A blog on the political, economic and social causes and implications of the crisis in the Southern periphery of the Eurozone.

I'm a political scientist working on political parties and elections, social and economic policy and political corruption, with a particular focus on Italy and Spain. For more details on my work, see CV here, and LSE homepage here. For media or consultancy enquiries, please email J.R.Hopkin@lse.ac.uk.

Saturday, December 24, 2011

Peter Hall tells it how it is

Excellent analysis of the Euro crisis by Peter Hall. In particular, he summarizes the macroeconomic imbalances, and their inevitability, very succinctly here:

In the past, (Southern Europe followed) growth strategies led by domestic demand and then devaluing their currencies to offset the inflationary effects of such strategies on their external competitiveness. In EMU, they were unable to do that. Instead, not unreasonably, they took advantage of the cheap credit flowing from northern Europe to promote economic growth. But, unable to offset the inflationary effects through devaluation, they lost competitive advantage to the north. The result can be seen in the gross imbalance of payments between the two parts of the Eurozone.

Pity so few influential policy-makers seem to have figured this one out.

Thursday, December 22, 2011

Print and be damned

It looks that the ECB is finally, by a circuitous route, doing what needs to be done. It remains to be seen whether it will do enough, but the combination of nearly half a trillion euros - in one day - in cheap loans to banks, with the acceptance of troubled sovereign debt as collateral, is a step in the right direction. The direction, that is, of acting as a lender of last resort, despite German protestations.

This is a smart move by Mario Draghi, who talked tough on bail-outs, then effectively ate his words, but did so in such a way as to leave most German voters unsure as to what has really happened.

Anyway, this is just a start. The austerity medicine will still depress Southern European economies, and monetizing slices of their debt just as we approach the abyss is not exactly going to resolve the problem.

Wednesday, December 21, 2011

Is there such a thing as moral hazard for nations?

Just in case you needed any more reasons to oppose austerity, here's another, outlined in this neat and evocative Guardian piece ('Europeans migrate south as continent drifts deeper into crisis): emigration.

Yes, in a development that has probably never occurred to Europe's blinkered political leaders but is blindingly obvious to anyone residing in the real world, young, ambitious and dynamic European citizens are escaping from the misery of austerity and seeking a new life elsewhere, often outside the EU. It is hardly worth pointing out the obvious implication - that austerity is even less likely to work if the most productive sections of society are bailing out and leaving the pain behind.

This is neat in all sorts of ways, but what I find intriguing about it is the stark distinction it draws between the collective responsibility of debtor nations and the individual responsibilities of their citizens. So Greece must suffer for its mistakes, otherwise moral hazard will encourage it to behave badly in the future; but of course there is nothing stopping individual Greeks leaving the sinking ship and evading the punishment.

This reminds me of a neat piece of prose on the crisis by John Lanchester, who has made more sense out of this mess than many economists. In a piece published in the London Review of Books last summer, he noted the following:

From the worm’s-eye perspective which most of us inhabit, the general feeling about this new turn in the economic crisis is one of bewilderment. I’ve encountered this in Iceland and in Ireland and in the UK: a sense of alienation and incomprehension and done-unto-ness. People feel they have very little economic or political agency, very little control over their own lives; during the boom times, nobody told them this was an unsustainable bubble until it was already too late.

In consequence, people don't feel that the crisis was in any real sense caused by them:

The austerity is supposed to be a consequence of us all having had it a little bit too easy (this is an attitude which is only very gently implied in public, but it’s there, and in private it is sometimes spelled out). But the thing is, most of us don’t feel we did have it particularly easy. When you combine that with the fact that we have so little real agency in our economic lives, we tend to feel we don’t deserve much of the blame. 

It's difficult to argue with this. But irrespective of whatever moral responsibility an individual Greek may bear, there is no law whatsoever against him or her leaving the country and starting afresh, washing their hands of the whole mess.

A kind of citizen's default. So much for moral hazard.

Saturday, December 10, 2011

One step from disaster

A pretty good assessment of yesterday's summit outcome from Tim Duy's Fed Watch (via Mark Thoma).

