Eurozone debt,monetary union and Argentina

Greek capitalism has failed.  So has capitalist production in the smaller Eurozone nations.  Nothing demonstrates more the need for a pan-European economy to use all the resources of the continent, both material and human. The smaller and weaker capitalist economies have been driven into a long winter of depression by the global slump.  The euro crisis is not really one of sovereign debt or a fiscal crisis.  Its origin lies in the failure of capitalism, the huge banking and private credit crisis and the inability of undemocratic pan-European capitalist institutions like the European Commission, the Council of Ministers and the pathetic European parliament to deal with it.

The ambition of France and Germany to compete with the US and Asia on the world stage through monetary union was fundamentally flawed.  The original dream of a united capitalist Europe, of free markets in production, labour and finance, ever utopian, has turned into a nightmare.  Now the single currency union is under threat.  It always was ambitious.

JP Morgan recently looked at whether the ‘right conditions’ under capitalism existed for setting up a currency union in Europe.  They measured the difference between countries using data from the World Economic Forum’s Global Competitiveness Report, which ranks countries using over 100 variables, from labour markets to government institutions to property rights. They found that there’s an incredible amount of variation among the euro zone’s member nations. The biggest differences come in pay and productivity, the efficiency of the legal systems in settling disputes, anti-monopoly policies, government spending and the quality of scientific research.

Indeed, the euro zone countries are more different from each other than countries in just about any hypothetical currency union you could care to propose. A currency union for Central America would make more sense. A currency union in East Asia would make more sense. A currency union that involved reconstituting the old USSR or Ottoman Empire would make more sense.  In sum “a currency union of all countries on Earth that happen to reside on the fifth parallel north of the Equator would make more sense.”  

But the currency union went ahead because of the political ambitions of France and Germany to have a Europe led by them, even after British capitalism refused to join.  Of course, the aim was to bring about a ‘convergence’ between the weaker and stronger economies.  That dismally failed in the boom years of 2002-7.  The Great Recession just exposed and widened the inequalities.

Can the existing currency union survive?  Well yes, if economic growth returns big time or if German capitalism grasps the nettle and is prepared to pay to help the ailing smaller capitalist economies through fiscal transfers.  It is no good the Germans saying they will do so if the likes of Greece, Portugal, Ireland, Spain etc “stick to fiscal targets”.  They cannot.  So Germany will have to decide on more transfers without more austerity.

And it won’t be cheap.  The Cologne-based IW economic research institute reckoned that West Germans paid about $1.9 trillion over 20 years, partly via a “solidarity surcharge” on their income taxes, to help integrate and upgrade Eastern Germany. That was roughly two-thirds of West Germany’s GDP then. The subsidies helped cover East Germany’s budget shortfalls and poured money into its pension and social security systems. At the same time, nearly 2 million East Germans — a full one-eighth of the population — moved west to seek work.   That is the sort of transfer of funds and jobs that will have to take place to save the currency union.

Currency unions cannot stay still – Europe’s has been around for only 13 years. Either they break up or they move onto full fiscal union where  the revenues of the state are pooled, especially when crisis concentrates the minds.  That means the smaller states agreeing to German control of their budgets in return for fiscal transfers and the Germans allowing proper fiscal transfers to the poorer ‘regions’ of the currency union.

Take the example of the UK.  This is a government of four nations and many regions.  Taxes are raised by a central state (although there has been some devolution to Scotland, Wales and Northern Ireland) and raising debt is mostly made by the central state (there are some local government bonds or loans).  Wales is a poorer part of the UK.  It runs a ‘trade deficit’ with the rich south-east of England.  Its inhabitants contribute way less in tax revenue than they receive in government handouts.  So Wales has twin deficits on its government and capitalist sectors, just as Greece has with the rest of the Eurozone.

But it is not an issue for Wales because it is part of the United Kingdom of Great Britain and Northern Ireland.  Sometimes there are grumbles from the rich south that they have to pay for the unemployed Welsh but that argument does not have much traction.  After all, the extreme logic of that is to say that the extremely rich inhabitants of Kensington in the posh part of London should not have their tax revenues redistributed to the poor inhabitants of east London.  That would mean Kensington would have to break with the fiscal and currency union that is Britain, put up border controls and find their own government, armed forces and central bank.  Of course, their riches would soon disappear because they are based on the labour of all the people in Britain and even more from abroad.  It is a point that many nationalist elements in Germany and northern Europe forget.  If the Eurozone breaks up into its constituent parts, the ongoing (not just immediate) losses to GDP for northern Europe would be considerable.

The example of the US also shows the advantages of a federal state over the commonwealth of states that existed to begin with.  It took a civil war of bloody proportions to establish a unified state that wiped out the idea of secession for good.  Now the US federal government raises taxes and debt and provides funds to the states (even though they raise their own taxes).  A full financial union came later than fiscal union in the US, when the Federal Reserve Bank  was set up by the large private banks after a series of banking collapses.  Now dollars are redistributed through the federal reserve system to cover ‘deficits’ on trade and capital between states.

So what happens now to Europe’s currency union?  In the absence of German capitalism bailing out the south with huge fiscal transfers, the only way that the peripheral countries have to restore growth and avoid the break-up of the EMU is by defaulting on the debt they have accumulated – in effect a forced fiscal transfer.  Remember most of this debt is the result of the collapse of the banking system and the Great Recession.  It is not due to ‘excessive ‘ spending by governments.  The excessive debt was in the private sector: in mortgages and banking debt.   That debt got transferred onto government books through bailouts and social benefits.

Take Greece.  I have made an estimate how much the rest of the Eurozone is exposed to Greek sovereign debt in one way or another.  Greek government debt stands at €337bn as of March 2012. Of that, about €220bn is held by the EU institutions (EFSF, ECB) and the IMF. Foreign banks have reduced their holdings dramatically to about €36bn in long-term debt.  In addition, the ECB and Eurozone central banks have lent the Greek banks about €250bn directly and indirectly.  So when we add it all up, the  Germans, French and others face default by Greece on a total of €500bn, or 5% of Eurozone GDP.  So if Greece defaults on its sovereign debt, it will be Europe’s official sector that will take the blow.   And this does  not account for losses in GDP in the euro area if Greece defaults, causing a new credit crisis.  The Institute of International Finance reckons the total cost is closer to €1trn, or 10% of Eurozone GDP.  This is all the more reason why the Troika and the European Union could be forced to abandon their fiscal austerity approach and replace it with a real plan for Greek economic and social recovery.

Debt ‘deleveraging’ is necessary under capitalism.  If dead capital remains stuck on the books of companies, then they won’t invest in new production; households won’t spend more if they have mortgages hanging over their heads and the value of their house is worth less.  And governments cannot take on new public projects if the interest cost of existing debt eats into their available revenues.  In their very latest report, the historians of debt, the Reinharts and Kenneth Rogoff confirm the relationship between debt and growth under capitalism (see Carmen M. Reinhart, Vincent R. Reinhart, and Kenneth S. Rogoff, Debt Overhangs: Past and Present, NBER Working Paper No. 18015 (April 2012)).  They looked at 26 episodes of public debt overhangs (defined as where the public debt ratio was above 90%) and found that on 23 occasions, real GDP growth is lowered by an average of 1.2% points a year.  And GDP is about 25% lower than it would have been at the end of the period of overhang.  It is the same when private sector debt gets to very high levels.  Such is the waste of capitalism and fictitious capital.

The correlation between high debt and low growth seems strong, but it is a matter of debate within mainstream economics on the causal direction.  Is it the contraction of the economy that leads to high and rising debt (Krugman and the Keynesians) or is it high and rising debt that leads to the contraction of the economy and low growth (Rogoff, the Austrians and the Minsky).  I think that it is the contraction of profitability that leads to a collapse in investment and the economy which drives up debt.  But until debt is deleveraged, profitability and growth cannot be restored.

What is clear is that debt cannot be reduced for the smaller capitalist states of Europe without default.  If Greek public debt was written down to 60% of GDP, as the new Euro fiscal compact demands, it would allow the government to spend on investment another 5% of GDP a year.

Growth will not be restored by the neoliberal solutions demanded by the Euro leaders and the Troika.  The OECD claims that ‘structural reforms’ would deliver a rise in the level of GDP per capita over ten years worth 13% of GDP for Portugal, 18% for Greece and 15% for Spain because these economies are so ‘uncompetitive’ i.e. about 1.3-1.8% a year.  But what are these wonderful growth-enhancing structural reforms?  For Portugal, the Troika has decided that they are a reduction of four public holidays a year, three days less minimum annual paid holidays, a 50% reduction in overtime rates and the end of collective bargaining agreements.  Then there would be more working time management, the removal of restrictions on the power to fire workers, the lowering of severance payments on losing your job and the forced arbitration of labour disputes.  In other words, workers must work longer and harder for less money and with less rights and a higher risk of being sacked.  Southern Europe must become a cheap labour centre for investment by the north.  That’s the Troika’s reforms.

