(qui la versione italiana)
I wish to thank Magdi Cristiano Allam for inviting me to this important meeting.
I will speak in English, and this is somewhat ironic. Why? Because English is the language of a country where the economic science was born, at least the economic science as we know it, and that, perhaps for that reason, did not enter the euro, and is seriously considering to leave the European Union. It is perhaps paradoxical to remark that in order to be understood by the largest share of European citizens, I have to use the language of this country. This is an important lesson for those who believe in the United States of Europe as a real possibility. And there are two lessons in that. The first is that you are a majority of Italian people, so the most democratic solution would be for me to speak in Italian. But I am giving you a lesson of European politics. I belong to an elite, and I am proud of it, and I decide for you: I will speak in English, and that is the first lesson. The second lesson is that I am not against Europe. I can travel across Europe, and speak in their languages with most of the people I meet. It was funny, the first time I went to Portugal, my son said to my wife: “Mom, that’s the first country where dad cannot speak the language of the people we meet!”. That is true, because unfortunately I cannot speak Portuguese and I cannot understand it. But with English you can travel all around the world.
So, now, that was the premise. Let us go ahead with the content of my presentation. I will try to put things in perspective, and the first thing I will show you is that financial imbalances, debt crises, very often come out of income distribution imbalances. This is something that should not be underrated, because it gives us a positive message about what should we do once we leave the euro. The second point is that the alliance between a single currency and economic reforms is very uneasy. We were told that the single currency would have forced us to make the reforms that we badly needed, but you should know now that the economic literature gives us many arguments to put forward the opposite argument, namely that fixed exchange rate, or a single currency, are very useful to delay economic reforms.
Then I will move on and give two lessons that we have received from the crisis. The first lesson is that we should start from a reform of the labor market at the European level, and of course that we should remove the euro. These are two necessary conditions, for the reasons that I will briefly show you and that were partly explained by Antonio and Claudio.
Just another premise. The Eurozone crisis finds its root in private finance. The financial imbalances in the private sector were fostered by competitiveness problems and unregulated financial markets. It is a completely fake argument to present the Eurozone crisis as a public debt crisis, and it is not Claudio Borghi Aquilini who made this statement, but Vitor Constancio. Who is Vitor Constancio? He is the Vice-president of the ECB. So, let us hear the word of the Lord, with a capital “L”. Point 1: “imbalances originated mostly from rising private sector expenditure...”; point 2: “financed by the banking sector of the lending and borrowing countries”; point 3: “European financial markets did not perform according to the theory” (let me add a cautionary remark: according to his theory, because many economists had foreseen what is happening now); point 4 “exposure to stressed countries more than quintupled” (and this is what Claudio showed; by the way, he also showed that Italy was the country least involved in this massive explosion of foreign debt); finally: “this led to loss of competitiveness”.
My summary is that peripheral economies were doped by external debt, i.e., they were doped by credit from “core” countries. Vitor Constancio said that in Athens, on May 23rd 2013.
You do not need to applaud me: it is very trivial. Anything I will say today is very trivial. Any economist knows that, believe me. Not Mario Draghi: believe me.
Let us go ahead.
Primary public expenditure in the Eurozone. Italy is very often blamed by people coming from Northern countries, from mosquitoes exporters, for being the country with the most profligate public sector. This is simply not true.
Have a look at those data: Italy has a public expenditure-to-GDP ratio which is very close and under the Eurozone average, if you consider primary public expenditure. If you consider total expenditure the situation worsens but not that much. And now have a look at another detail: France, Finland, Austria, Belgium, Germany, the Netherlands, the so-called virtuous countries, did expend much more, as a ratio of their GDPs, than Italy, and more than the supposed Pigs (Portugal, Ireland, Greece, Spain). I suppose that you did not know those data. Many people do not know those data. But they are important, because they are showing you that a whole political class, a whole media system, is lying to you. And we are in democracy. Let us go ahead.
A mantra. We live in a mantra economy. The mantra is that we must become more competitive, therefore we must compress labor costs (why? Because raw material costs are in most cases exogenous, so we must insist on labor costs), and we must become more productive.
So, let us have a look at the historical experience of an advanced country, which is very often quoted as an example for us. Why? Because we think that our problems can be solved by becoming the United States of Europe. Let us have a look at what happened in the United States of America.
That is an interesting graph in my opinion. In blue you have labor productivity, and in red you have real wages. They are indexes going from 1890 to 2007, namely to the beginning of the crisis, and what you see is that there were period in which productivity grew faster than real wages, especially at the end of the sample. If you believe in the mantra, that should have been periods of prosperity. Why? Because a country were productivity grows, while real wages stagnate, becomes more competitive. Now, have a look at this table. I took the average growth rates. I know we are in a political institutions, where numbers are perhaps not very welcome, but it pays to have a little look at those data.
I stressed in red the two periods in which labor productivity grew faster than real wages. The first period was from 1919 to 1932, namely in the eve of Wall Street crash. The second period was from 1971 to 2011, namely in the eve of Lehmann crash. And we had real wages growing faster than productivity in the New Deal period, and we had real wages growing at the same rate than productivity after World War II, in the period in which the United States liquidated the massive amount of war debts that were accumulated in order to free Europe from you know what.
So, the question is: why do things go wrong when we behave well? Why we do have a crisis at the end of periods in which we are so competitive? And there is a simple answer: because capitalism works if there is enough aggregate demand. You do not produce in order to produce, you produce in order to sell. The problem is that if you repress wages, demand has to be financed through indebtedness. And there are many kind of indebtedness that you can use for that purpose. If you are Keynesian, you may perhaps want to use public debt, and this happened in the United States. Well, it may seem ironic, but it actually happened under the Republican rule of Ronald Reagan, and the same happened in Italy. If you are so to speak a “liberist”, a liberal, well, a right-wing economist, you may appreciate private debt, and say “Yes, free up capital movement, let finance work”. If you are German, you will use someone else’s debt, and adopt a mercantilist policy. Lend money to the other people, and have the other people buy your goods (and repress wages at home). This is what Germany did, and it is very clever, I do not contest that, but it leads to an unstable system, and we are now paying the price for that instability.
The fall of the wage share in the period of the third globalization was a general phenomenon, all around the world. You have it in the USA, in Germany, France, Italy. The most important fall from 1991 to 2007 was in Germany, -8 percentage points, and in Italy, -5 percentage points, but everywhere we had that. The problem is that wage repression is sometimes a beggar-thy-neighbour policy, because you make wage dumping in order to become more competitive and to sell more abroad, but it is always a beggar-thyself policy, because wage repression destroys the domestic market. And destroying the domestic market goes against the logic of the European Union. Why? Because as Alberto Alesina, who teaches at Harvard, not at the Gabriele D’Annunzio University, put it very clearly in 1997, when he was against the euro, the main benefit of an economic union is to enjoy a large domestic market, which can act as a buffer against external shocks (here, in his comment to Obstfeld's paper). I mean, there is recession somewhere in the world, but you will continue to grow because you have enough demand at home, if you are a big market. Now, this did not happen in the Eurozone, why? Because it was managed as a zero-sum game, where what Germany won was lost by the Southern countries, as Claudio has so clearly explained.
And now we are going from a zero-sum game to a negative-sum game. I mean, the euro is a walking dead, and you see that from that graph, that was published in the Washington Post:
You see that after the Lehman shock the United States, the euro area and Japan fell together. Then they resumed growth. Then there was Fukushima in Japan, Mario Monti in Italy, and the troika in the Eurozone. The tsunami lasted for one day, and afterwards Japan resumed growth. The troika is still in power in Europe, and what is really frightening is that this walking dead is walking in the wrong direction: it should go up, and it is going down. Mind that graph!
What is really sad from an academic economist point of view is that this outcome was foreseen by economic theory, and we know very well that politicians decided to take a decision that was against economic logic, because by hindering or altering the functioning of markets, the single currency has perverse effects on both the public and the private sector of both the weak and the strong member countries. You should never forget that, because all these effects are and were well known, they are less evident for strong countries, but they are still there, and it is for that reason, for its perverse effects on strong countries, that I believe that the euro will quite soon come to an end.
