Tuesday, 29 November 2011

Fast track union changes will not help

France and Germany are pushing on with fast-track treaty changes, trying to find the loopholes that will allow the Euro-zone to impose German-style budget discipline on the other member countries without being bogged down by democratic procedure.

Presumably it means that the ECB subsequently will be allowed to act like a central bank. Or at least one hopes.

I  have come to believe that Germany still does not get it. The German policy is consistent, but wrong. The method for budget discipline now being pushed is just an ├╝ber-version of the tragically mis-named “Growth and Stability Pact” (PSG), Germany’s contribution to the euro from 1997.

Already back then, economists pointed out, that the PSG would be procyclical. It means that a country typically runs a (bigger) budget deficit in a period of slow or negative growth. The PSG was then intended to impose cut-backs on countries already having economic problems. It would deepen the problems, hence causing even bigger cyclical swings on the country in question.

We all know that the PSG was largely ignored – even by Germany, when it found it necessary.

It is correct that budget discipline and a manageable government debt are necessary for long term stability. But it will not work to impose deflationary policies on the other Euro-zone countries, when growth is desperately needed to in order to grow out of the deficit situation.

In order to balance the European economy, Germany needs to support the weaker Euro members with long term loans to the most needy and by adding to domestic German demand.

I agree with the German vision that it is better to have an economy based on producing things people actually need. But structural changes cannot be introduced quickly. Greece and Portugal will probably never be efficient producers of reliable hairdryers, much less advanced tool machines and industrial robots. Such changes take years, and in the meantime economic growth will be depressed.

So here is a yardstick by which you can measure the various ideas being touted in the press. It is good news if it brings us closer towards one of following:
  • Long-term loans to the countries in problems
  • Stimulation of demand in the countries that can afford it
  • Co-ordination of economic policies to stimulate demand
  • Help to structural development where needed
  • ECB to assume the role of a real central bank.

If a new policy idea or international agreement does not bring us closer to any of those elements, it is either bad news or quite simply irrelevant.

Whether this will end in a deep depression (as the OECD warned yesterday) or a long period of slow growth, nobody knows yet. But if the scale tips towards the depression outcome, Germany will suffer more than believed today. Ouch!

No comments: