John Bruton

Opinions & Ideas

Category: competitiveness

CAN GERMANY BAIL OUT ALL OF EUROPE?

There is a tendency, whenever a euro zone country gets in to difficulty, and needs help from its neighbours, to blame Germany for the severity of the terms imposed, and to say there is bullying involved.

In both Greece and Cyprus, we hear references to the Second World War, as if offering Greece a low interest loan to keep its state functioning , was equivalent to a military invasion, of the kind Greece experienced in 1941.
There is also talk of  the “solidarity” that Germans ”owe” the rest of the rest of the euro zone, even though  any money Germany might pay has to be raised from German citizens, under the German tax system. This is the way it has to be done, only because there is no common euro zone tax system, applicable to all euro zone citizens, from which the money might otherwise come. Indeed those who call most loudly for “solidarity” would probably be the first to object, if a common euro zone tax system, equally applicable to all euro zone citizens, was proposed.
Others criticise Germany for insisting  on “austerity” in spending by countries that are spending more than they are earning, as if there was some alternative to spending less in those circumstances. The fact is that some countries, including Ireland, are still spending more than they collect in taxation, even after one has left out of account the interest paid on past debts. Such countries have what is called a “primary deficit”.

Ireland had a huge primary deficit in 2010, has a small one today, and hopefully will have a tiny primary surplus next year. 

But if it is  to reduce its debts, and  thus not be vulnerable to disaster, if there was to be a sudden increase in international interest rates, of the kind that occurred in 1979/80, Ireland will have to have a primary surplus for many years to come.

That is the only way to reduce the debts it ran up through the primary deficits it ran in the recent past. This is not something “imposed by the Germans”, it is imposed by the rules of mathematics, and by compound interest in particular.
Of course there is one alternative-inflation-  the alternative of inflating debts away. Inflation devalues everything. It reduces the value of money, and in so doing, it also reduces the value of debts…….and, of course, of savings.

If inflation is greater than the rate of interest, debts will reduce. But the value of pension funds, of bank deposits and of life assurance policies would also reduce. Inflation would mean falling living standards all around, because, if a country is to stay competitive, wages would have to increase at a slower rate than prices. Those on fixed incomes would see their living standards decline even more, because they could buy much less each year with their fixed income.

Inflation is very hard to keep under control, once it starts to take hold. Germany tried to inflate away its First World War debts in the 1920s, and the experience was a complete disaster. Understandably, it does not see inflation as a solution to Europe’s debt problems today, and nor should we. 
Some argue that Germans themselves should spend more and save less, and say this would help other countries in Europe. This is already happening to some extent . German imports were 10% higher in 2011, than they were before the recession, whereas almost every other European country is importing less now that it was then.   It is fair to say that Germany’s balance of payments surplus, at 6% of GDP, is very high indeed, too high, and that this surplus is not being used all that wisely. Germany could do more to free up its own internal market, and the OECD has been critical of it on that score, but that offers a long term, rather than a short term, solution for the rest of Europe.
It is also important to deal with the myth than Germany is a terribly wealthy country, that it can afford to bail everyone else out.

Germany’s present competitiveness is of recent origin. A dozen years ago it was the “sick man” of the European economy, struggling with the unexpectedly high costs of absorbing East Germany. 
Germany got a big bonus from the opening up of China, which imports a lot of German engineering goods, while other European countries( eg.Italy) have lost for the  same reason, because Chinese consumer goods are undercutting them in their specialist markets.
Germany is an elderly country, with far more people approaching retirement age than are preparing to enter the work force. 
Probably for this reason, its medium term growth potential, and thus its medium term debt repayment potential, is low, by comparison with other countries in Europe. 
The OECD did an estimate of real growth potential for different countries from 2016 to 2025. Its estimate for Germany was  only 1.2% pa over the ten year period, for Netherlands 1.4%, for Italy 1.5%, for Portugal 2.1%, for Spain 2.3%, and for Ireland  it  was projected to be 2.7% a year!
German families are apprehensive about the future, and if those OECD figures are to be believed, it is hard to blame them.
German families do not FEEL wealthy.

