european economics errors and lessons from euro debt crisis, Guide, Progetti e Ricerche di Economia Dell'integrazione Europea

Scarica european economics errors and lessons from euro debt crisis e più Guide, Progetti e Ricerche in PDF di Economia Dell'integrazione Europea solo su Docsity! Course: European Economics: mid-term Student ID: Gabriele Galici, Matteo Francese, Bryan Greguol, Giulia Dal Ben, Francesca Musella Instructors: V. De Romanis Wordcounts: 4780 Luiss School of Government Master in International Public Affairs a.a. 2020/2021 Introduction The failures and deficiencies in fiscal policy consolidation have inevitably led to a sovereign debt crisis in the euro area and public finances, far from being improved by the Stability and Growth Pact, have suffered from both financial and economic crises due to spillovers which have worsened the entire Eurozone, with some countries more than others. It is the reason why governance measures need to be taken for effective policy coordination and sound public finances (Schuknecht, et al., 2011, p. 4) to promote strong and sustainable growth and reduce poverty. Faced with the challenge of tackling the increased fiscal imbalances due to the 2007 meltdown in the US mortgage market, European leaders have returned to a more active fiscal policy by establishing a number of plans, including the Maastricht Treaty and the Stability and Growth Pact which nonetheless seem to have failed to realize the transfer of sovereignty of fiscal objectives to the European level. (Schuknecht, et al., 2011, p. 5) This led to a set of proposals aimed at improving the SGP, namely the 2005 revision and the Six Pact in 2010-11. The “debt crisis” started in the Eurozone when the Greek government announced that its public debt was much higher than it had been previously reported and a potential default of a sovereign debt in a European country became possible, also given that Eurozone countries refused to provide low-cost funds to Greece. (Zezza, 2012, p. 38) Fiscal Compact was then introduced after Germany’s insistence on more reforms in fiscal policy and it was signed on 2 March 2012. It dealt mainly with debt and deficit criteria and gave much more authority to European legislation insisting on the necessity for governments to comply with SGP measures when circumstances get worse, but it overlooked measures designed to prevent the occurrence of imbalances. (McArdle, 2012, p. 7) These measures of fiscal contraction have led to controversial discussions regarding the austerity policy and its effects. The term “austerity” used in public discussions has a strong political connotation and often becomes a real political weapon, as it affects people’s interests by cutting public expenditures and personal incomes. These measures work towards the restoration of macroeconomic equilibria, by lowering extreme budgetary deficit and unsustainable public debt. They are reflected in both creating and collecting budgetary income and in the expenditure of public money. (Iancu & Olteanu, 2015, p. 5) The current situation of crisis-hit countries has led us to question whether austerity measures can really solve the problem of fiscal consolidation and at what extent they can be considered meaningful as a solution to the crisis: countries might really diminish their budget deficit and public debt, or their economy might as well further deteriorate. (Iancu & Olteanu, 2015, p. 6) Available data suggests that fiscal austerity in the presence of large public debts will have strong consequences for the redistribution of income from taxpayers to the owners of such debt. In addition, since public debt is financed by financial markets in foreign countries, interest payments on the debt will be directly assigned to foreigners and it will intensify the contractionary impact of austerity on domestic growth, and it will lead to the impossibility of a lower debt-to-GDP ratio. This situation reveals that, since public debt is held abroad when a country faces a deficit, the real problem lies in the management of trade imbalances in the Eurozone. (Zezza, 2012, pp. 51-52) The paper will proceed by presenting the case of Greece and its crisis in 2009, which has led to the rise of a number of austerity measures which on one side caused a deep recession, while on the other have enabled the country to avoid further external deficits. It follows the case of Spain and the bursting of the housing bubble in 2009 which show that undertaken structural forms have proven to be effective allowing the Spanish recovery. The study moves towards a critical analysis on the origins of the crisis, pointing out that the primary cause of the turmoil in the financial markets was in the high costs of service of interest rates. To conclude, an overview on the European fiscal policy given the context of the pandemic crisis is presented. Greek and Spanish crises The case of Greece provides the first example of European financial aid since the creation of the Eurozone. The