the financial markets suddenly wake up, as they often do, and do not want to lend  . This is partly is behind the need for prudent finance now. 

“Austerity” has become an all purpose term of abuse. Those who use it, should first define it.

I define austerity as spending less than one is earning. At the moment the reverse is still the case.

The government plans to spend more than it will take in next year, to run a (small) deficit. But, under the Fiscal Compact Treaty, negotiated by the Government and approved in a referendum, we are committed to running a surplus from 2018 on, until we halve Government debt as a percentage of our national income. This may well take 10 years, depending on the rate of economic growth.

When I referred to this Treaty based requirement to run surpluses, it seemed to shock some in the media, and even in the Dail, who seemed to be unaware of the contents of the Treaty approved by the Irish people. 

An ageing population, such as we have in most developed countries, means that there is an inbuilt tendency for government spending to rise, even without a policy decision. With no policy change since 2008, by 2013 the number of people of pensionable age increased by 13.5%, and people of that age use more health services. 

The same problem arises in the United States. 

Things have been difficult for many people since 2008. But life will be much harsher in the future, if we refuse to publicly about long term problems like these, because we are afraid, that when we do, we will attract the sort of personalised criticism that your correspondent and others have directed at me.
  
On the question of banks and bankers, if we do not diagnose our problems properly, we will simply repeat the mistakes again.

I do not believe in over simplifying issues, or in exclusively scapegoating individuals, or a class of people, for the economic downturn.  

Irish bankers are indeed to blame for bad lending decisions, and some for worse things than that. But that is not the whole story. 

The foreign banks, who lent recklessly, through the Irish banks, into the Irish property bubble share responsibility too.  They have not been called to account. So too do the bodies supervising all those banks, here and abroad, including the ECB, who failed to devise policies to detect and prevent bubbles.

Central Banks, like the Fed, who increased global money supply unnecessarily to finance the US trade deficit share blame as well. So does the then Irish Government, which increased spending levels permanently, on the strength of revenues from construction  that they knew were temporary.

Only about a third of the increase in our debt since 2008 is due to bailing out banks, and two thirds of it is due to having maintained spending levels, despite the fact that tax revenue had fallen. 

The remarkable thing about the article last week, and others like it, is that the author takes no stand on any issue. She prefers just to sneer, and leave it at that.

For the record, much of the criticism is directed at comments I made for which I was not seeking any particular publicity at all, without a script being issued to the media to get coverage. In New York , I was speaking at a purely private event, and had no notice that my remarks were to be recorded or disseminated. 

But I am happy to take responsibility for what I said.

IRELAND’S BUDGET….KEEPING AUSTERITY IN PROPORTION

Ireland faces another difficult budget in the next week or so.  Irish people have seen the value of their assets fall, and most of them have seen a fall in their incomes through a combination of  wage reductions and tax increases.

But it is important to keep “austerity” in proportion
  • Real GNP is back now to the  level it was at in 2004, but it is still  60% higher than it  was in 1997 (in 2007 it was 90% higher than it  was in  1997)
  • Household net worth (which takes account of borrowings) is back to the  level it was in  2003 
  • Consumer spending in the first quarter of 2012 was  back  to the  level it  was  in 2006, but  is  still 80% higher than it was in 1997 (Admittedly there are more people in the country than there were in 1997, do  consumer spending per person is not 80% up on  1997)
  • Ireland has regained competitiveness. Its real exchange rate vis a  vis the rest of the euro zone has recovered from the worst excesses of the bubble economy and is now back to the  level t was at in  2000, but Ireland is still  a good deal less competitive than it was in 1997.
So, overall, the spending power of Irish people is  still there, but it is differently distributed than it was at the height of the boom, and than it was back in  1997, when  the country had a solidly based economy, that had not been  pumped up artificially by borrowing. Some of the changes that will be made in the budget  will be ones that we would have had to make anyway, evn if our creditors were not demanding them, because of the eventual  ageing of  our society and the extra costs that will bring.