Only 44% of Germans own their own home, as against 58% of French people, 69% of Italians, and 83% of Spaniards. According to a recent Bundesbank study, the average household wealth in Germany is  195,000 euros, as against 229,000 euros in France, and  285,000 in Spain.

This is the reality with which German politicians have to cope.

It does not mean that they are always right, but it does mean that they have to be cautious. It also means that Germany alone cannot solve Europe’s  financial problems.

THE FRENCH PRESIDENTIAL ELECTION

I was in France this week,  and had a chance to have a closer look at the  French Presidential Election Campaign.
It is a two round election, with only the top two in the first round, contesting the second  round three weeks later.
At the moment,it is likely the two in the  second  round will be François Hollande, the Socialist(now on 27.5%) and Nicolas Sarkozy (now on 29.5%).
The third and fourth candidates, Jean Louis Melanchon of the  Left Front, and  Marine  le Pen of the National Front are both on 14%, so neither of them is likely to overtake the front runners. Francois Bayrou, the Centrist candidate, is on only 10%.
When voters are asked who they would vote for in a straight fight between Holland and Sarkozy,  they plump for Hollande  by a margin of 8 points.
This is because Hollande  picks up a bigger share of the eliminated candidates’ votes.  For example, Hollande has a margin of 81/3 among Melanchon’s voters, and 40/32 among Bayrou’s.   Sarkozy beats Hollande by 49 to 16 among  Le Pen’s electorate.
Sarkozy’s best chance to win is if he can convert Bayrou’s voters to his  cause, possibly by offering the Prime Ministership to Bayrou, while still holding on to the National Front electorate. This would not be an easy task, because there is little or nothing in common between Bayrou’s electorate and that of the National Front
Some of the campaign debate is about taxing the rich. This is in response to the fact that incomes at the top in France have risen faster than incomes in the middle and lower range.
Clamping down on Islamic militants, and employing more teachers, are other recurring themes.
The fact that France has an excessive budget deficit, has lost competitiveness vis a vis Germany, and as a result has a big trade deficit, is not getting attention from the big parties.

FRANCE’S LOSS OF COMPETITIVENESS

Hourly labour costs in France are now 10% higher than in Germany , whereas ,in  2000, they were 8% lower.
The State in France spends 56% of GDP. Deductions from wages to pay for health and pensions (the retirement age is only 62)  are extremely high and deter job creation. Yet French politicians blame things like the Irish 121/2% tax rate for their problems in attracting investment, rather than the cost of employing people in France itself.
If Hollande wins, he could find himself dependent on Deputies from the party of the Left Front, who favour a complete ban on redundancies, and a 100% tax rate on incomes above 350,000 euros. Hollande himself already favours a top 75% tax rate, and an increase in the wealth tax.
France has a revolutionary tradition and a passionate belief that political action can change things. The difficulty is that globalisation, European integration, and accumulating Government debts,  have reduced political options more than French politicians are willing to  admit.

FREE MOVEMENT OF CAPITAL IGNORED IN THE DEBATE


The policies of the French Left would be very difficult to implement, because as long as France continues to allow free movement of capital, people who feel they are being overtaxed can simply leave the country, and take their money, and their factories with them. 
Free movement of people, and of capital, are requirements of EU and euro membership, and have allowed France to develop world class companies, like Pernod Ricard ,which owns Irish Distillers.
France  is prepared to take the benefits from globalisation, but has not accepted that these benefits come with limitations on what is politically feasible.  
 I believe that the unreality of the debate in France about its public finances, and about its true economic options, could become a threat to the future of the euro.

SHORT TERM EUROPEAN DEBT RELIEF WILL LACK CREDIBILITY, UNLESS IT IS ACCOMPANIED BY A LONG TERM PLAN TO REGAIN COMPETITIVENESS.