What are the perverse effects on weak countries? It is quite the contrary of what was told us, namely that a strong currency would have a discipline effect on the public sector. The economic literature tells us that things go exactly the other way round. Why? Because if you adopt a fixed exchange rate, and your government makes too expansionary a fiscal policy, you do not have any effect on the Forex market, because the exchange rate is fixed. If instead the exchange rate is flexible, once the country engages itself an a too expansionary monetary or fiscal policy, it will get indebted with the rest of the world, and the exchange rate will devaluate. In that case the depreciation of the exchange rate gives to the markets an immediate signal that something is going wrong. Why on Earth did people continue to lend money to Greece at a huge pace, some 10% of Greece GDP for years and years? Because Greece was credible. Why? Because it had the euro, it had a fixed exchange rate, and there was no signal that could come from the currency market that things were going wrong. This is the problem, and this is what Tornell and Velasco explained in the Journal of Monetary Economics (it is not the Pravda or the journal of any little Italian province: is a leading journal in the field of monetary economics, published by Elsevier). There is another problem, that was stressed by Martin Feldstein in the Journal of Policy Modeling, and it is that if you adopt a single currency, you will have more or less a single interest rate, and that interest rate will be too low for weak countries. We are now blamed by Germany for having enjoyed too easy credit conditions, and that is true, but that is the very argument against the logic of the euro, because different countries must have different interest rates, in order to manage their economies well. And also the private sector in weak countries has an incentive to take too much debt, and this is basically what Vitor Constancio told (at the beginning of my presentation), and this is an argument that was put forward very clearly by Roberto Frenkel and Martin Rapetti in the Cambridge Journal of Economics four years ago.
But there are also perverse effects on strong countries. This is important, because if you remove the exchange rate risk and the exchange rate signals, the private financial institutions of strong countries will lend too much abroad. German banks lent too much abroad. I mean: you cannot take too much debt, if someone is not lending too much. Have you ever tried to get some money from your bank? Ok, you know that!
But there is another bad incentive that comes from the single currency, because the single currency is too weak for Northern countries, has Claudio has explained very clearly, and this means that it allows countries like Germany to make huge profits out of an undervalued currency, and for that reason those countries do not have incentives to invest anymore, and the private non-financial sector of strong countries will invest too little at home. It is Hans-Werner Sinn, a German economist, who made this argument, it is not an “envious” American economist or a “lazy” Italian economist. It is a strong, very professional and very clever, I really admire him (well, not always), German economist.
Have a look at the data: Germany is the country with the lowest investment-to-Gdp ratio in Europe, in the period from 1999 to 2007. Forget the fairy tale of Germany being competitive because it invests a lot, please do forget that.
What did Germany do?
Germany did a very standard “beggar-thy-neighbour” income policy. You know, we are blamed because we did not do structural reforms. What are structural reforms? They are paying the workers a little less. Germany did that starting in 2002. Here you have the graphs of the wage shares (in Italian: quote salari), Germany is in black, and you see what its wage share did from 2002 to 2007after the so-called structural reforms put forward by Hartz, who seems to have had habits very similar to those of Berlusconi, but this is another question, I will not enter into gossip. Have a look: it is impressive! By lowering wages they became competitive. Why? Because the exchange rate was fixed. We will come on that later.
But “beggar-thy-neighbour” income policies have hidden social costs. Look at that.
This is the graph of income inequality in Germany. Have a look at how fast it rises after the adoption of the so-called structural reforms. There is a growing inequality in Germany, it is the country where inequality grew much in the euro period, there is a growing poverty, there is a growing divide between West and East, and between workers with typical and atypical contracts.
There are two necessary conditions to overcome the crisis.
The first one is to harmonize the member countries labor markets by bringing real wages again in line with labor productivity, everywhere in the Eurozone, because if a country plays the dirty game of Germany by compressing real wage dynamics under productivity dynamics, things will suddenly come to an end. We will have to re-regulate the European financial markets, and we have to dismantle the euro now, for both short-run reasons, and long-run reasons. Let us take these points in some depth.
(Source: Reinhart, C., Sbrancia, B., 2011, "The liquidation of government debt", BIS Working Papers, N. 363).