NO CAMPAIGN WANTS TO SADDLE CHILDREN WITH PARENTS DEBTS

Nobody loves austerity.
But if the alternative to austerity is adding to your debt , all you are doing is asking your children to undergo the austerity on your behalf. And asking them to undergo much  greater austerity , because they will have to pay  back interest as well. 
Young people, who are being targeted by the NO campaign should reflect on that.
The No campaigner actually want to saddle Irish  young people with a lifetime of paying off their parents debts, or of  leaving the country to avoid doing so.
That is the logical outcome of the crowd pleasing, truth avoiding, message of the No campaign.  
The Stability Treaty adds little to measures already in force under the authority of Treaties already ratified by the Irish people. 
It simply requires us to do what the Government is doing anyway, putting in place a debt brake  and independent Fiscal Advisory Council  to prevent phoney budgeting by Irish Governments in the future. 
Austerity has come to Europe because  lenders are suddenly wary of lending to Governments.  For everybody’s  sake, we have  got to  make lenders confident in lending to Governments again. 

Ireland’s ratification of the Stability Treaty would be a small ,but important, step in that process.  

FRANCOIS HOLLANDE’S VICTORY- WHAT DOES IT TELL US ABOUT FRANCE ?

The result of the French Presidential election was no great surprise in a way.

In fact, when one considers that  most of his first round competitors had  endorsed Hollande,  outgoing  President Sarkozy did  well to get  48%,  as against the mere  27% he had  got in  the first round.

The  Centrist Bayrou, and the Left Front candidate Melenchon, had both explicitly endorsed Hollande, and  the National Front  candidate  Marine  le Pen, most of  whose  supporters were otherwise trending in Sarkozy’s favour,    said she was  going to  vote for nobody  .

The breakdown of the vote is interesting .

Sarkozy did best in a Northern  block of territory  from Normandy over to  the German  border in Strasbourg, and  Hollande did best in Paris, and in the  rest of France, apart from the  Riviera.

Unlike the US, where women  are more for Obama, and men more for Romney, the two candidates in France got more or less the same level of  support from men as from women.

Those with higher educational qualifications voted more for Sarkozy ( 54%/46%). So also  did those who were financially better off.

Employees were  54/46 in favour of Hollande, whereas  business and self employed were  58/42 for Sarkozy.

AGE GROUPS VOTED DIFFERENTLY

The age distribution of support was most marked.

Those under  24 were  59/41 for Hollande.   
The 25 to 34  and the 50 to 59 age groups were  for Hollande.

But the 35 to 49 age group, and the over 60s, favoured Sarkozy.

SO DID PEOPLE OF VARYING RELIGIOUS VIEWS

The most remarkable cleavage of all was on the index of religious practice.

Practising Catholics were 73/27 for Sarkozy.

Protestants were 61/39 for Sarkozy.

But those who said they had no religion were 66/34 for Hollande.

Muslims supported Hollande by a margin of  93 to 7!   Sarkozy’s anti immigrant  rhetoric and his talk  about strengthening borders may have  won him  support from elderly voters, but it  may make it difficult for his party to win Muslim votes in future elections and they are a very important  voting bloc in France.

HOLLANDE IS ALSO COMMITTED TO AUSTERITY

Some may think that the election of Hollande will mean an end to so called austerity policies in France.  In fact ,he  gave that impression himself during the campaign. Outside France, some people  have seized on Hollande’s campaign rhetoric as a sign that   borrowing does not have to be reduced, and  budgets do not have to be balanced. They are mistaken.

In fact, if those who voted for him read his programme closely they would see that he is committed   to getting the French budget deficit down to  3% of GDP by  2013, and to eliminating it altogether by  2017.  That simply  cannot be done without austerity, at least  in France itself.

Of course a little less austerity  IN GERMANY  might help achieve that goal, if it meant that more Germans bought French goods, or took their holidays in France.  But even that is not guaranteed.

France’s big problem is a poor export performance. Whereas Spanish manufactured  exports are at 108% of the level they were at in  1999, French  exports are now   at only 72% of their  1999 level.  This is not, it seems , because French wages are too high, but rather that French companies have not innovated enough.

Meanwhile the French national debt is at its highest level ever, apart from the peaks it reached after the two world wars.

Hollande is committed to increasing the corporation tax on big companies to 35%, and reducing the tax on small companies to 15%. This would create and incentive to companies to stay small, which may not help the French export effort much.

He is also committed to employing more teachers. This will be difficult to reconcile with his plans to eliminate the budget deficit.