country, devastated by the 2009 sovereign debt crisis which triggered the Troika corrective intervention, has then been one of the hardest hits by the 2011 financial crisis which exacerbated the previous debt-related depression. Under the European Commission pressure for economic and financial convergence, from 2009 onward austerity measures were adopted across the Eurozone in order to cope with labour market rigidity, decreasing competitiveness and current Secondly, the austerity measures required a structural reform of welfare state spending in order to boost employment, relax market flexibility and save further, allegedly unnecessary, public spending. In particular, the agenda targeted chiefly those elements the Growth, Competitiveness, Employment Paper (EC, 1993) pointed out as the main cause of structural unemployment and market labour rigidity1: the ‘educational system, labour laws, work contracts, contractual negotiation systems and the social security system[s]’ (European Commission, 1993, p. 15). Table 1 sums up how the average spending per capita in social protection measures has steadily decreased since the adoption of austerity policies. In fact, the Greek government was called to implement reforms upon aiming wage bargaining and collective bargaining systems; social protection systems; and labour markets and employment protection legislation (EPL). As Hermann (2014) shows, the set of reforms on collective bargaining, for instance, entailed several, critical, measures: the encouragement of fixed-term employment and agency work; the fostering of employment contracts with minor remuneration; the weakening of job security employment protection for public workers; the reduction of layoff notice periods and the increase in thresholds and reduction of obligations for mass layoffs; finally, the lowering of severance pay. Aside to these policies, a strong decentralization of the collective bargaining mechanism was enacted: the favourability principle2 was dismantled, allowing therefore the application of company agreements implying worst employment conditions than collective and protective arrangements; the ‘after effect’ (Hermann, 2014, p. 120) was set at three months, as opposed to the previous six; bargaining bodies were weakened through the suspension of binding clauses guaranteeing the extension procedures of agreements between employers and trade unions; finally, state interference in collective bargaining dynamics were incentivised (Hermann, 2014, 120). This resulted in an overall weakening of labour force representation, as Standing (2011) highlight at the outset of the crisis. He highlighted several countereffects of comprehensive market flexibility policies: labour market insecurity, employment insecurity, job insecurity, work insecurity, skills reproduction insecurity, income insecurity and, as stated above, representation insecurity. In fact, the third key priority of the austerity campaign was the necessity of reforms upon the labour market: its aim was to trigger internal devaluation within the Greek private labour market in order to reduce labours costs but ‘increase (the) country’s competitiveness, attract investment, create jobs and boost growth’ (Hermann, 2014, p. 116). Among the most relevant measures adopted by the Greek government: the cut of the minimum wage (by 22%) and the introduction of a sub-minimum wage 1 This belief was reiterated in the Labour Market Developments in Europe (EC, 2012): the document considered EPL as ‘linked to reduced dynamism of the labour market and precarious jobs. Moreover, by hampering the inter-sectoral re- allocation of labour, rigid EPL may hamper the process of macroeconomic rebalancing’ (p. 4). 2 In a context of multiple collective agreements, those guaranteeing pejorative conditions for the worker cannot be implemented. for under 24 y.o. employee; the abolishment of special employment protection for civil servants; the relaxation of laidoff obligations and the tightening of unemployment benefits eligibility criteria (Hermann, 2014, p. 118). In contrast to neoliberal expectations, the austerity measures aiming to make the Greek labour market more flexible, dynamic and eventually competitive have produced controversial outcomes: the unemployment pattern (Table 3) seems promising, although the 2020 15.47% is yet to be impacted by the pandemic crisis and is still way above the Eurozone average (8.1%) (Eurostat, 2021d). On the other hand, the unemployment rate (Table 4), whose growth was the main objective of the austerity programme, have steadily declined since the onset of the crisis3. Table 3 Unemployment rate 3 Particularly critical it is the Greek youth unemployment: the access to the labour market being already restricted and made additionally less attractive by the sub-minimum wage for under 24 years of age, in 2020 32.51% (Statista, 2021b) is still higher than the 1999 rate (30.03%). Furthermore Kennedy (2019) observes that flexibility policies not only have failed in ‘significantly’ decreasing unemployment but also impelled ‘the prevalence of the precarious employment that the reforms were intended to reduce’ (p. 299). Table 4 Employment rates by sex, age, education attainment level and citizenship Greece is not the only European Member States which experienced a serious financial crisis at the beginning of the 21st century. Another example, which is partially different, is the Spanish crisis. After the 1992-1993 European recession, Spain experienced a 15-years period of uninterrupted growth (1993-2008) at an average rate of 3,5% (IMF, 2012). According to the IMF World Economic Outlook’s database, between 1993 and 2007, Spain’s GDP per capita switched from 16,000$ in 1993 to 33,000$ in 2008. The strong economic growth and the increase in employment allowed Spain to match the main European countries in terms of economic convergence, reaching in 2006 a GDP per capita above the EU average (Royo, 2008). The Spanish public debt was reduced from 68% in 1995 to 38% in 2007: in this way placing Spanish public debt among the lowest in the European Union. The public deficit switched from 5,5% in 1996 to three consecutive surplus years between 2006 and 2008 (IMF, 2012). Source: Eurostat. Looking at the data – which analyze the real GDP pro capita in Spain, Europe and Greece starting from 2000 to 2020 – we can see a major difference between Greece and Spain. In more than 10 years, Spain was able to increase its productivity, implement a variety of reforms and, indeed, reduce the public debt. Spain was able to return to an economic growth in 2014 and continued performing above the euro area average up until the outbreak of the COVID-19 pandemic crisis. Looking at the job creation and employment we see that, compared to Greece, Spain experienced a rapid increase in employment starting from 2014. This data confirms a positive feedback from Spain to the educational reforms carried out in the previous years. Source: Eurostat Hence the EU firmly believed that austerity measures would not also bring the above- mentioned economic benefits to in-crisis countries but would also propel financial and economical convergence across the Union. However, the cases of Spain and Greece suggest that EU comprehensive financial and economic intervention must take national differences in economic and social systems into account: despite several signs of economic recovery were recorded in the last two years preceding the pandemic and the Eurozone crisis has seen “convergence in terms of policy trajectories, there is a significant divergence in employment [and unemployment] outcomes” (Kougias, 2019). In addition, looking at the life expectancy, Spain in 2018 demonstrated how a person aged 65 years living in Spain could expect to live 23.2 years more (Kougias, 2019). Source: Eurostat. In conclusion, the structural reforms demonstrated their effectiveness: competitiveness gains have supported economic rebalancing towards tradable sectors, and exports of goods and services have stabilized at historical highs (above 20% of GDP) (Strauch, 2019). The large and persistent current account deficit, which had reached 9,6% of GDP in 2007, has turned into a surplus averaging 1.5% of GDP in the period of 2014-2018 (Strauch, 2019). However, there are still some challenges, such as the high public and private debt, the unemployment rate which is above the euro area average (see table below) and low productivity (Spain produce about 40% less than his US counterpart, and 20% less than the average worker in Europe) (D'Antoni and Nocella, 2020). Source: Eurostat. Hence the EU firmly believed that austerity measures would not also bring the above- mentioned economic benefits to in-crisis countries but would also propel financial and economic convergence across the Union. However, the cases of Spain and Greece suggest that EU comprehensive financial and economic intervention must take national differences in economic and social systems into account: despite several signs of economic recovery were recorded in the last two years preceding the pandemic and the Eurozone crisis has seen ‘convergence in terms of policy trajectories, there is a significant divergence in employment [and unemployment] outcomes’ (Kougias, 2019). The Eurozone crisis: a critical perspective In the aftermath of the Eurozone crisis, especially dramatic in the peripheral countries, different points of view shed light on various possible explanations that underpin the crisis itself. Some observers linked the onset of the crisis with the decline in the housing market and the collapse in the US sub-prime mortgages sector. In a nutshell, the US financial sector use (melius abuse) of General government net lending in the Eurozone. General government primary surplus in the Eurozone The Eurozone crisis: the role of intra-European current-account imbalances The flourish of debates among economists following the European crisis revived the theory of optimum currency areas (Mundell, 1961). In line with this