Have a look at the red line here: it is one century of sovereign debt in advanced countries. We have two peaks. Look at this period (red box): this is the period where advanced countries liquidated the huge debt that had been accumulated because of World War II. It is a period that lasts from 1946 to 1971. Now, this is the current period (green box): you see that we have a sudden rise of public debt. Why? Because the need to rescue private finance imposed to the governments a huge effort, that translated into a massive and sudden accumulation of public debt. We are now, as far as public debt is concerned, in a situation which is very similar to that we had experienced at the end of World War II. What happened the first time we reached such a high peak in sovereign debt? What did the government do? Two things. The first one is what we have seen before. This is the period in which real wages grew in line with productivity, so we had a fair distribution of income, and the second thing is that they regulated financial markets. Let us take this point. The liquidation of the huge post-WWII debt was made possible by two things: the first one is what economists call financial repression, I would rather call it financial regulation. Carmen Reinhart and Belen Sbrancia made this point in their 2011 paper. The second point is that in that period we had a fair distribution of revenues: we had capitalism working as capitalism pretends or claims to work, namely, by paying the factors of production according to their productivity. This made possible growth, and this made possible the liquidation of debt, because any problem of debt is always a problem of the growth of income.
What does financial repression mean? We should re-introduce, for instance, some kind of Glass-Steagall regulation, by separating commercial banks from investment banks. The German model of universal bank did not work. We should rethink central banking: central bank independence has been finger pointed by some economists, like Josef Stiglitz, or Axel Leijonhufvud, who is less known to the general public, but it is a very important Keynesian economist, as a threat to democracy.
What does it mean a fair distribution of income? Well, there are many proposals for that, I will take one from a German economist, Eckhard Hein, just to show you that German people are not my enemies, they are my friends, because we are all living in the same world, and for a very short life, and there is no point to make this short life a bad life, when we have technical means to live much better. Fair distribution means that nominal wages should rise at the rate of growth of productivity plus an inflation target, if we decide to keep the same inflation target.
This is what fair distribution of revenues mean.
The euro is a walking dead. If you noticed the declarations by Jens Weidmann, the governor of the Bundesbank, when he told that the next stress test on the banking sector will be performed by allowing for different risk coefficients for sovereign bonds, this means that the “whatever it takes” statement by Mario Draghi was a bluff, because if Mario Draghi was right, government bonds would be riskless. That means that in Germany some people are getting sick of that situation, and want to dismantle the euro, and the declarations by Hans-Werner Sinn, that Berlusconi was sacked because he was preparing a euro exit for Italy, are also very telling in this respect. Sinn has always said that Southern countries should go out of the euro, and he is a German economist. If he makes such a statement it is a very important political signal.
There are short-run reasons for dismantling the euro, because exchange rates allow for a symmetric rebalancing of the huge imbalances that have been accumulated during the euro period. But there are also long-run reasons. In order to integrate their economies, the European countries cannot give up two features of the flexible exchange rate: the signaling feature, namely the fact that the flexible exchange rate gives a quick and clear signal to the markets if something is going wrong in a country; and the enforcement feature.
What do we mean by “enforcement”: well, James Meade told that very clearly in 1957, before winning the Nobel prize in 1977. He is an important economist, that was forgotten, but in my book I end my political proposal by using a paper which was written in the same year in which Rome Treaties were signed. What does Meade say? He says that if some European national government is going to use monetary or budgetary policy for purposes of domestic stabilization, if for example, look at that sentence: “in their present situation of balance-of-payments surplus the German authorities are nevertheless going to use their monetary policy to prevent a domestic inflation, and if it is desired to avoid the use of quantitative import restrictions on trade... a greater use of the weapon of exchange rate variation will have to be made”. Exchange rate variation is a defensive weapon against the non-cooperative behavior of the other member States of an economic union, and it is the most effective, because in front of such a huge wage dumping policy, as the one practiced by Germany with the Hartz reforms, its nominal exchange rate would have appreciated. Well, you are the good guys, you did the reforms, that’s good, your goods are more affordable, fine, we will buy them, wonderful, you are a surplus country, bravo, clap the hands, but if in order to buy German goods we had to buy German currency, the German currency would appreciate, and that would re-establish an equilibrium. And it is a market! We are living in a Soviet system, where we have planned the most important price for an economy, the price of its currency.
What should you do as European MPs? Since by defending the euro at any cost this Commission is destroying any prospect of survival of the European Union, you should exercise your power of censure and force the European Commission to resign, because it is destroying Europe, and this is not what the European Commission is supposed to do. You may lack the numbers to do so now, but after the next elections, things could change, as I had foreseen two years ago, and if you do not signal your dissent for this situation, you will take a political risk and you will probably have to pay a political cost.
Mind the gap, and good luck!