MEANWHILE HE HAS TO FIGHT ANOTHER ELECTION………

The immediate task facing President Hollande is that of winning a majority in the National Assembly. This may mean that he will avoid facing really difficult choices until June, when the Assembly elections are due, and  stay in campaign mode until then.

His difficulty is that the financial markets may not give him the  space in which to do that.  If the markets feel that, in the medium term, the French budget  deficit is going to rise faster than that of Germany, interest rates on French bonds will rise faster than those on German bonds . That could create problems for the euro, something to which President Hollande is committed.   

AND DEAL WITH THE PROBLEM OF GREECE

The Greek election result poses an even more immediate problem.

Greeks favour staying in the euro, but do not favour the conditions on which they  can access funds provided by the taxpayers of  other euro area  countries.

These conditions involve reforming wage agreements, cutting pensions ,improving tax collection, and  cutting the cost of  pharmaceuticals used in the health service. There is also a difficulty that Greece has  not done all the things it  promised, like eliminating supplementary pensions and getting rid of off budget funds.

The trouble is that things are now so bad in Greece, that many Greek voters convinced themselves that they cannot not get worse, and thus  voted for parties that want to reject the conditions on which money is  currently being lent to Greece to  keep its  government functioning.

Unfortunately, things can get much worse in Greece, even than they are now, if taxpayers in other countries decline to provide more funds.   A collapse in the banking system, and a disorderly exit from the euro, would be worse than anything Greece has experienced  so far.

President Hollande, as a new leader, with a democratic mandate, has a capacity to persuade  the Greek people to see sense, to a degree that may not be open to other European leaders, including Chancellor Merkel. President Hollande can  be persuasive in Greece because

France favoured Greek entry to the euro.

France never occupied Greece.

French banks have lent to Greece in the past.

Francois Hollande is a man of the left.

All these  things give him an authority  to speak to the Greek people,  at a critical moment  for them, and for Europe.

GERMANY BASHING IS BESIDE THE POINT……….. IT IS TIME TO FACE THE REAL CHOICES

We read that there is a severe outbreak of anti German feeling in Greece.Under the second EU/IMF bailout, Greece is being lent extra money  at interest rates  far below those at which it could borrow commercially, and in the meantime a portion of its existing debts are being written off. 
But  Germany is being blamed for the  unwillingness of the EU and the IMF  to sign off on this  second bailout , without , what some Greeks see as,  humiliatingly detailed assurances that
  • the money will be used properly ,
  • Greece will adopt specified policies to cut back state spending and raise taxes and that it will
  •  liberalise its economy, so that it can grow fast enough to be able to repay the extra money it is now to be lent.

The trouble is that Greece has a poor record in presenting honest accounts, and in implementing in practice, changes it has agreed to in principle. The extra assurances are being sought so that more good money is not poured down a black hole along with the debts that are now being partially written off.
Without this loan, Greece would default and it would leave the euro.
In fact, what Germany is really doing is defending the interests of savers, including Greek savers, from what would happen, if Greece defaulted and left the euro. If Greece left the euro, its banks would collapse, and Greeks would see their savings, whether   in the form of bank deposit accounts, life assurance policies, or claims on pension funds, disappear.

THE CHOICE FOR GREECE IS BETWEEN PLANNED AUSTERITY, AND SUDDEN INDISCRIMINATE, AUSTERITY

 
Some argue that “austerity” is a mistake, because the cuts in spending and tax increases dampen confidence so much that the economy stops growing. In the short term, this is true.  But those who criticise on that basis,  have no realistic alternatives to offer.
Where can Greece get the money on better terms than it is getting from the EU/IMF?  
 Nowhere.
There really is no Keynesian alternative for Greece.   The Greek economy is too elderly, too inward looking and too riddled with restrictive practices, to benefit from a Keynesian stimulus, even if someone could be found to finance it. Greece must modernise first. The EU/IMF programme gives it some breathing space (perhaps too little) in which to do that.
Keynesian economics might have been relevant in the  1930s, when the European  population was much younger and could respond to an economic stimulus.  Europeans today are much older, many are retired, and their priority is saving for their old age, rather than going out shopping in response to a boost in government spending. It is not going to get easier. The age dependency ratio in the EU in 2007 was  25%, by 2050 it will be 50% !   What people are looking for now, is stability.

 Greece faces an alternative of two forms of austerity
  • austerity through  planned  cuts and tax increases under the EU/IMF programme or
  • austerity through indiscriminate inflation, of the kind that would  occur, if Greece  left the euro and devalued.
One of Greece’s problems is that it finds it very difficult to reduce wages, which is one of the many things it needs to do if it is to make its exports more competitive. Wage setting is highly regulated in Greece. That is why some favour Greece leaving the euro and allowing devaluation and inflation to cut the real value of Greek wages, and thus  regain competitiveness.  Inflation is the politically easy way to impose wage cuts, but the effect on living standards is at least as bad as cutting the wage rate, and much harder to control.
 But the price of this inflation/devaluation option would be high.  If Greece left the euro, its banks would collapse and the savings of ordinary Greeks, who were patriotic enough to leave their money in Greek banks, would disappear.  Inflation is hard to keep in check once it starts, and Greece also lacks big export industries ready to boost exports quickly on the back of a devaluation.

THE REAL POLITICAL DIVIDE………SAVERS VERSUS BORROWERS
 
It is true that current EU policies are favouring savers over borrowers.    This is so because the ECB, unlike the US Federal Reserve and the Bank of England, is not willing to engage in “quantitative easing” ,printing money indiscriminately, to revive the economy temporarily.
ECB refuses to print euros without limit, and refuses to use them to buy Greek bonds without conditions. It refuses to do so because that would lead to inflation, and to a devaluation of euro. The more euros that are printed the less the euro will be worth.  That, of course, might suit borrowers, because the euros they would using to pay back their debts at the end of their loan, would then be worth less,  than the euros they borrowed in the first place.
 
But that approach would be bad for savers, who would see the purchasing power of their savings disappear.
 
The real political divide in our societies today, is not between Greeks and Germans, or between the profligate Mediterranean nations and the thrifty northerners.
It is between savers, who do not want their savings devalued or confiscated, and borrowers, who would like to be allowed to pay back less than they owe.

“ORDINARY PEOPLE”, SOMETIMES THE SAME PEOPLE, ARE ON BOTH SIDES OF THIS DIVIDE

But if borrowers pay back less than they owe, someone somewhere else has to take the hit.
If  borrowers are helped by having  their debts being  written off, or having  their debts  are  devalued by inflation, someone else will lose.
Who would lose? 

  1. The losers would include taxpayers, who now own  many of the banks, and who would  see the value of those banks go down
  2. Other losers would be pension funds and insurance companies who own bank shares, and the people who rely on these pension funds and insurance companies to pay their pensions, or insure them against risk.
  3. Yet other losers would be   the people who have deposits in banks, who would see the value of those deposits reduced by inflation, and who could even lose those deposits if the bank collapsed. 
The challenge we face is that of devising an economic policy that acknowledges that there are ”ordinary” decent  people on both sides of this divide.
We also need to acknowledge that no one will be willing to lend any European Governments money any more unless they face up to realities about the cost of ageing societies that will  grow steadily everywhere over the next twenty years.
Greeks bashing Germans, or all of us bashing bankers, may give emotional satisfaction, but it will not pay our bills.
 
We need to think things through , rather than emote. We  need to strike a balance between debt relief, and protecting the savings we need to prepare ourselves for  a time when, instead of four,  there   will only two people at work,   for every one  that is  one too old to work

