Lessons from Dublin EcoFin meeting (Part 1)
by Seán Whelan, Economics Correspondent.
Michael Noonan invited the Brussels-based economic think tank Bruegel to contribute a thought provoking paper to the ECOFIN meeting in Dublin Castle last Friday on Europe’s growth problem. Director Jean Pisani-Ferry and economist Zsolt Darvas duly obliged, and let the ministers have it with both barrels.
For example, the very first line of the paper reads: “Europe’s pre-crisis growth performance was disappointing enough, but the performance has been even more dismal since the onset of the crisis”.
Yes ministers, that’s your performance we are talking about. And it goes on – “Unlike the US and Japan, growth and employment numbers have consistently disappointed since 2007”. Europe, it says, is trapped in stagnation. Vicious circles have set in: weak growth undermining bank recovery, high unemployment eroding skills and weakening long term growth prospects, and stagnation making Europe less attractive to inward investment.
“Since 2007, theEU15 has taken a productivity holiday, while productivity has increased rapidly in the US”. Even Germany lags behind the US for productivity. Britain is no different from continental economies. The very strong productivity growth in Ireland and Spain is due to the collapse of low productivity sectors like construction and retail (something the Central Bank here has been saying for years). Poland is one of the few truly good performers.
“Private debt deleveraging in Europe has proved slower than that in the US”. This one seems important. In Europe the emphasis has been on dealing with government debt levels (hence the obsession with debt/GDP ratios and deficits). But corporate and household debt has continued to rise.
The opposite has happened in the US – household debt has been sharply reduced, and corporate debt has stabilised. While the public debt has increased sharply (all that fiscal cliff stuff), total debt (excluding the financial sector) has increased “markedly less than in Europe”. The US, Bruegel concludes, is more advanced in the deleveraging process than Europe.
It puts forward four reasons why that may be so:
1. European business has a lower level of profitability than US business, making it more dependent on borrowing for investment, rather than using own resources.
2. Different bankruptcy laws – “Household debt in the US was significantly reduced through personal bankruptcies”. Of course you don’t have to hang around for 12 years there – or even three. But Britain has fast, US style bankruptcy too – has it made much difference to economic growth? Hard to see it at the moment, but dealing with debt swiftly seems the best way to proceed.
3. More expensive financing conditions in parts of Europe – this is the breakdown in the transmission policies that Draghi has been going on about for the past year – higher borrowing costs in the periphery. And weak banks are continuing to extend credit to weak firms to avoid realising losses (a process known as zombification).
4. Lower nominal GDP growth – partly caused by budget consolidation/austerity policies against a background of a still weak private economy.
Bruegel says fixing the banks is the key – nothing new there, but remember, they got the chance to say this directly to the finance ministers and central bankers.
They point out that five years into this crisis, about one quarter of the EU banking system is still under state aid control (ie being bailed out by taxpayers), whereas in the US banks have long ago regained independence.
Its prescription is an immediate process to recapitalise undercapitalised banks – before the next round of stress tests, which means by the autumn – and the resolution of insolvent banks (y’all know how to kill zombies). As an incentive, they say such recapitalisation costs to government should be treated as a one off exception, not triggering the excessive deficit procedure. Too late for Ireland, of course, but then our deficit excluding the bank bailout was so bad we were going into the EDP anyway (remember the way the government used to urge us to look at the “underlying deficit” – we did: it was four times over the limit!).
To stop austerity totally killing economies, the authors say there should be a frontloading of EU spending for the southern states (do we qualify as southerners? Certainly not on meteorological grounds). This is to deal with demand weakness during a time of heavy duty fiscal adjustment. It also says SME credit subsidies would help create jobs and boost exports. Actions to get around ECB rules on collateral that discourage SME lending by banks need to be taken.
And the boot kept going in . “Europe’s long term growth strategy has been a failure so far. Much of Europe suffers from a mutually reinforcing interaction between limited productivity gains, protracted deleveraging, weak banking sectors and distorted relative prices” (in case you needed reminding, it says wages have started to adjust in the EU, but prices “exhibit rigidity”).
Bruegel says wage adjustment should involve Northern Europe as well as the south: inflation should be allowed to rise above 2% in the north, to counteract the falls in the south – the aim should be to stop inflation for the euro zone as a whole from falling below 2%. This implies paying the Germans and Dutch more, while the rest of us take pay cuts or see no more rises for several years – sound in theory, but a potential political nightmare if it leads to popular resentments.
Mr Noonan publicly thanked Mr Pisani-Ferry and Mr Darvas for their contribution.