In the end, this mess is entirely a political one. Not that economists aren't in large part to blame, but the key point is that some economists have figured out what the answer is, but too many politicians find it convenient to stick to the line that made some kind of sense until 3 years ago, but makes no sense at all now.

So what we need is a theory of economic policy lunacy.

Thursday, December 8, 2011

Weber's revenge


Markets have faith in Protestants (% of Protestants in population, by logged 5 year CDS price today).
The Rsq without Greece is .45, meaning that Protestantism predicts almost half the variation in the log of CDS prices.

Quite why Protestantism is related to the perception of fiscal responsibility is one for another post.

Tuesday, December 6, 2011

Ever closer union

The Guardian reports that Radical eurozone shakeup could see Brussels get austerity powers.

Is this really what 'ever closer union' was supposed to mean...?

Monday, December 5, 2011

When will Germany start living beyond its means?

In most of my posts on the southern Europe debt crisis I've focused on the contractionary nature of fiscal retrenchment, and the 'paradox of thrift' it engenders - that by retrenching, Southern Europe risks shrinking its GDP, thus cancelling out any putative gains from austerity.

Paul Krugman, in response to Ezra Kleinreminds us that there is another big obstacle to this strategy: that Southern Europe cannot recover without unwinding its trade deficit, and its trade deficit is the counterparty to the German trade surplus.

In other words, are the Germans willing to run a trade deficit to make this happen? Because if they are not, it's not going to work. And nothing I've heard out of Berlin recently sounds like coming close to recognizing this.

Elementary, Signor Monti

Fascinating stuff - yields on Italian debt dropped sharply today (FT Alphaville » Signor Monti, sensazionale). Monti's €27 billion of contractionary budget cuts and tax rises really did the trick...

The fact that Spain's yields did much the same suggests a momentum behind the Euro crisis management strategy of Merkel and Sarkozy. It also suggests that should this week's summit fail, we could pretty quickly be back to where we started last week.

All of this goes to show that policy's real effects seem to matter less than their effects on expectations, and that countries like Italy and Spain are only at risk of default if markets think they are at risk of default. There is nothing remotely rational about our current financial arrangements.

'via Blog this'

Munchau is depressed

Reading Wolfgang Munchau is not a lot of fun at the moment. His doom-laden pronouncements are all the more depressing for the fact that he is almost certainly right to predict that France and Germany look set to fudge it yet again.

In any case, at least the scenario is becoming clearer. The ECB will probably act if given the political backing, as Draghi suggested the other day. But Merkel only seems to want ECB action if the Southern Europeans commit to open-ended austerity. This is politically implausible, as well as being almost certainly economically counter-productive.

So here we are. If we were a game theorist, I could probably write a nice paper about this. It's basically a Prisoner's Dilemma game, but I fear it's an unbalanced one, because I'm not sure the Germans even understand what the cooperative outcome would be. So they dig in their heels.

Let's just hope they blink, because they're going to be dragged down by this as much as anyone else. What price those years of 'sacrifice' for competitiveness if they end up with a Swiss exchange rate and an insolvent banking system?

Sunday, December 4, 2011

The Monti treatment

Contractionary measures for contractionary times (Monti outlines tough measures for Italy). €27 billion taken out of a stressed economy, which is also suffering financial uncertainty on a colossal scale.

Can any of this work? Yes, but only as an offer to the Gods of austerity, giving them the political offer to authorize a monetary bailout through the ECB.

Peculiar how entirely irrational policies can become rational, if they are designed to encourage irrational leaders to do rational things.

Wednesday, November 30, 2011

Feldstein on Italy

Martin Feldstein weighs in on the Euro crisis (Italy can save itself and the euro), and makes some interesting points.

First, as Feldstein notes, Italy has a huge stock of debt, but it's flow situation is not that bad - it has been running a large primary surplus for years, unlike Greece. It could reduce its deficit and enhance market confidence with realistic adjustments to taxation and spending. This is an important point, since the measures asked of Greece are truly impossible to successfully implement.

