March 1, 2016
Some Eurozone countries are playing a foolish game. Structural reforms are oversold with moralistic arguments to avoid accepting the obvious: some kind of transfer system is necessary and urgent.
We all agree that the European Monetary Union (EMU) needs a different institutional framework with better governance. We also all agree that EMU economies will never completely converge and, actually, the process of readjustment to “fundamentals” occurring in Italy, Greece and other Southern countries is very painful and politically disruptive. The mantra of structural reforms is a desperate attempt from Germany and other Nordic countries to avoid accepting the truth: the EMU will never work without some kind of cross-country transfer system to mitigate unbalances in the short-medium term.
What are structural reforms for?
Structural reforms cover a broad range of policy areas. In countries like Italy, the average number of days required to enforce a contract is three times higher than in Germany. Southern European countries in general have low appeal for innovators and public funding to research and innovation lags behind Germany and France (see here and here). Greece scores quite badly in the Ease of doing business indicator compared to other EMU peers. Structural reforms have indeed the potential to increase the long-run GDP levels of the “weak” Eurozone countries. Yet, this does not mean structural reform will restore balance in the monetary union, nor make it sustainable.
As Dani Rodrik from Harvard University wrote in The Mirage of Structural Reforms:
Any serious assessment of the actual results produced by structural reforms around the world – particularly in Latin America and Eastern Europe since 1990 – would have poured cold water on such expectations [on structural reforms in Greece]. Privatization, deregulation, and liberalization typically produce growth in the longer term at best, with short-run effects that are often negative.
This is a no-brainer. Increasing productivity is not an easy task and it often involves painful surgery – that is short-term losses for monopolists and for other firms with low productivity, as well as defaults to clean up the economy from zombie firms. As it is for surgeries, it takes time to heal and complete cure is not guaranteed.
You might confuse structural reforms with measures that rebalance labour costs through cuts in real wages and prices but you should not. Structural reforms, as correctly interpreted by Rodrik, aim at achieving convergence in living standards between Germany and Greece. We might order Greece to cut public sector wages to realign costs with productivity but this has very little to do with long-term growth. This is about asking Greece to rebalance their public and private expenses with the fundamentals, that is to move to an equilibrium where labour and capital are paid according to their productivity. This can be done quickly – in a monetary union is done with real devaluation – but this just ensures that Greeks live with what they can afford now. Such adjustment do not necessarily lead to higher long-term productivity.
The political game
Germany leads the group of EMU countries opposing any kind of transfer system within the monetary union. The President of the Deutsche Bundesbank, Jens Weidmann, recently stated that:
[…] But the big risk is that payments intended to cushion country-specific shocks become permanent one-way transfers.
Some have even come out and explicitly called for a revenue-sharing arrangement. France’s economy minister Emmanuel Macron, for example, said in an interview with the Süddeutsche Zeitung: “Monetary union without a revenue-sharing scheme – that’s impossible! The strong have to help.”Macron concedes that advocating permanent fiscal transfers is breaking a taboo for Germany, but in turn, raises the prospect of reforms in France, arguing that we all have to change our ways. In other words, France wishes to remain the sole decision-maker in questions of structural reform, but is indicating good intentions.Ladies and gentlemenIf I may return to the image of a crooked frame: regular transfer payments, without setting up a genuine fiscal union, would be like skewing the angle of a crooked picture even more.
The German establishment claims that all other EMU countries should copy Germany’s model and the Eurozone crisis will be solved. All the emphasis on structural reforms comes from Germany. I borrow a sentence from Lawrence Summers‘s paper on secular stagnation, that perfectly fits in this case:
to the extent that the focus of structural reform is on increased competitiveness, it is likely to be a zero-sum game.
Germany’s fortune in the last decade came from exports (any doubt on that, check this out). The Eurozone is the major export market for German firms. If everyone exports more – which is anyway unlikely – Germany will suffer heavy losses. International trade is ultimately a zero-sum game. Summers continues, while discussing measures that will possibly overcome sluggish productivity growth in developed countries:
That is not to say that structural reform is a bad thing or should not be substantially encouraged. But the idea that structural reform will help area-wide secular stagnation can be supported by neither theory nor evidence.
The rhetoric used to oversell the benefits of structural reforms has the problem of being too extreme. Germany and its allies are pretending that the only possible solution of the current EMU instability comes from firm rules and economic policy measures that have uncertain and, in the best case, long-run positive effects. Nice to have clean and respected rules to guide expectations and improve credibility. At the moment, rules only manage to anchor investors expectations that we are heading towards a disaster and convince observers that the EMU is consistently designed to implode sooner or later. The dominant view in the Eurogroup is that order and coherence are important values per se.
Restore intellectual honesty
My message is simple. Structural reforms are not substitutes for a Euro area mechanism that mitigates unbalances in unemployment and asymmetric downturns in GDP across countries. Yes, it is some kind of transfer system but it should not necessarily involve the transfer of money from a government to another. Such system is crucial to avoid political upheavals in suffering countries. What about a Euro area unemployment benefit scheme that goes from a central EMU authority to the individual unemployment person, regardless of the nationality?
The current approach of the Eurogroup assumes that Eurozone economies will not diverge over time and, if they do, national politicians will bear the political cost of the painful transition periods, because it is their fault if their country does not catch up. Any reasonable observer knows how absurd is this assumption, reality is just very different. As you can see, at the moment the EMU governance is based on moralistic principles and no substance.
The political game of some EMU countries that avoids acknowledging the necessity of some kind of short-term transfer system and oversells structural reforms with moralistic arguments is extremely dangerous. There is a high risk that political upheaval in Southern countries will break the Euro apart, if we only rely on the effects of structural reforms.