Then there is deregulation of markets.  Utilities are to be opened up to competition.  That means companies competing to sell electricity or broadband to customers who must continually change their suppliers to save a few euros.  Pharmacies are to have their margins cut, so small chemists are to earn less but there is no reduction in the price of drugs from big pharma, the real monopolies.  And the professions are to be deregulated, so lawyers cannot make such fat fees but anybody can become a teacher or taxi driver or drive a large truck with minimal or no training.   Finally, there is privatisation of the remaining state entities sold cheaply to private asset companies in order to pay down debt and enlarge the profit potential of the capitalist sector.  It’s more or less the same proposals for Greece, Spain, Italy and Ireland.

So the neo-liberal solution to restore growth is to raise the rate of exploitation of the workforce, destroy pensions and public goods like healthcare and education and to squeeze small businesses.  The argument goes, this would boost profitability and so the private sector will then invest to create jobs and more GDP, assuming, of course, that capitalism does not have another slump before then. But the UK and US economies already implemented all these ideas a decade of more ago and what was the result?  Did these economies avoid a financial collapse or a slump?  On the contrary. There is no mention of public investment. Investment is down to the private sector because government is ‘unproductive’ (which it is in a capitalist sense).

The idea of a pan-European economy must be right – but it just cannot be achieved through wage reductions, deregulation and fiscal austerity.  Equally, just leaving the euro would be no panacea for the likes of the Greeks or the Portuguese.  Argentina is usually cited as a successful example of a capitalist economy sticking its fingers up to the IMF and achieving fantastic growth after defaulting and devaluing.  Clearly, writing off what Greek left leader Alexis Tsipras has called  ‘odious’ debt must be part of the escape from recession.  But leaving it at that and devaluing the currency by leaving the euro is no answer, even in the short term.

A recent report by the Federal Reserve Bank of Dallas (Default and lost opportunities: a message from Argentina, May 2012) showed that Argentina was lucky in 2001 when they defaulted and devalued the peso.  After a big drop in GDP, real GDP per capita rose by 7% a year for next seven years.   But that coincided with the huge global commodity boom benefiting sales of agro products that Argentina produced.  A similar default and devaluation of 1983 did not deliver a great recovery.  Then, in the depths of a global recession (much like now), real GDP fell 15% and did not recover to pre-crisis levels until 10 years later.

Under the capitalist mode of production, the smaller economies of Europe are stuck in a generation of austerity, whether they leave the euro or not.  With public ownership of the finance and productive sectors of the economy and a plan for state-led investment, growth could be restored.  Even then, that won’t be possible unless it moves onto a pan-European level, where fiscal and capital transfers are integrated to reduce the imbalances and differences highlighted by JP Morgan’s study.

12 thoughts on “Eurozone debt,monetary union and Argentina

    1. Yes I saw that. More investigation needed. All I would say is that Argentina’s earlier default crisis was not resolved by devaluation because it was in the middle of a slump unlike 2001.

  1. Good point about fiscal transfers. But in the U.S., transfers go beyond “Dollars…redistributed through the federal reserve system to cover ‘deficits’ on trade and capital between states.”

    The federal taxation system is an important source of transfers — taxpayers in the Northeast and West Coast states consistenly send more taxes to the federal government than their states get back; poor states, especially those in the South, consistenly receive more than their taxpayers pay. Spending by the U.S. federal government tends to be allocated through complicated formulae that lead to these results.

    I’ll leave aside the irony of the places that hate government spending the most being subsidized by the places most willing to support government spending…

    1. That’s a short sighted way of looking at things. For instance, a very low percentage of the people working for Apple in Cupertino were actually educated K-12 in California. There is a flow of people between the states that render any blue-red comparison rather trivial.It’s not like people live in a blue or red state their whole life; the phenomenon you are describing are technological centers which people from both red and blue migrate to, and which have to do with location and government policy.

  2. Considering you see the current crisis as a crisis of a too low profit rate, do you really believe alleviating the main contradictions of the Eurozone and some kind of a pan-European public investment programme would be enough for the EU/Eurozone to survive? Wouldn’t we still need a devaluation or physical destruction of constant capital on a mass scale (cf. your post on the austerity debate)?

    1. It is capitalism that needs a destruction of capital values on a mass scale to be able to restore profitability and growth. That is the rational irrationality of the capitalist mode of production, only profits drives investment: money to make money, not social need. Public investment taking the place of capitalist investment would end that irrationality.

      Would it help Europe or Greece to devalue? I think the Euro leaders are thinking of letting the euro weaken to help all in the region to get out of the current recession. But it can only have a limited effect in time and extent – and this is a capitalist solution that does nothing to remove the capitalist system. And it is subject to competitive devaluation by Japan and the US in a race to the bottom.

