Economics and politics - comment and analysis
10. April 2015 I Friederike Spiecker I Economic Policy, Europe

How should better governance of the EMU look like? (Part III)

This is the (updated) translation of an article that was published March 24, 2015 on flassbeck-economics. We are publishing one article in English every week to allow more readers to follow closely our analysis of global and European events. However, translation is not free and we have to ask for a contribution from our English speaking readers also.

This is the third part of my discussion of the paper “Preparing for Next Steps on Better Economic Governance in the Euro Area”, which was used at an informal gathering of the European Council in Brussels a couple of weeks ago. The first and the second part are here.

In the third section of the ‘Analytical Note,’ the authors list five reforms of the regulatory framework that have been implemented in order to combat the economic crisis in Europe. The authors add that, in their view, if these regulatory mechanisms had existed ten years earlier, the development of the EMU, both before and after the financial crisis, would have led to significantly better results. Is this an admission that they did not do their work in a proper way? They refer to the European Stability Mechanism (ESM), the Banking Union under the supervision of the ECB, the Macroeconomic Imbalance Procedure (MIP), the Fiscal Compact and the further development of the European statistics agency Eurostat. In my opinion, only the MIP is relevant to this discussion because it is this procedure that stood and continues to stand in the way of solving the euro crisis. However, the MIP is not criticised in the EU text. It only mentions that the further development of the MIP would lead to more powerful early stage detections of macroeconomic weaknesses (”vulnerabilities”), so that the best instruments can be selected in order to correct them.

But here the trouble starts again. The paper is silent about the macroeconomic ”vulnerabilities” the MIP is supposed to detect. There is nothing in this text about which (new or updated?) instruments could be used or developed to remedy or eliminate these ”vulnerabilities” (also note the choice of the word: we are not talking about anything like structural deficiencies, but about the gradual elimination of ”vulnerabilities” within a system which in itself is not questioned). But this is, of course, the whole problem. It is exactly here that the opinions differ so widely that they are impossible to reconcile. Germany, for example, succeeded in ensuring that current account deficits and surpluses are assessed asymmetrically (surpluses are fine but deficits are a major problem), so that its exuberant excesses will not be subject of any European countermeasures. This highly controversial point, which goes to heart of the whole matter, is not mentioned in the paper and there is a reason for this: the last thing the authors want is to stimulate a debate on economic policy within the EU, let alone a change of the macroeconomic regime. Instead, there are some vague, not to say meaningless, considerations about the working of the MIP. It could have prevented (or, at least, mitigated) the crisis of competitiveness, although how exactly remains a secret. Instead the motto seems to be to ignore the problem until the consequences become unbearable and then proceed with the implementation of ”reform programs” in the crisis countries.

In the fourth section, ‘Where do we stand now?’ the following chart (Chart 5 on page 6) stands out. It shows the average annual growth rate of GDP per capita in different countries from 1995 to 2004 and from 2005 to 2014. The countries are listed according to their growth rate from left to right: Germany on the left and countries with very small or negative growth on the right. Here is the original chart:


The reader will note that the per capita growth rate was positive for both periods in three of the seven countries as well as for the euro area (EA) as a whole, although growth was significantly weaker in the second period in each country, except Germany. In Portugal and Spain, the growth rate was only slightly negative for the last decade, after a first decade of decent economic growth. But in Italy and Greece the growth rate was negative (-1 % for Italy and – 2 % for Greece). This is certainly worrying, but the negative growth of the second period is still compensated in both countries by the positive growth during the first period (there are small differences: if Eurostat data from November 2014 are used, Greece’s negative growth was about – 2.2, slightly worse than the figure in the paper. But perhaps this information was too recent to be included in the paper).

These data reminds us of the introduction of the paper. Here, the authors made the point that the monetary union can only continue to exist if its benefits outweigh its disadvantages for the majority of the citizens in every member country in the longer run. The graph seems to prove exactly this point.

However, closer inspection casts mortal doubt on its validity. The problem is not the pro capita figures and their evolution over time, but the division of the two periods. The EMU has nothing to do with the four years before 1999 – it did not exist then. So, why are the years from 1995 to 1998 included in an assessment that deals with the performance of the EMU? Secondly, on which basis did the authors decide to end the first period and start the second one in 2005? Why 2005? The financial crisis broke out in 2008. Every other graph uses 2009 as a starting point. The explanation accompanying the chart doesn’t deal with the evolution of unit labour costs during these decades. It does not mention the rigidity index about which the paper made so much fuzz in an earlier section. It is silent about the evolution of debt levels.

Why does the graph not present per capita growth rates from 1999 to 2008 and from 2008 to 2014? I produced my own version of Chart 5 in order to give the reader an idea of how much this changes the whole picture.

Abb BIP pc

For this graph, no figures from before 1999 were used and the two periods refer to before and after the outbreak of the financial crisis – the logical caesura. It shows a very different picture. It makes the point that the EU is so eager to make – that on average, citizens from all the countries within the EMU benefited from being in it – much more difficult to accept. It is obvious that this is certainly not the case for Greece or for Italy and only very slightly so for Portugal. It is also clear that the only country that could avoid falling income after 2008 is Germany, although Germany’s positive growth after 2008 is nothing to write home about either. The authors choose to cover this up. They carefully construed a graph that is meant to hide the truth. As we said before, the last thing the authors want is to send out an invitation to question their economic policies.