theory, a high level of integration7 would provide an efficient macroeconomic reaction to asymmetric shocks. However, as we know, it is not the case for Europe to date. To worsen the scenario, Europe lacks an automatic stabilizer that could allow for countercyclical fiscal transfers between the Member States. More generally, it is well 7 Both political and economic. recognized that to obtain an 'optimum policy mix', 'fiscal and monetary policies must go hand in hand' (Kenen, 1969, p. 45). Conversely, it is plain that a high degree of economic divergence has been displayed within the Eurozone since the abandonment of the various national currencies to enter the Euro (Rossi, 2007). Furthermore, more significant is that inflation rates have also diverged across the Eurozone countries, especially considering Germany, where from 1999 to 2007 has always been lower than in the other Member States. Germany, indeed, historically adopted an export-led growth regime based on sustained wage repression to reduce unit labour costs in real terms, thus improving its competitiveness concerning the other Member States (Cesaratto and Stirati, 2011; Bibow, 2013). Critical economists argue that 'core' countries within the Eurozone indeed exploited their export-led growth strategies as 'beggar-thy-neighbour policies': the paramount savings yielded via their net exports have been lent to deficit countries, being the interest rates there significantly higher (Vernengo and Pérez-Caldentey, 2012). As a result, the latter countries financed their current account deficits, and a debt-led economic growth boomed in peripheral countries before the global financial crisis. At the same time, core countries (first and foremost Germany) persistently recorded trade surpluses until the external imbalances became unsustainable for the profligate countries (Rossi, 2013). For this explanation being supported, the Eurozone crisis is essentially a balance-of-payments crisis; meaning, an external-debt-sustainability crisis (Bagnai, 2013, p. 12). Not surprisingly, during the new millennium's first decade, the current account imbalances between the Eurozone countries have reached unprecedented levels, having not been narrowed in the aftermath of the great recession of 2008-9 (Brancaccio, 2012)8. Before the onset of the European crisis, many studies had already focused on foreign debt as a significant indicator of a country's potential insolvency (Manasse and Roubini, 2015). Moreover, some studies highlighted that the current account has a significant impact on risk premia (Barrios et al., 2009), while for the International Monetary Fund (2010), it is a critical predictor of credit-default swap spreads as the fiscal deficit. A test carried out on twelve Eurozone countries points out what alleged above. In Table 19, a watershed in 2007-8 is clear-cut. Indeed, the relationship between government deficit and spreads 8 Italy’s current account deficit as a share of the gross domestic product (GDP) was 3.5 percent in 2010, compared with 4.5 percent for Spain, 9.7 percent for Portugal, and 12.3 percent for Greece, whereas Germany had a current account surplus of 5.8 percent. Moreover, no substantial move toward restoring balance was expected by the end of 2011 (AMECO, 2011). 9 The following yearly historical series were extracted from the Eurostat AMECO database: net lending or borrowing relative to general government as a share of GDP; balance on current transactions with the rest of the world as a share of GDP; and spreads between nominal long-term interest rates on the bonds of the different countries with respect to German bonds. Linear regression analysis was then used to compare the average data for current account and government deficits during a three-year period with the averages of the spreads in the becomes relevant with the onset of the recession in 2008. Furthermore, when we considered all the periods taken into account, the relationship between countries current accounts and spreads shows a higher coefficient of determination and lower p-value than government deficit and spreads. Consequently, if the interpretation of the Eurozone crisis based solely on the role of the public deficit seems untenable, the government's deficit seems to be less relevant than the current account as a determinant of spreads (Brancaccio, 2012). Besides, in Table 210, in the only two periods in which output are significant, the foreign debt proves to be a more critical determinant of spreads than the public debt. A typical standpoint is that spreads incorporate the Eurozone collapse risk, thence of exchange rates (Brancaccio, 2012). These outputs, concluding, seem to uphold the thesis, which stresses the linkage between the European crisis and the exposure of the peripheral countries to an unsustainable private debt-led growth in a condition of current-account imbalances as above explained. year immediately after this three-year period. The analysis begins with data for 1999, the year the euro came into being. 