As the European Commission said last Thursday we need to break the vicious triangle between doubts over
- The sustainability of debt of some countries
- The stability of the banking system and
- Growth prospects of developed countries
Unless we find a reasonably convincing way of resolving these doubts, and of breaking the vicious triangle, whereby each doubt aggravates the other, we are in real difficulty.
GETTING GOVERNMENT BORROWING UNDER CONTROL
The sustainability of Government debt depends on vigorous action to cut spending, and increase revenue. But this will take time. In the short run, the debts of some countries , including Ireland, will actually increase as a proportion of national income. This is because the gap that has opened up suddenly , between revenue and spending , cannot be closed overnight. This is Ireland’s case.
Essentially, the official agencies need to be able to deploy such a huge volume of financial fire power that it will scare off speculators who might be tempted to short Government bonds of some countries, in the hope of making a quick profit.
A credible plan to reduce debt levels in the public and private sectors in most EU countries is crucial. We should not think that “Austerity” is an optional policy choice. It is an arithmetic necessity.
THE POLICIES OF THE ANTI AUSTERITY PROTESTERS WOULD BRING US BACK TO THE LIVING STANDARDS OF THE 1930s…ALMOST OVERNIGHT
The current protests about “austerity” do not put forward any credible policy alternative, that would not involve a far more dramatic, and more sudden, fall in living standards than anything current policies would entail.
A refusal to service existing debts, while maintaining current spending levels, would lead to an immediate drying up of Government funds. Cheques would bounce, and people would try to get their money out of the country. A return to the living standards, and autarkic economic policies, of the 1930s would quickly ensue. That is where the protesters ideas would lead us very quickly indeed.
EU MEASURES ARE FAR REACHING…..AND WITHOUT TRATY CHANGE
I believe the so called “six pack “ measures, recently agreed in the European Parliament, will be a lot more intrusive than most people think. They could mean, for example, that countries that fail to take action on unsustainable economic practices will be liable to EU fines. This plan will apply to much more than excessive Government borrowing. It could cover wage setting policies and unsustainable energy policies. If these measures can be implemented under the existing Treaties, I doubt if we will need any further Treaty change.
BUT ‘’TOO BIG TO FAIL’’ BANK PROBLEM IS BEING IGNORED
Restoring the credibility of the banking system will require more honesty than we have had up to now. Some countries, including Germany, have been unwilling to have their bank’s situation independently examined. The stress tests have been based on heroic assumptions, notably in respect of the repayability, in full, of all Greek debt.
None of the proposals currently being considered address what I consider to be the basic banking problem.
In the present artificial setup, some banks are too big too big, and too interconnected with other banks, to be allowed to fail.
I believe that it is now only possible to tackle the “too big to fail “problem at EU level, because too many banks have already grown far too big for their home counties .
But a bank that is too big to fail at national level would not necessarily be too big to fail at EU level. We need a real EU Single market for banking if we are to get control of the “too big to fail” problem.
- An EU wide deposit guarantee scheme,
- An EU wide system of banking supervision, and
- An EU limit on the size of banks and on bank remuneration systems.
GIVING ECONOMIES MORE GROWTH POTENTIAL IS A SLOW BUSINESS
Getting growth prospects to improve is actually the most difficult of the three things we must do. This is because the things that Governments can do takes the longest times to deliver results. But it is very important. For example, the structure of the Italian economy is so creaky that it starts to have price inflation if it grows by more than 1%. Greece and Portugal have similar constraints.
The measures needed to put this right will deliver big returns in the long run, but are difficult politically, and sometimes slow to deliver results in the short run ie. before the next election.
Let me illustrate my point by referring to some the things the OECD recommended the Irish Government do to lift Ireland’s growth potential. The OECD said there should be
- A Further decline in labour costs. This may be possible to negotiate in the private sector, but difficult in the public sector because of the Croke Park deal. But the German example shows that reducing comparative labour costs does lead to big competitiveness gains over time. Germany is now getting the benefit of labour cost reductions it accepted ten years ago.
- Imposing Civil fines for breaches in competition law. This is essential ,but will take time to deliver results.
- Cutting legal and medical fees charged by the professions. Again very important, but will take time. It involves taking on groups that are very good at getting media attention. The resistance to hospital service reorganisation shows how medical interests can manipulate public opinion, even though they are intelligent people and know the country is in receivership.
- Reducing Long term unemployment benefit rates, the longer a person remains unemployed, and addressing disincentives to taking up work, caused by rent supplements. The present rates of payment are apparently such that Ireland has the highest “replacement rate” (80%) in the OECD. The replacement rate is a formula that compares the level of social welfare income, to wage income. The average OECD replacement rate is 60%
- Improving reading and maths standards in Irish schools, which have dramatically disimproved by comparison with other OECD countries, since 2000.
The OECD recommends much closer inspection of teaching standards, which will be difficult to do without recruiting a lot more schools inspectors. This is hard to do when there is an embargo on recruitment under the EU/IMF programme.
TO GET LOWER INTEREST RATES TODAY, A COUNTRY MUST SHOW HOW IT WILL GROW FASTER TOMORROW
All these ideas make a lot of sense. Similar, and more far reaching ideas, have been put forward for other EU countries.
That is how all the three things, Government debt, banks and growth prospect are linked to one another. The vicious triangle must be turned into a benign triangle