Daily Archives: July 20, 2011

Europe faces a critical juncture on Thursday – one that may determine not only whether the euro will survive, but whether the global economy will be once again plunged into turmoil. To an economist what needs to be done is simple and clear: Greece’s debt has to be brought to a sustainable level. That can only be done by lowering the interest rate that Greece pays, lowering its indebtedness, and/or increasing gross domestic product. There are several ways this can be accomplished. But the institutional details are less important than an understanding of what will, and what will not, work.

The strategy of the past 18 months of dealing with Greece’s debt difficulties – the minimal response necessary to deal with the moment – has (predictably) not worked. Nor will more of the same. Official lending (from the International Monetary Fund and the European Union) has seniority over the private sector. The riskiness of new private sector lending is thereby increased, with obvious implications for interest rates. Meanwhile, as official lending replaces private sector lending, the risks associated with past lending is shifted to the public. The pattern, and the disappointment, should be familiar to those who watched IMF/G7 programmes of the past.

Economists may differ on whether the austerity prescription will work – though the evidence from Ireland, Greece, Spain, Latvia, and host of other experiments shows that the ensuing economic downturns reduce tax revenue, so the improvement in the fiscal position is inevitably disappointing – but the market has rendered its verdict: it too is signalling that more of the same will not work. Lowering GDP worsens debt-sustainability (typically measured by the debt to GDP ratio) every bit as much as increasing indebtedness. The speculators have been handed an opportunity, and they have seized it. They make money from volatility. Of this we can be certain: Europe’s response so far has amplified uncertainty concerning the future of the euro. “Contagion” has now spread from the periphery to the centre, namely Spain and Italy.

So too “reprofiling” – changing the timing of payments leaving the level of indebtedness unchanged – simply postpones the day of reckoning. If, as often happens, it is accompanied by higher interest payments, the likelihood of an even worse crisis down the line is enhanced. The reason that Greece and the other crisis countries of the periphery face a liquidity problem is that markets believe, probably correctly, that – without access to better terms and/or a debt writedown – there is a real risk of non-repayment.

The problem facing Europe is not so much economic as political. It is easy to see what should be done. If Europe issues eurobonds – supported by the collective commitment of all the governments – and passes on the low interest to those in need – debts are manageable. Even a 150 per cent debt to GDP ratio can be handled if interest rates are low enough, but if rates are high they cannot be. At 6 per cent it takes a primary surplus of 9 per cent just to service the debt. Europe can access capital at low interest rates; after all, its collective debt to GDP ratio is actually better than that of the US.

Those who, putting aside any sense of European solidarity, worry about creating a “transfer union” should be comforted: at such low interest rates the likelihood of a need for real subsidies is limited. But even if there were some subsidy, Europe could afford it. With a $16,000bn dollar economy, even if Europe had to bear costs commensurate with the size of Greece’s debt, these are minuscule compared to what will be lost if Europe does not come to the assistance of the countries facing trouble.

The current strategy has reached not only its economic, but also its political, limits. In at least some of the countries, citizens have put the EU on notice – not just through protests, but though actions. With free mobility of labour and capital, neither workers nor entrepreneurs can be forced to pay too much for the sins of the past. They can move, and they are moving.

Europe is lucky that in most of the countries in its periphery, there were responsible governments that did not take populist stands. What George Papandreou has done in the past eighteen months has been truly impressive. One could hardly have expected more. That the improvement in Greece’s fiscal position has been less than what was hoped is not because he did not deliver but because the benefits of structural reforms take time to be realised – more time than the political process allows; because austerity seldom works and because Greece’s trading partners’ economies have not done as well as hoped.

In at least one of the countries – and perhaps in the future, in others – there wait in the wings less responsible politicians who would take advantage of widespread views that Europe has not done what it should, while imposing harsh conditions. Rather than shared sacrifice, they are even calling for tax cuts. The IMF may have been able to impose harsh conditions in Asia and Latin America, but Europe has vibrant democracies, with an informed and active citizenry. What was possible there may not be possible here.

There is one more ingredient to a successful response: restoring growth. The current uncertainty has had an especially adverse effect on banks and bank lending. Even well-run small and medium-sized businesses are being starved of funds. Growth tax revenues languish, even if governments do a good job at tax collection. A solidarity fund for stabilisation could, together with the European Investment Bank, make needed investments in the countries in trouble – investments that would more than pay off at the low current interest rates. A small business revolving loan fund could provide money to proven enterprises, to help restart the engines of growth.

