Structural Reform and Economic Sustenance in European Austerity

Speaking at the World Economic Forum in Davos, Switzerland on January 25, 2013, Mario Draghi, president of the European Central Bank(ECB), said the bank’s program to buy the bonds of heavily indebted E.U. states had been “very helpful” in reducing the perception that the euro was on the verge of collapse. He also pointed to the structural reforms that heavily indebted states had enacted as “now bearing fruit.”[1] He urged those governments to continue to implement structural reforms so those states could take advantage of the ECB’s low interest rates and easy credit to banks. In short, the strategy of the ECB was to use monetary policy as leverage for long-term-oriented structural reforms at the state level. Political risk analysts listening to the central bank official likely came away with a more optimistic stance on the long term prospects for the E.U. economy.

Even though the progress achieved already on the debt crisis provided “light at the end of the tunnel,” the matter of structural reforms at the state level was subject to politics and was thus more uncertain. Also, economic conditions could worsen, hence making it politically and economically more difficult to make the needed structural changes. Chancellor Angela Merkel of the state of Germany warned the governors of heavily-indebted states such as Greece and Spain against the impulse to reduce the pace of structural reform in the face of economic stagnation. She pointed to the record unemployment numbers announced in Spain on January 24, 2013 as fodder for the anti-austerity political forces there. She further observed that “experience tells us that often pressure is required to enable structural reform.” The obstacles could have come from political officials or bureaucrats at the state level, and even from the people, upset at the economic austerity cut-backs hitting themselves and even the poor who depend on funding for sustenance. Advocates for those people were doubtlessly contesting that survival in the short run should not be sacrificed for long-term structural reform. 
Interestingly, making a qualitative (i.e., difference in kind) distinction between government programs that keep people alive on a daily basis and all the other budget items could actually permit more budget cutting because so much would be found to be subject to cuts without risking lives. In the U.S. at least, the qualitative difference has typically been made between domestic and military spending. This dichotomy has enabled huge increases to military programs even as cuts to food assistance have been proposed. Of course, the unemployment caused by a cancelled defense contract could put people in danger of losing their house or going without food. However, such individuals would be covered by the continuance of the programs providing sustenance as long as they were held apart from the other spending categories. Having an indirect effect on sustenance, such as military contracts can, does not render a particular budget item itself in the category of vital programs for sustenance, such as building more halfway houses for the mentally ill who are homeless.  This reflects the American culture more, wherein much more is deemed conditional than in Europe, where the principle of solidarity has been and is still more salient politically.
In short, long-term fiscal reform need not be at the expense of people eating and having shelter as well as medical care. Based on the firm foundation of human rights, programs primarily geared to sustenance can be isolated and protected such that the structural reform can be implemented more smoothly. Buffering sustenance programs from the massive cuts everywhere else would significantly reduce the vehemence of the protests and soothe the path of structural reform by isolating the entrenched officials and bureaucrats as the only primary obstructionists. 

See also Essays on the E.U. Political Economy, available at Amazon.  

1. “Davos: ECB’s Draghi Says ‘Real’ Economy Still Stagnant,” Deutsche Welle, January 25, 2013.

When 4.3% Is below Full Employment

CNN reported that the U.S. economy added “a strong 209,000 jobs” in July of 2017, with the unemployment rate falling to 4.3% to match a 16-year low. Unemployment had peaked at 10% in 2010, after the financial crisis of 2008. CNN cited many economists as saying that the 4.3% rate was “at or near” full employment, meaning that the rate would not go down to a significant degree.[1] Yet even within CNN’s own reporting, we can find reason to doubt this claim.

The first indication is the mention of wage growth being sluggish. “Wages grew only 2.5% in July compared with a year earlier.”[2] Chris Gaffney, president of Everbank World Markets, noted at the time that questions remained about when a spike in wages would be seen. Were full employment at hand, shortages in the supply of labor would have been pushing the wages up appreciably.

The explanation lies in CNN’s reporting of a statement by Steve Rick, chief economist at CUNA Mutual, an insurance company. “There’s still lots of people coming back into the labor market, looking for jobs.”[3] With a significant number of people deciding to resume looking for jobs, the official unemployment rate of 4.3% understated the actual unemployment numbers, which includes people no longer filing for unemployment compensation or even simply applying for jobs. In other words, the actual unemployment rate was significantly higher, so even if 4.3% would have corresponded to full employment, the U.S. was not at full employment. Hence, wages were not spiking.

A problem with CNN erroneously reporting full employment involves the resultant impression by the American people and the elected representatives that nothing further in terms of public policy was needed to get the structurally unemployed back to work. Put another way, relying on the official unemployment rate risks settling for economies that have written off the long-term unemployed.