  3. I think this is an excellent article, partly because it shows that simply rejecting the debt, in and of itself, is not THE solution, although it’s a necessary step. Two points I would like to emphasize and a (possible) disagreement on what may be a secondary issue:

    1) Part of the crisis in Greece and the EU flows from the contradiction of the nation state in the era of the world economy. As the article clarifies, the basis for a monetary system (e.g. the euro) is a certain level of economic and political integration. Given the huge historical and political differences in Western Europe, they were only able to paper over these differences during a boom period. That period is over.

    2) Another aspect of what is happening in the EU is that the European working class is being dragged, kicking and screaming, into that old race to the bottom — the race in which workers of one country or one region or another are forced into ever greater competition with other workers for who will work for less. That is the meaning of the “reforms” advocated for the Portuguese workers as described in that article.

    And what will happen if those reforms are carried out? German capitalists will then start to increase their investment in Portugal vs. Germany. Unemployment will increase in Germany, and then similar “reforms” will be enforced there.

    One small disagreement I have with Roberts’ article is that he seems to say that such “reforms” cannot increase investment. As far as total world capitalist investment, he is of course right. In fact, by cutting the market (because workers can buy even less), it will tend to decrease world investment. But it can increase investment in the particular country where the total wage (including the social wage) is cut. Look at the US, where some manufacturers are increasing production here at home exactly because wages have been so reduced here. In one case, Caterpillar, that was at the expense of the Canadian working class. So what will be the result? The Canadian workers will come under increased pressure to cut their wages, and on and on…

    Clearly a first step is real international solidarity in action, in deeds, not just words.

  4. Mr. Roberts, great article indeed. What do you think about the Argentinian devaluation story highlighted in this article by Naked Capitalism? Reading the last passage of this post, it seems that your interpretation clashes with Naked Cap’s argument, because you argue (and I agree) that the Argentinian success in devaluation is a matter of luck.

    1. Yes, I have seen the paper by Mark Weisbrot et al (CEPR, The Argentine Success Story, October 2011). It is very interesting. What it reveals is that devaluing the currency to allow exports to recover had only a limited effect on growth. What mattered was defaulting on the debt burden and using the freed up funds to invest. There was a massive slump on defaulting and devaluing in 2001-2002 but then fixed investment expanded sharply, contributing around 50% of the fast recovery in the ensuing four years, while government spending also helped. This was made possible mostly by the debt default rather than the devaluation (as net exports contributed only 12% of all the increase in GDP after 2002 according to Weisbrot).

      So if the story of Argentina is supposed to prove that devaluation is the way out, it is inconclusive. If it is supposed to prove that fiscal stimulus and rising wages will do the trick, then it is also inconclusive. Government investment along with private investment is more the likely driver. I would need to investigate further. I would only add that in the previous crisis in the early 1980s, when the global economy was also in a slump (as it is now), defaulting and devaluing did not revive the Argentine economy for the whole decade. So the commodity boom of the 2000s may not have been the ‘lucky’ cause of the Argentine recovery in 2002 onwards, but the evidence does not suggest that devaluation is a sure way to get out of a slump either.

      1. I completely agree on that point. I think that the public-private investment driver would be the key to save the Eurozone from the actual slump, but the main question is: from Italy’s standpoint, for example, is it better to stay or leave the Eurozone?
        I think that a massive reform of the EU institutions, inspired by public investment, should be the ideal objective for a progressive Italian policymaker.
        What do you think about this matter?

        Thank you very much in advance.

  5. Your solution to the European debt crisis seems to be over and over the same one so popular in the media right now: “let the Germans pay more”.

    Several problems come to mind immediately. When the West Germans transferred the 2/3rds of their GDP [as you referenced] that was for the sake of ‘solidarity’ with other Germans who would now be part of their country playing by their rules. Not with Greeks who’ve been constantly portraying the German leadership in Nazi terms in their newspapers. The Greek/Mediterranean line seems to be: “send money, and then stay the f*ck out of our business.” Only an idiot would actually abide to that request.

    But Greece is only a small part of this problem. The bigger dominoes unfortunately are Spain and Italy, and it is quite simply ridiculous to think Germany can foot the bill for their combined population of 105 million. Germany itself now has a debt of over 80% of GDP.

    This stinks of a deus ex machina solution. Unfortunately it’s a lot easier for politicians [and bloggers] to hope for a solution from somewhere else rather than explain to their voting publics the most fundamental of economic rules: “that which can’t go on forever, won’t”.

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