Feldstein also makes another good point - that with public spending running at half of GDP, there must be savings that Italy can make somewhere. This is clearly true: Italy has a public sector that wastes resources on a truly awesome scale. However, it is also true that any major cuts will be contractionary in the current climate, and could reduce what little growth Italy has in store.

And that brings us to another point. As Feldstein shows, that required fiscal adjustment, with measures taken to increase growth, could quickly rebalance the situation. But if the reforms needed were so easy to achieve, maybe they would have been implemented already, given Italy's poor economic performance over the past two decades. Clearly, the time for such reforms was in the more buoyant climate of the late 1990s and early 2000s - now they will probably have contractionary effects.

That all said, there is a lot of low-hanging fruit when it comes to possible reforms. More women could be encouraged in the labour force very easily (see the weird but interesting proposal by Alesina and Inchino to reduce employment taxes for women), competition could be usefully introduced into some closed markets (the 'professions', local transport, retail). A bonfire of pointless regulations could save a lot of time and energy for businesses and citizens and allow resources to be deployed more productively.

The trouble is, there is at present no political constituency for these measures. The majority position in Italy is economic and cultural conservatism, with occasional bursts of intolerance towards groups such as immigrants that are key to the country's future. Berlusconismo has to be defeated before anything good can happen.

Monday, November 28, 2011

The Euro elite

Reuters reports that Germany is planning 'elite' bonds with 5 nations. So this is still all about saving Germany's skin? The only reason to be hopeful about a development like this would be if it was a preliminary step to a bailout of the periphery. But that bailout needs ECB intervention, and I can't see how a 'hard' Eurobond makes any difference to that.

Saturday, November 26, 2011

The German burden

Paul Krugman once again puts the boot in (Mysterious Europe). What occurs to me reading this post is that ultimately all that the Germans would be required to do to resolve the problem is allow the ECB to backstop Southern European debt, and in the meantime spend some (preferably all) of their surplus on Southern European products.

So, we are inviting the Germans to spend some nice holidays in Greece and Spain, preferably eating lots of good local food, and buy a bunch of Gucci handbags and the odd Ferrari.

Is that really so much of a sacrifice?

'via Blog this'

Thursday, November 24, 2011

Understanding the Euromess

Great lecture from Barry Eichengreen - Europe's Never Ending Crisis (link courtesy of Mark Thoma). All you need to understand the basics of what is going on in Europe.

Wednesday, November 23, 2011

Chart of the week

Here's great chart courtesy of Nick Andrews. It shows the bond yields for Eurozone countries from the early 1990s to the present:



Yet further proof of the efficient markets hypothesis, if you ask me.

Reform, reform, reform!

The technocratic turn in the Euro crisis has brought us yet more talk of 'reform'. German central bankers grimly warn that there can be no quick fixes and that debtor countries must 'reform' in order to save the euro. But what do they mean by reform?

There is a deep irony in all of this. Germany spent close to two decades being lectured by the Anglo-Saxons about 'reform' - the German social market economy, based on social partnership, long-term investment, strong social protection and a heavily regulated service sector, were singled out by neoliberals as the reason for Germany's weak economic performance after reunification. And Germany did reform - the Hartz measures moved the German social model in a more liberal direction, permitting the creation of more low skilled and low paid jobs and reducing welfare entitlements, at least for some workers. And lo and behold, Germany quickly shed its reputation as the sick man of Europe and is once again calling the shots in Europe.

How much of this is down to 'reform', rather than Germany's rather conservative consumer culture, is a difficult question to answer. However, one simple point that can be made is that Germany is not the only country in Europe that has 'reformed'. Italy and Spain have both had waves of labour market reform and important institutional changes in financial markets. The obvious implication is that reform is not necessarily a solution to anything, and that we need to be a bit more specific about what reform means.

One good example of this is that the dominant orthodoxy of the last couple of decades has been the deregulated capital markets were good for both stability and growth. Ahem. Germany actually resisted reform in this area (the famous Mannesman takeover by Vodafone led to a more restrictive law), much to the disgust of Anglo-Saxon observers. Meanwhile Spain embraced contemporary financial practice much more enthusiastically, resulting in an unsustainable housing boom which has left the country deeply exposed in the current crisis.

