Wednesday, 11 January 2012

European fiscal stability pact. How credible or good is the Schuldenbremse?

The favourite catch-phrases of political and financial commentators nowadays seem to be gravitating around the tabloid-friendly idea that Germany may have lost the war but finally, after 70-odd years, just won the peace. Disappointingly, there is no talk of eurozone’s citizens goose-stepping dressed-up in lederhosen. The Europeans will first have to demonstrate their credentials and cast in law, constitution or stone, the cornerstone of the Teutonic austerity that is the Schuldenbremse. This “debt-break” for us, the non-German speakers, is meant to inject a bit of responsibility into the dealings of profligate European governments that like to spend the next generation’s money on this year’s Christmas party.
All in all, not such a bad thing. Many West-European governments  worked hard to implement the left half of the communist ideal, i.e. to everyone according to their needs, not worrying too much about the bill that comes, as we know, exactly when economies start sliding down on the choppy economic cycle of the day. The deal is in fact a limitation of the deficit the government can run (which in the case of Germany is to be eliminated by 2016 at the federal level) and  seeks to limit eurozone’s members to a structural deficit of 0.5% of GDP. This will be achieved, i.a. by fining governments whose budget deficit exceeds 3%.
Poorer countries such as Poland, have already implemented hard debt limits, as have other non-Europeans such as Georgia. The poles have a 60% cap on public debt in their constitution, but this is a limit that they have not reached in the recent history, so not something where they had to get after years of hard-fought surpluses, but rather something not to get too close too. Italy’s debt to GDP is at over 120%, France’s sails towards the 90% mark that will surely mean a debt downgrade and  Germany is just under 83%. The crisis has pushed down some of the current account balances of the PIIGS countries, but in relative terms this is just cosmetic. The Dutch and the Germans will still be more productive and will still run surpluses that seem to match the deficits of their southern partners in the eurozone, irrespective of what Merkozy, Barroso and van Rompuy say.
The practicalities of implementing a debt limit are huge and will clearly test the political will of most European countries. It is not at all clear that economies poisoned for decades by sclerotic labour markets and unsustainable fiscal indiscipline can implement such a task without a major impact on the standard of living of their citizens, particularly when strangled in a monetary union where traditional quick-fixes such as devaluation are not possible. Italy is probably the first example on everybody’s lips, but Spain, Portugal, Greece, all countries with poor labour markets and productivity well below the European average, are in the same situation. These are countries with chronic budget deficits, old-fashioned labour relations and a propensity to protect vested interest of various interest groups, be they lawyers, notaries, pharmacist or taxi drivers.
Germany’s unit labour costs have barely notched-up around 5% since 2000. Over the same period, France’s jumped well over 20%, while Portugal, Spain and Greece are all happily hovering around the 30% mark; all are expected to notch down a bit over the next two years, according to OECD. Italy alone, happily to indulge in the bunga-bunga Berlusconian style of running the economy, has increased its unit labour costs by over 35% and may fare even worse over  the next two years in spite of the honest efforts of Professore Monti. In the Italian case, such an abysmal performance has been achieved over a period when the average GDP growth was the world’s smallest, bar basket cases such as Haiti, Zimbabwe and Somalia. This is the key factor behind the eurozones imbalances and, given it’s huge, visible and immediate impact of any correcting measure, it is something difficult to correct.
Germany will be able to set an example of sombre management of their deficit by flagging the self-imposed limit and push their economic model as they are indeed the European paymasters. In the meantime, the other eurozone member will be too busy to notice that last year’s generous deficit calculation gives Germany a wonderful base-effect breather, which will be reflected in the state employees 2012 bonuses. In the meantime, all those “lazy” Europeans will get back to work (whoever has it) and more and more austerity. The danger is that, while sipping on their espressos halfway through the day, they will start thinking whether to repay or not that loan they took from Deutsche Bank to pay for the shiny new BMW.

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