In my opinion, the next graph – graph 6 on page 6 – should win a prize for the complete misunderstanding of the matter under discussion. Here, private and public debts (as of June 2014) are compared to the annual average potential growth for the period 2015-2019 for 19 European countries. (Note that what is given here is not a normal prognosis. The authors confuse potential real growth with hypothetical growth that could materialise if conditions were different). The graph does not produce annual growth forecasts over the next five years (as scenarios and prognoses are meant to do). Instead, the graph deals with arbitrary potential increases of economic capacity that may materialise on the supply side. It is not even a theoretical speculation, it is a mechanical exercise without any meaning.


The authors insinuate the existence of an inverse positive correlation between the potential growth of a country and its current debt level. The higher the current debt, the lower the growth potential. But the graph does not show this. The cloud of points representing the countries seems to show little or no correlation. A regression line is expected to be more or less steep. If it does not have good statistical support, it is wiser to not draw it. There is no correlation here. For example, Italy, which has a debt level that is comparable to both France and Great Britain, is given an average growth potential of about 0.3 per cent annually for the next five years. However, for France the average growth potential is about 1.3 per cent. For the UK it is about 2.3 per cent. According to the forecast, Germany will not accomplish much more than France, although German debt is significantly lower than the debt of France. It follows that the Commission itself cannot find a close relationship between debt and growth potential. Otherwise, it would not deal with other growth factors. But why then, the reader asks, is this graph even in the text? It just looks like clumsy work – and do not forget: this a document from the very highest EU policy level.

The problem is not only that it is not clear what this graph is trying to prove. What is really questionable is that it is not even clear, which debt levels the EU is talking about here. It is a moot point. If it is the sum of the public and the private debt of a country, the sum total of the debt of the three economic actors, government, households and private companies, as we can assume, how is it then possible that Germany, which according to the graph has a debt of nearly 200 per cent of its GDP, has a positive net asset balance abroad according to statistics from the Deutsche Bundesbank?

If we consider that the household sector fiscal balance was positive for decades in Germany and that the savings rate of total household was positive throughout, we wonder about the debtors to be found behind the 200-percent GDP German debt. The German government is known to be in debt for less than 80 per cent of GDP. The remaining 120 per cent of GDP debt is the difference between the total assets of households and a huge debt mountain of private enterprises (which had in turn, miraculously, as a sector, also a positive fiscal balance for many years). But even if German companies would have accumulated such a gigantic debt, the question needs to be asked: who are the creditors of this debt of 120 per cent of German GDP. It cannot be foreign countries because they are net debtors in relation to Germany.

The only answer that makes logical sense is that the reported figures represent the gross debt of all sectors together. But what do these numbers tell us if only one side of the coin is added up? Does it tell us that the financial relations between sectors of a national economy on the one hand and between several national economies on the other hand tend to change over time? Has the difference to do with the total capital stock or with the degree of the division of labour? What does the ”potential” growth of a country even signify (the forecasts and even measurements of which we, at flassbeck-economics, consider questionable anyway)? Or is it that a relatively high gross debt of a country reflects a strong involvement in financial speculation (which inhibits growth)? If this is the case, why are the forecasts for Luxemburg and Ireland so positive? These are all necessary questions. No answer is being provided. The point that the authors of the ‘Analytical Note’ are trying to make remains completely in the dark. The authors present it as evidence for the ”structural reforms” that they advocate, especially reforms of the countries with poor growth potential and high level debt levels. At this point, predictably, the four presidents refer again to their favourite topic, the further flexibilization of labour and product markets. However, as everyone can read from the chart, debt is indifferent to such flexibilization.

The authors present their general conclusions in the last part of the paper. In the short term, they aim for a consistent strategy within the wider framework of the “virtuous triangle” of structural reforms, investments and fiscal responsibility. This ‘triangle’ will lead to effective, growth-promoting, structural change. The proper working of the internal market has to be improved (through greater mobility of labour, the elimination of barriers to investment and the further elimination of barriers to the free movement of capital). The authors opine that, if all relevant actors would support this program, significant change could be accomplished: the effort would ”contribute” to a reasonable functioning of the EMU within 18 months. In the short term, they conclude, both labour and products markets have to become more flexible. It seems to be just a matter of everyone having to work sufficiently hard. If that happens, the euro will be safe.

In the long term, the EMU framework has to become more robust. The authors provide a list of questions dealing with the development of this framework. The list may give the reader the idea that the authors want to think through the regulatory framework of the monetary union: what are the fundamental problems and which policies and instruments can be developed to deal with them? What are the basic conditions to make the monetary union work? How can the steady progress of the prices levels within the member countries be controlled? What is to be done about the relationship between labour costs and trade surpluses and deficits? Unfortunately, there is nothing in the whole text that would deal with these problems – exactly those problems that need to be solved. It is sad to note, but there can be no doubt that the euro crisis will remain unresolved if papers like this one are produced a the highest level. The European leadership does not understand and does not want to understand the fatal deficiencies of the EMU. Hence, they are not willing to consider the fundamental changes to the overall framework of the EMU that are urgently needed.

Translation W. Denayer