(updated version) The euro is playing the starring role this week in a global loss of confidence in bonds issued by Governments, although the average Government deficit and debt situation of euro area countries is actually is no worse than that in the United States, the United Kingdom, and Japan. The euro area is the target because it is easier for speculators to pick off euro area countries one by one. But this is not the root problem. Even if the euro was somehow broken up, the underlying problem of the credibility of sovereign debt would still be there.
 The real problem of almost all developed countries, except Germany, is that we have used Government and/or private borrowing, to smother the symptoms of a deeper loss of earning capacity.
The sovereign debt crisis is a symptom. The disease is a profound loss of competitiveness.
Since about 2000, the developed world, except Germany, has lost ground in the competition to produce goods and services at prices the rest of the world is willing to pay.   China, India, Brazil and others are now competing for markets that the developed world previously monopolised. They are doing this with technologies developed in the West, but at costs much less than those applying in the West.
This loss of markets over the last ten years should have meant a relative fall in relative living standards over the same period. But almost all developed countries avoided this, and kept their standards up by borrowing more, either directly as households, or indirectly through their Governments.  In Ireland during the boom the number employed in the traded sector actually fell, while the number employed in services ballooned. This was all too easy because the countries, like China, who were winning markets, lent their profits back to us at cheap interest rates.
In essence, the cause of today’s debt problems  is that developed countries awarded themselves a living standard they had not earned. That could not go on forever. Now we must tackle the disease as well as its symptoms.
Any short term fix for the euro area finances must be accompanied by a long term plan to rebuild up our capacity to produce goods and services that the rest of the world will want to buy on a greater scale than they are doing today.
 Europe must abandon its culture of entitlement.
For example, there must be reform of educational systems.  Third level education in Europe must be changed from being an undemanding and free rite of passage for young people , into an innovative and flexible system to help people of all ages, who have lost their jobs,  to readapt themselves for a world which has changed utterly.
Getting our costs down will also require an end to restrictive practices, and padded  costs,  in the Government sector, in schools, in the labour market, and in the professions.  However indirectly, all these reduce Europe’s ability to reduce its export prices enough to win back markets abroad. This is particularly necessary in countries like Italy and Greece, but also in Ireland.
It will all mean postponing increases in living standards, paying more tax, and getting less benefits from the Government. Germany did this in the 1990s when it dealt with the huge cost of reunification. Since 1990, living standards in Germany increased by only 20%, whereas they increased by over 100% in Ireland.  Germany kept its costs down, shared the burden of adjustment by short time working rather than unemployment, and focussed on exports.
Some will argue that what worked for Germany will not work for Europe as a whole. They will say that if the rest of Europe adopts  an austerity and export model, there will be no market for the exports because of the austerity. Their preference would be for Germany to start inflating its economy, so as to buy the exports of the rest of Europe.
 That will not work for a number of reasons. If Germany did inflate its demand, the imports would come from the rest of the world, not from the rest of Europe (unless, of course,  the rest of Europe becomes competitive). Furthermore, Germany has an ageing population and needs to save now to support its future retirees.
This is also a problem with proposals for the issue of Eurobonds to meet the funding needs of euro area countries, like Ireland, who are too weak to borrow commercially on their  own account. Until the rest of Europe becomes competitive, these bonds will essentially be issued against the credit of Germany.  Given its ageing problem, even German credit has limits.
The ECB can give out more credit as a way of getting through our present short term difficulties. That is what it is doing by buying bonds of countries like Ireland, Italy and Spain. It could also extend a credit line to the European Stability Fund to allow it to buy bonds too.  To the extent that such activity increases money supply faster than present or future economic activity justifies, it builds up future inflation.  
 And who does inflation hit hardest? Elderly people with fixed incomes, and those with savings.
 And what European country has the biggest number of people who will soon be in that category? Germany.
 Germany increased the money supply to pay for the cost of the First World War, and that led to the inflation of the 1920’s, which wiped out the German middle class. That is part of German folk memory and explains why Germany insisted that the ECBs mandate be concerned solely with keeping inflation in check.
What is needed now for Europe, as a whole, is a convincing overall plan, a plan that links short term relief for those with financial difficulties, with long term plans to permanently lift productive capacity.  Only in that way can Germany be convinced that  short term relief now will not lead to more inflation later.
It is not reasonable to expect Chancellor Merkel to produce such a plan on her own.  Every euro area Government must contribute. We have all got to start thinking as Europeans, and devise a plan that is based on realism and modesty in what we ask of our neighbours, and strict honesty in  what we  ask of ourselves.  None of us can solve our problems on the back of someone else’s sacrifice.

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