THE EURO AREA FISCAL COMPACT

A new fiscal compact was announced on 9 December  by the  Euro area  Heads of Government,  as a means of protecting the stability and integrity of the  Economic and Monetary Union,  and of the  European Union as a whole.
This is a vitally important goal, especially for Ireland which has gained more than almost anybody else in terms of market access, funds, and influence since it joined the European Union in  1973.
It is most important for Ireland that this fiscal compact be credible with the markets, and also  understandable  by the electorates of all 27  EU member states.
AUSTERITY WAS COMING ANYWAY, BECAUSE OF THE AGEING OF EUROPEAN SOCIETIES.
A fiscal crisis in Europe was always on the cards around now, even if there was no single currency, because of the ageing of the European population.
 Repeatedly, the European Commission has produced reports that said that, with unchanged policies, the debt to GDP ratios of many European states were going to reach  500% by  2050,  simply by virtue of the increased size of the likely  retired elderly population relative to the  working age population.
 During the boom, these reports were ignored by bankers, bank regulators, bond market participants, Finance Ministers, and political parties.
 But if you want to understand the rationale for   German attitudes today, you have only to look at the prospective ageing of its population.
 Germans are worried that the savings they have put aside for their retirement will be devalued by inflation generated by excessive monetary easing by the European Central Bank, or by fiscal irresponsibility by other European states that are unwilling to balance their current budgets.
Critics of Germany do have a point when they say that, in the short term,  Germany is asking a lot of some other  euro area countries(like Italy and Greece) when it demands that they must  suddenly become more competitive, increase their exports, and thereby earn the money to pay off their debts when, at the same time, their major market (Germany) is retrenching and reducing its demand for imports. 
But the motivation for the German caution is the ageing of their own population, as much as it is fear of a repeat of the hyper inflation of the 1920’s. And Greece and Italy also face the ageing of their population too, so they would have had to retrench anyway, whether Germany insisted on it or not.
It is also important to keep a sense of proportion about “austerity”.
 Admittedly expectations and prices have risen in the meantime,  but austerity in 2012,  is not quite the same as austerity was in the  1930’s , or even the 1980s, because  almost all European  countries are starting from a much higher income level that applied in the  1930’s or  in the 1980’s.
IT IS IMPORTANT TO RESPECT BASIC ARITHMETIC
 It is also important to respect basic arithmetic.
 For example, Ireland could not expect to have a welfare state as generous as that of Sweden, at tax levels similar to those of the United States.
 As the late Garret FitzGerald pointed out on many occasions, and it did not add much to his popularity, Ireland is not, overall, a heavily taxed country.   Pay, benefit , and pension levels paid from public funds are also  higher than  those in many  other EU countries for  comparable situations.
 A choice about the distribution of benefits and burdens has to be made, and these are the most difficult questions of all. They are the ones politicians, who are usually trying to build the widest possible coalitions, prefer to avoid if they can.
During the boom these questions were  easily avoided by borrowing, and by funding permanent expenses with temporary revenues.  That is now over.
 Even if the EU had no fiscal rule, the markets have now woken from their long slumber, and are demanding that those, to whom they lend , show how they will balance their books,  and repay what they owe when it is due.
 In that sense, the new EU fiscal compact is almost superfluous, in that  markets will be imposing discipline anyway, euro or nor euro, pact or no pact, Britain in or Britain out.
The choice is between slow, negotiated, and slightly less destructive austerity, imposed by the EU compact, or fast,  and much more destructive,  austerity imposed by the markets.
Therefore, I argue that it is best for Ireland that there be strong and credible EU rules. It is important, however, that these rules be as operational as possible, as credible as possible and as understandable as possible.
In that spirit, I raise one or two questions about the detail of the  proposed compact.
HOW, AND BY WHOM, WILL THE NEW STRUCTURAL DEFICIT RULE BE INTERPRETED?
In paragraph 4 of the EU leaders statement, they say that the annual structural deficit shall not exceed 0.5% of GDP and that that this rule shall be introduced into member states legal systems at “constitutional or equivalent level”. 
This is separate from the Excessive Deficit Procedure, under Article 126 of the existing EU Treaties, which provides for fines if deficits exceed 3%, and which is being strengthened under proposals that come into force this week. It is also separate from other changes, which require no Treaty or constitutional change,  which will  penalise countries for excessive debts as well as  excessive deficits, and which will require  countries to reduce debts progressively by a fixed amount each year
 This 0.5% provision    is something new and different,  not published before, which is   to be introduced into the domestic constitutional arrangements  of all member states.
 The concept of a structural deficit (of 0.5% of GDP) is different from the 3% limit in the Stability and Growth Pact.
If  this part of the pact is to be understandable, workable, and enforceable, one must ask the key  question.
 How easy will  it be to define  the structural deficit at any given time?