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[1] Patrick Gillespie, “Milestone for Trump: 1 Million New Jobs in Six Months,” CNN, August 4, 2017.

[2] Ibid.

[3] Ibid.

Should the ECB Buy State Bonds and Encourage State Deficits?

In remarks at Jackson Hole, Wyoming, European Central Bank president Mario Draghi urged greater fiscal and monetary coordination to boost the E.U.’s economy. A ship cannot move along at full speed if all the sails are not coordinated so that each is poised at its optimal angle to the prevailing winds. So too, various policies in a political economy must all sail in the same direction for a full-sail recovery to really take off. Just as a sailing ship must avoid jagged pitfalls lurking in rocky waters, so too must policy makers; for it is all too easy in focusing on one point on the horizon to ignore or dismiss baleful downsides to the dominant policies.

At the foot of the Teton Mountains, there being no foothills, Draghi “called for explicit policy co-ordination between the [Eurozone’s] monetary guardian and [the states].”[1] Brandishing considerably less concern on inflation, he linked the ECB’s future purchases of state bonds (i.e., quantitative easing, or QE) to structural reforms, tax cuts, and more spending at the state level. 

At the time, E.U. law limited state budget deficits to 3% of gross domestic product. Pointing to the existing flexibility in that law, the central banker urged the state governors to “better address the weak recovery and to make room for the cost of needed structural reforms.”[2] I submit that the accent should be placed on the latter, as they would have more staying power. It is like the difference between consuming sugar (even in fruit) before running, and drinking a protein shake after lifting weights; both food elements are helpful, but only the protein becomes a part the body and can thus strengthen it for the future.

Quantitative easing can unfortunately impact an economy in both foreseen and unforeseen ways due to the intended artificially-low interest rates. The market-mechanism cannot but be distorted, with harsh byproducts free to silently ravage certain segments while others benefit without merit. The human brain is not so omniscient as to be able to fully anticipate and plug all the leaks that can arise from a systemic distortion in a macro-economy. That is to say, the system is so complex that a huge distortion using one macro policy tool can introduce significant systemic risk.

In the U.S., for example, low rates in the 1990s incentivized a housing bubble whose collapse in 2007 triggered the potentially catastrophic credit freeze and collapse of Lehman Brothers in September of 2008. The government bailout of GM, AIG, and Wall Street banks worsened the federal public debt. By 2014, that debt reached over $17 trillion. Meanwhile, the Federal Reserve printed money far exceeding the meager growth of GDP by buying bonds to artificially lower interest rates to prompt a recovery.

With interest rates low, money flooded into stocks. “The market is in effect rigged because of the [low] interest rate,” Charles Biderman said on CNBC as the summer of 2014 was coming to an end.[3] A grinding ethical fault-line ran between the stocks increasing at 25% a year and the wages and salaries increasing at a mere 3 percent. Moreover, the middle and lower economic classes would doubtless feel the brunt of a collapse of the stock market due to irrational fear should rates be raised to counter the inflation from too many dollars chasing too few goods.

With borrowing money being so cheap at the low rates, government officials did not feel the normal market pressure to hem in the deficits. Corporate managements could borrow money cheaply to acquire or merge with other companies without being perhaps as discerning of the degree of compatibility and synergy as would be the case under naturally determined interest rates. In 2014 through August, more than $2 trillion in mergers and acquisitions were announced—an increase of 70 percent over the same period the year before.[4] While managers, stockholders, and lawyers make out like bandits on the deals, subordinate employees are left out of the largess and may even lose their jobs as the price of synergy.

As dark as the underside of quantitative easing is in pushing rates abnormally low, the most potentially harmful byproduct of Draghi’s plan concerns his intent to encourage the E.U.’s state governments to make greater use of the “existing flexibility” already in the federal law limiting state budget deficits to 3% of annual economic output. Even large states such as France and Germany had had trouble keeping within the law; states such as Greece, Spain, and even Italy carried so much debt that the systemic risk of default became a problem not just for the E.U., but for the global financial system as well. To encourage flexibility might be like giving money to an alcoholic standing outside a liquor store. The last thing state legislators need to hear is additional flexibility to tax less and spend more can be found in the fine print.

As an alternative, Draghi could have emphasized that the ECB would focus on assisting states with structural reforms both by lending its expertise and finding the right monetary incentives that would not distort the financial market in potentially unforeseen ways. Sticking to old ways is not necessarily the best route to getting structural changes capable of ushering in new ways.

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1. Claire Jones, Peter Spiegel, and Robin Harding, “Draghi Softens Tone on Austerity,” The Financial Times, August 22, 2014.

2. Ibid.

3. Charles Biderman, CNBC TV, August 28, 2104.

4. Trish Regan, “Has Fed Jumped the Shark?” USA Today, August 26, 2014.