The Euro crisis is bad for everyone, but the pain does not seem to correspond in any consistent way with the extent of reform in the various European countries. It is not easy to see how more of this ill-defined reform is going to solve the problem.

Tuesday, November 22, 2011

The myth of technocracy

Paul Krugman has written a great Op-ed (Cruel Euro Romantics) which, as usual, nails it.

The arrival of technocrats at the helm of two of Europe's most stressed governments has been largely welcomed by people who should know better. And indeed, no genuine democrat can really regret the demise of Silvio Berlusconi. But what exactly can technocracy offer us in the middle of this terrible crisis?

Well, they don't have a magic wand, for sure. Times remain tough, and Italy's bond spreads have merely stabilized at the unsustainable levels they reached under Berlusconi. But, as Krugman argues, the problem with technocracy goes further - that in fact, these technocrats are the ones who got us in this mess in the first place, with their fantasy world of a diverse Eurozone gliding seamlessly towards convergence under monetary union. Why on earth should anyone have expected this to happen?

So these technocrats are really 'romantics' - rather than robotically applying the findings of the best economists, they chose instead to invent for themselves an imaginary world in which the Euro would succeed where other monetary experiments had failed. Krugman, of course, argues that the failure of technocracy is their choice to use the wrong kind of economics, and that the right kind - his kind - would allow us to solve the problem, or least avoid catastrophe. I'm inclined to agree. But there is something else here that Krugman misses.

The other problem with technocracy, is that it does not engage the people. In fact, this is the very point of it. Technocrats have the theories and facts to make the right decisions, so they should be left to do it, free of the daily noise and fury of politics. But even if they had the right policies, they still have to convince the people that their policies will deliver some approximation of the collective good, otherwise the compliance with rules and norms any society rests on will break down.

This is the colossal failure of the European Union. It is bad enough that they designed institutions that have left us on the brink of disaster. But worse, they did so without ever bothering to explain what the benefits, costs, and likely risks of the project were. Now, again, the European policy elite wants us to write another blank cheque to the same people who have already let us down. It can't work.

My thoughts on Italy...

Piece for Foreign Affairs: How Italy's Democracy Leads to Financial Crisis.

Blurb: Monti’s appointment fits an established Italian pattern: fiscal laxity under populist center-right governments followed by brief emergency periods of technocratic austerity under the center-left and EU. To make fiscal responsibility stick this time, Brussels should back Monti as he builds up a popular mandate for gradual reform.

Friday, November 18, 2011

Time for Germany to show leadership

Great piece by (interest declared) my friends Matthias Matthijs and Mark Blyth in Foreign Affairs: Why Only Germany Can Fix the Euro. They argue that Germany is copping out of its responsibilities: 'As the eurozone's biggest economy, it was Germany's job to stabilize the system when the first signs of financial trouble appeared. Instead, it did precisely the opposite. Whether the euro survives depends on Frankfurt finally assuming its role as leader.'

The argument is similar to Wolf's but punchier. And there are some valuable home truths thrown in. That Germany's virtue is the mirror image of Southern Europe's supposed vices, that Germany can only be like Germany if others are like Greece, that deflation can only end in disaster, and that the answer lies with the ECB acting as a lender of last resort. Some great data snippets in there too: the Euro engineered the colossal current account imbalances within Europe that have created the problem. So

Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion.

Basically, the Euro locked Southern Europe into acting as the borrower of first resort for German savers. Then when the music stopped, they asked for it back, all at once. Too late.

Martin Wolf on Italy

A characteristically clear and articulate analysis from the FT's Martin Wolf: Europe must not allow Rome to burn. Wolf argues that Italy can survive the crisis, but only with strong support from outside, and that means Germany authorizing the ECB to backstop Italian debt.

Given Guido Westerwelle's obtuse offerings in the same newspaper yesterday, the chances of this happening don't look good.

Thursday, November 17, 2011

You turn if you want to

Like the markets, I'm oscillating between fear and terror on the future of the euro. On a good day, I'm simply deeply worried. On a bad day, I stick my head under a blanket. This article by Guido Westerwelle (Germany is not for turning on how to save the euro) is actually the kind of thing that keeps me under the duvet.