If something is to go into a constitution, its meaning must be both clear, and constant.
To see the sort of difficulties that might arise, one should look at  a recent  OECD study on Ireland(OECD working paper number 909, by David Haugh published 2 December 2011).  It said
“Rules specified in terms of cyclically-adjusted balances or equivalently balances measured “over the
cycle” are difficult to operationalise and monitor because they depend on forecasting the size of spare
capacity in the economy, which cannot be observed and is particularly difficult to estimate for a small open economy such as Ireland’s.
The Swedish Fiscal Policy Council found it difficult to assess compliance with the government’s target of a 1% surplus over the cycle (Calmfors, 2010).
 Disputes over when the cycle started and finished were among the most contentious aspects of  rule that operated in the United Kingdom until the end of 2008 (OECD, 2009).
Reliance on such measures may also induce policy mistakes. With the benefit of hindsight, initial cyclically-adjusted fiscal balance measures appear to have given an overly optimistic view of the Irish fiscal position prior to the crisis, which may have contributed to a sharp rise in expenditure in 2007 before the crisis hit”
If economists in the OECD have difficulty with this concept of a structural deficit , as indicated in this  quotation, one must wonder what the judges of  the Irish  Supreme Court will make of it.
 My understanding is that economists often radically revise their opinion, afterwards, about what the structural deficit really was in a previous year. That would  make life very difficult for the Supreme Court!
While the European Court will verify the transposition of the new 0.5% rule at national level, it will be the Irish and other national Supreme Courts that will have the job of interpreting it. If something like this is written into the Constitution, the ultimate decision on whether a  budget for any  given year is compliant with the constitution will have to made by   the judges  of the Supreme Court.  This certainly will bring judges into areas of judgement which are not, to put it mildly, their primary expertise.
There is also the question of what sanctions the Supreme Court could impose, if a structural budget  deficit exceeds 0.5% of GDP .
As far as I know, some countries, like France,  have relatively soft sanctions for breaching the constitution,  while other  countries, like Ireland, immediately strike down as null and  void, something that is unconstitutional.  It may seem fanciful at this stage, but one also has to ask what would happen if Britain, which has no written constitution at all were to join the Euro at some future  time?
When is this new arrangement to come into force?
If the provision is intended to influence the markets, the date cannot be pushed too far into the future. The Commission is to propose a calendar for this. Will it be the same calendar for all members, or will countries with the biggest structural deficits get more time?
According to NCB, even if we follow all of the plan, Ireland’s structural  deficit will still be at  3.7% in 2015, which is well above the 0.5% to be written into our constitution.
 According to Deutsche Bank, the structural deficit of the Euro area as a whole stood at 3.2% in 2011, so the rest of Europe has a long way to go too.
I believe this particular proposal needs to be teased out , rigorously and in great detail, and I have no doubt the Irish Government will  be doing  that in the next few months.
A LIFESTYLE CHANGE MAY NOT BE ENOUGH, THE PATIENT MAY ALSO NEED EMERGENCY TREATMENT!
As I said earlier, the ageing of our populations requires us to follow the path laid out in the fiscal compact.
 Keynes General Theory was formulated for a society with a very different demography than the one  Europe has today.  That is why we have no choice, euro or no euro, but face up to the fiscal challenge posed by the statement of the EU  Heads of Government of the   9 December.
But, as I have  said,  we need to get the details right.
 In the meantime, the ECB must act as a normal Central Bank and provide liquidity for the markets.  The risk now is of destructive deflation, not of inflation. Germans may want to protect their savings, but they also need incomes, and their incomes will disappear if the European economy collapses. 
I hope Chancellor Merkel understands that, and does not stand in the way of emergency treatment of the economy by the ECB.
Lifestyle changes are important and necessary, but the patient needs to be alive, if he or she  is to change  lifestyle! 
It is also important that, now that the concept of the economic cycle is to be introduced into our constitutions, we do not pursue unnecessarily procyclical policies. Some have argued, convincingly, that the Basel Thee rules, as applied to banks, are unnecessarily procyclical.  They are dealing with   yesterdays problem, excessive exuberance, which the markets are punishing sufficiently anyway.
The Summit did not address the banking problem at all, and this is a pity. The difficulties of banks are at the heart of the problem. Society needs banks, and some banks are well worth saving, because banks are the repositories of our savings, and the engines of our economy
 But Martin Wolf was right when he wrote in the “Financial Times” last March “The German Government should tell their people that they are rescuing their own savings under the guise of rescuing peripheral countries”.
 I do not have the sense that that has happened yet, and that is why the 9 December Summit is not the final word on the crisis.
Remarks by John Bruton, former Taoiseach, at an event of the Dublin Chamber of Commerce, in DIT Cathal Brugha Street , embargoed for 8am  14 December  2011.

 

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