Europe’s problems today are not the result of a natural disaster, like those confronting Japan. They are man-made, partly the result of a well-intentioned, but imperfectly-conceived, monetary union. It was hoped that, in spite of the marked differences, if countries only managed their debts, all would work well. Spain and Ireland, which both had surpluses and low debt to GDP ratios before the crisis, showed the fallacy in this logic.

As Europe stands at the precipice, it is time to end brinkmanship and political squabbles. The European Central Bank should realise that a restructuring – even if it entails a “credit event” as determined by some American rating agencies – means that Greek bonds are safer than they were before. If they were acceptable as collateral before, they should be more acceptable after. Put bluntly, to not accept Greek bonds is to end Greece’s membership in the euro, with all the consequences thereto.

The ECB must recognise too that for citizens of many countries, a deal without shared sacrifice of the private sector – meaning debt reduction – is politically unacceptable. But those advocating private sector involvement need to realise that the private sector will be reluctant to take a haircut on old loans, and will refuse to accept less than a risk-adjusted interest rate on new.

The resolution of this crisis is easily within Europe’s grasp. It is not a matter of economics. It is only a matter of political will.

The writer is a recipient of the 2001 Nobel Memorial Prize in economics and University Professor at Columbia University

Response by Olaf Cramme

EU members must address integration-sovereignty trade-off

Joseph Stiglitz has given weight to the rising chorus of voices blaming politics, and not economics, for the eurozone crisis. In fact, a consensus is now forming about what needs to be done, but no one seems to know how to do it. National politicians are caught between irreconcilable positions: what is salvation for one interest group is treason for another. Why has it come about this way?

The best explanation I have come across is Dani Rodrick’s “political trilemma”, which outlines the inherent tensions between the simultaneous goals of deepening economic integration, hanging on to national control and providing democratic accountability. Kevin O’Rourke, in turn, has tried to show that Mr Rodrick’s conundrum does not only apply to globalisation, but also to European integration and the economic and monetary union in particular. Their accounts are compelling.

For too long, policymakers in Europe and liberal democracies more broadly have ignored the trade-offs that sit firmly on their table. Political parties have continued to play the traditional left-right tune on standard policy issues, ignoring the significance of constitutional politics: how should we govern – and be governed – in a region (and world) where borders count less and less?

In the crisis, then, worries about legitimacy have given way to concerns over sovereignty. Will the repudiation of European integration come next?

Against this background, it is somewhat surprising that populism has not spread further. The European Union remains a high-profile target for all those who want to challenge either its economic or cultural grounds. Its conditionality regime is easily set against democratic choice and self-determination; or both. This is only reinforced by a prevalent national rhetoric that presents external constraints as matter of malpractice and injustice.

To get out of this trap, and hence take on the political trilemma, EU member states must find a way to internalise and constitutionalise these constraints – so long as they cannot be legitimated at a higher political level (namely via federalism or true global governance). If conditions are deemed to be beneficial and reasonable, then they must enter the realm of domestic debate and political contestation. Silence will only make things worse.

The writer is director of Policy Network and a visiting fellow at the LSE’s European Institute

Eurozone leaders face a fundamental choice when they meet on Thursday. Either they declare, once again, that they stand ready to do “whatever is necessary” to overcome the eurozone crisis, or they actually do it. In the first case, markets are likely to step up to the next stage of their challenge to the European authorities. They will target larger countries, such as Italy and Spain, thus making the “whatever necessary” ever more costly and ever less credible.

Alternatively, the eurozone leaders could show leadership. Markets, so far, have been winning a game of divide and conquer, simply because countries are not providing a common response. Eurozone governments have been seeking “financial stability” by committing ever larger amounts of their taxpayers’ money. Yet, these sums merely measure the eventual cost to citizens of their leaders’ attempts to behave as if they were not part of a monetary union.

A more effective strategy would be to surprise the markets with a genuinely common policy. For such response to be agreed on, the government of the leading eurozone country, Germany, has to provide leadership among the member states and at home. This means convincing Germans that they are benefiting from the European Union, its single market and the euro; that the German “culture of stability” is permeating the rest of the union; and that Germany would be the biggest loser – in terms of stability, competitiveness and the financial cost – if the eurozone were to break up.

A German government that promotes common policies focused on the long term would be better able to protect German taxpayers’ interests than one which, in focusing on their shorter-term interests, convinces neither the markets nor its citizens. It is this lack of credibility that would generate, further down the road, a disruptive ‘transfer union’ that would likely lead to acrimony domestically and across borders.

Luckily for Chancellor Angela Merkel and for Europe, the two main opposition parties in Germany – the Social Democrats and the Greens – are pro-EU. Although the SPD initially opposed the euro and Chancellor Gerhard Schroeder, with President Jacques Chirac, undermined the credibility of the Stability Pact in 2003, earlier this week SDP leaders pledged support for unpopular measures to deal with the eurozone crisis.

This creates a fresh opportunity for Ms Merkel and Wolfgang Schäuble, German finance minister, to support the use of eurobonds – an initiative that would reinforce Germany’s real and perceived ties to the euro.

Commissioner Olli Rehn said last month in the European Parliament that, as part of an economic governance package, the Commission will be ready to propose the setting up of a system of common issuance of euro-denominated government bonds before the end of the year. This would be aimed at strengthening fiscal discipline and increasing stability in the euro area through market mechanisms, ensuring that those member states that enjoy the highest credit standards would not suffer from higher interest rates. The Commission’s report will, if appropriate, be accompanied by legislative proposals.

The proposal is for the use of eurobonds as an instrument of debt management, not as a financing instrument for new expenditures. It was put forward to the president of the Commission last May*, and introduced in the European Parliament in December by Sylvie Goulard**, based on research by Jacques Delpla and Jakob von Weiszäcker, among others.

Many options are possible, including giving the European Financial Stability Facility new powers. The new bonds would assert the euro currency in the global markets. It is not obvious that there would be a higher (absolute or relative) financing cost for the most creditworthy member states, when considering both the liquidity of the new eurobond market but also the existing turbulence of the sovereign debt markets. To liberate the European Central Bank from the role it has been obliged to play would also be in the general best interests and in line with the best German traditions.

There is growing consensus that it would be difficult to find a lasting solution to the eurozone crisis without the use of eurobonds. This week’s eurozone summit could give at least a clear political signal that it is worth considering the eurobond proposal. A European vision, based on the creation of a European instrument, backed by a precise timetable, could be a good way to restore trust and stability.

Mario Monti is president of Bocconi University and former European commissioner. Sylvie Goulard, co-author, is a member of the European Parliament and rapporteur on the economic governance package.

* ‘A new strategy for the single market: A report to the President of the European Commission’ by Mario Monti, May 2010.
** Report on economic governance, Sylvie Goulard, June 2011.

Response by Dag Detter

Privatisation should be part of Europe’s long-term growth plan

Many of the countries whose precarious fiscal positions most worry the European leaders meeting on Thursday actually have substantial portfolios of commercial assets: not only the usual suspects of utilities, banks and transportation assets, but also a very significant portfolio of real estate assets.

These are often barely managed, and there is a certain lack of transparency in what is held. Yet the so-called ‘state-owned commercial assets’ are now one of the larger asset classes globally – many times that of private equity and hedge funds combined – but yielding a very small return to their ultimate owners, taxpayers. Making these assets not just more transparent but also more efficient and profitable could be one part of the solution of improving the long-term prospects for countries such as Greece, Ireland and Portugal.

The concept of a government acting as an asset manager is not new, but tends to be more popular in wealthy export-oriented economies. Singapore and its National Wealth Fund, Temasek, is an obvious example. In the developed world, Sweden was one of the first countries to restructure its portfolio in the late 1990s. As a result, the value of the portfolio outperformed the local stock market for more than eighteen months.

Privatisation of state assets, as has been suggested in Greece, is often the most instinctive response from the financial perspective when considering this asset class. However this may not be the fastest or the most efficient reaction. The current timing and conditions might result in a hasty fire sale.

Instead, troubled countries could – once a fix is found for their immediate problems – attempt a longer-term solution by raising bonds on the back of a new national wealth fund created to manage the asset portfolio. Portugal and Spain already have such a fund, while Greece is in the process of setting one up.

Economists and analysts recognise­ the importance of restructuring these assets. It leads to a more efficient use of capital and resources, and enhanced competition in the affected sectors. As a substantial part of the domestic economy, the bonds from the national wealth fund would help introduce private sector discipline to the assets class and the portfolio, and thereby contribute to economic growth.

Correctly implemented, these commercial assets can become an engine for structural reform and growth in Europe.

The writer is an independent advisor and state asset specialist. He is the former president of Stattum, the Swedish government holding company, and the government director of state-owned enterprises.

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