As well as the ritual commitment to standing firm and avoiding easy get-outs (we prefer to do things the difficult way), Westerwelle shows a touching faith in 'reforms'. So, he states, the way to tackle the immediate crisis is for 'Greece’s government (to) without further delay adopt and implement the necessary reforms'.

Right. Presumably in a minute he'll tell us what the reforms are. Yes, here goes: 'Only when states regain trust by immediate and thorough reforms, can the crisis be overcome.'

Yes, couldn't agree more. So, these reforms are....? Well, he doesn't say, but he does mention that 'Putting the European Central Bank’s printing presses to work... would have dire consequences, both raising inflation and dissipating vitally important incentives for reform'.

So reform is the key. The thing is, there are reforms and reforms. Germany spent most of the last two decades resisting reforms that Brits and Americans insisted were necessary to drag it out of the post-unification torpor. It did make major changes to labour markets and the welfare state, but avoided reforms in a host of other areas. So not all reforms are good reforms, at least for Germany.

Southern European countries have also adopted reforms. Labour markets have been liberalized, financial markets opened, public spending cut, pension ages increased. Not just now, but well before the crisis. Some of these reforms were beneficial, maybe some didn't go far enough. But the notion that reform will solve everything assumes that we know what reforms will restore growth, competitiveness and fiscal stability. And we don't.

Hanging the fate of the Euro on a vague and untested programme of 'reform' is wishful thinking at its most dangerous. It won't work politically, and it probably won't work economically. And it certain won't deal with Germany's €182 billion trade surplus, which it lent out to the rest of the Eurozone.

Wednesday, November 16, 2011

So much for the Monti effect

I was hoping we would get more than just a few hours respite out of this (Europe edges higher as bond yields ease).



Monday, November 14, 2011

Bunga bunga economics

Only just noticed this great op-ed by Paul Krugman.

Apart from the great opening line 'this is the way the euro ends — not with a bang but with bunga bunga', the really interesting point is this:

"Spain and Italy in effect reduced themselves to the status of third-world countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. "

I've long believed that Europe was the main reason Italy had not ended up like Argentina. Maybe I was over-optimistic.

Economists at work

Research by Mark Hallerberg and my LSE colleague Joachim Wehner finds that Economically-troubled countries are more likely to be led by those with economics training.

Although my colleagues suggest the causal chain runs the other way, it doesn't look good for Papademos and Monti... More seriously, placing faith in technocrats might make more sense if they hadn't been such enthusiastic promoters of the particular model of monetary union that has created this mess.

The Monti effect

Saturday, November 12, 2011

The worst politician in democratic history?

Well, he's actually gone and resigned (Silvio Berlusconi si รจ dimesso la piazza in festa grida: "Buffone").

He leaves behind a country on its knees, and still in denial for the most part about what is happening. Maybe Monti can start by telling people the truth - will Italy be able to face it?

Friday, November 11, 2011

Nouriel Roubini's prophetic words on Tremonti, Italy and EMU

Paul Krugman reminds us of an incident in 2006 where Nouriel Roubini told Giulio Tremonti a few home truths, much to the Italian Finance Minister's disgust:
Italy’s Tremonti’s Temper Tantrums on EMU in Davos…a Sad Embarrassing Episode for Italy…

Pity Italians didn't pay more attention - it could have spared them a lot of trouble.

Tuesday, November 8, 2011

The Berlusconi effect



(spread with German bonds, Bloomberg)
Today is a big day. Berlusconi could survive today's vote, in part because the opposition may well abstain to avoid the technical difficulties resulting from the failure to approve last year's government accounts. But even the Northern League is now calling for him to resign. It may take a few days yet, but I'll be putting some champagne in the fridge (or maybe Prosecco).

Monday, November 7, 2011

Gavyn Davies on the Euromess

Seeing Berlusconi finally on the verge of political oblivion produces mixed feelings, because in fact he has not been defeated by his own mistakes or political weaknesses. Instead, like the fall of Papandreou and Zapatero, it is a result of the fundamentally unsustainable nature of monetary union.