10 Test of linear regression on the stocks of public and foreign debt, both public and private, of the Euro12 countries to the analysis of yearly balances (see Table 2). The AMECO database is again the source of data on public debt, and the international investment position (IIP) calculated by the International Monetary Fund (IMF) is used for foreign debt. At the end of 2021, when the suspension of EU fiscal rules will cease, institutions and economists will have to think about devising new approaches that EU must adopt in order to respond to future high levels of national debts, starting with an in-depth analysis of the issues that arose ex ante14. The main issue on which the European Union must focus its attention on is the deepening and investigation of the potential lack regarding the elements of effective legitimation of fiscal policy (Haroutunian et al., 2021). Over the years, during periods of crisis and also of well-being, states have repeatedly given evidence of the irreconcilability between their macroeconomic standards with the dictates of supranational rules, emphasizing a general dissatisfaction in the management of tax policies. Average compliance with fiscal rules across countries, 1998-2019 Source: European Commission. The criteria’s technicalities applied to European economic policy have turned out to be profoundly unsatisfactory from the point of view of results: to date, the strategies and processes 14 Communication from the Commission to the European Parliament, the Council, and the European Central Bank on the 2021 draft budgetary plans: overall assessment. adopted at EU level have done nothing but highlight how there is a substantial economic union based more on an aggregate effect rather than coordination projects aimed at harmonizing the fiscal system. What are the current options that can be put into play in order to respond to the consequences that will occur in the years after the end of the pandemic and to allow the European system to find its own fiscal frame in a lasting way? In the analysis of the factors characterizing the success of fiscal policies, there is an endogenous factor dealing with the degree of reception and acceptance followed by the countries. In this sense, among the various options that can be pursued in the near future, the most futuristic and decisive one promotes a change in Community legislation that passes from a system based on rules to one composed of standards (Blanchard et al., 2021). The convenience of a standards-based tax system has both upstream and downstream advantages, at least conceptually. In first place, the standards rely on the receptive system of countries and on the ability to implement virtuous and preventive processes in cases of new crises, unlike the rules which tend to rely too much on statistical data drawn up periodically, not taking into account the likely distorting externalities which could undermine the effectiveness of sound national planning. Furthermore, standards’ definition requires a continuous confrontation between the parties, the European Union and the Member States, and therefore greater adaptability to the sudden needs that the national government have to face both in internal and in intra-national economic dynamics. The identification of a central body capable of acting as a guarantor and vigilant for the achievement of standards minimum requirements is a crucial step in order not to leave too much discretion to individual national entities in the management of economic instruments. In conclusion, the suspension of the European Union’s fiscal rules must not only represent a temporary help, but a decisive framework for all the parties involved in order to define a common strategy and to elaborate a completely new valid system, built on the lessons learned from the two crises of the new millennium, to be consistent with the different economic realities within the States. Conclusions After this brief journey within the European crisis, we assessed the origins of the Eurozone crisis investigating not only the sources but also the way it affected differently the various Member States. We started with a comparison of the Greek and Spanish crises, highlighting the differences in outcome and sources. Moreover, we evaluated different critical perspectives and approaches concerning both the origins and the results of the European crisis. Finally, considering the most updated debates regarding the new proposals to tackle the fiscal policy of the European Union. As a result of our analysis, we consider that probably what the European Union missed is the sensitivity of the divergences among the countries. In other words, even if fiscal rules are necessary to create an unique sound voice to resist (above all) external shocks, perhaps the need to improve the recognition of the divergences among the countries is a betterment for the decade to come. Above all, in order to avoid further fragmentation and inequalities among the European Member States.