As Gavyn Davies points out in the FT, the German current account surplus more or less exactly corresponds to the current account deficit of Spain, Greece, Italy and Portugal. The stark implication of this is that

Viewed in this light, it is clear that there needs to be a capital account transfer each year amounting to about 5 per cent of German GDP from the core to the periphery. Without that, the euro will break up.

I wonder how many Germans have understood this. In any case, as Davies points out, there is not way this can happen under current arrangements (austerity, deflation and limited ECB intervention). And so the end game continues until the Southerners have had enough and opt for the Argentine route.

Berlusconi, Papandreou and the various corrupt networks they represented should not be exonerated, but ultimately the collapse of this phase of monetary union is not actually their fault. Ireland, with a very difficult social structure, economic regulation and political system (although corrupt enough in its own way) is in a similar mess. More enlightened politicians would probably not have averted disaster. The proof of this is that Spain, the star pupil of economic reform in Southern Europe, is barely better placed than Italy and Greece.

The sad thing is that Northern Europeans may happily blame corruption for the South's plight, but Southern citizens are not in the mood to listen to the sermon. Ironically, the humiliation of the bailout arrangements could end up stirring national pride and generating an alternative (and equally implausible) narrative: blame the Germans.

Berlusconi finally meets his match



Yes, Berlusconi has dealt with pretty much anything that Italian politics has been able to throw at him over the years, but in the end the power of the bond markets is going to get him ("Va via": borsa su. "Resta": crollo I mercati e il destino del premier).

Brings to mind the famous phrase of James Carville, about the bond markets being far more powerful than a president, a pope, or a .400 baseball hitter.

Anyway, I think Silvio may well go tomorrow, if the vote in parliament on the government accounts doesn't produce a majority. If not, with bond yields hitting their Euro-era record today, it can't be much longer.

Friday, October 21, 2011

It's too hot to work

Nice post by Kash Mansori at The Street Light: Where Exactly Are Those Lazy Southern Europeans, Anyway? Mansori points out that there is no evidence of lazy or feckless behaviour being any more prevalent in the South than in the North - working hours, overall employment, social spending and pensions are mostly close to the European average, although welfare coverage is on the whole less generous and working hours longer.

In fact, the prevalence of the grey economy should mean that Southern Europeans are working harder than the data suggests, although this is not an argument likely to impress Northern Europeans.

Of course, Southern Europe has its problems, and its history of corrupt leaders and authoritarianism have left legacies that continue to hold the region back. But the broad picture some Northern Europeans wish to believe in, of lazy Mediterraneans exploiting their virtuous neighbours, is based entirely on ignorance.

Saturday, October 8, 2011

Greenspan meets Max Weber

So Alan Greenspan, perhaps the key architect of today's global economy (yes, that is not a compliment), has decided to weigh in on the Eurozone crisis and in particular on the North-South dimension of Europe's problems.

It's hard to know where to start, but here goes. The least interesting part of the nonsense Greenspan talks is that he rehearses the standard story about Mediterranean profligacy, of the Southern periphery living beyond its means as it hurtled to its inevitable reckoning with the harsh reality of the bond markets. This story is still popular, despite being debunked over and over, most recently by Mansori here. It is unpopular, of course, for the reason that it blames the victim, a common response on the part of the supporters of free market capitalism to the crises their prescriptions generate.

What more interesting is the apparently unselfconscious Orientalism of Greenspan's assessment of the Southern countries. Greenspan's analysis of the North-South divide in Europe goes as follows:

There remains the question of whether most, or all, of the south would ever voluntarily adopt northern prudence. The future of the euro beyond a select group of northern countries with a similar culture will depend on the ability of all eurozone nations to follow suit.


What would this 'similar culture', based on 'northern prudence', involve? Well, for a start it presumably doesn't involve the Anglo-Saxon recklessness exhibited by Northern European countries such as Britain, Ireland and Iceland. So we are talking about particular areas of the North whose prudence is expressed in  wage restraint and sound public finances: the countries generally referred to in the comparative political economy literature as 'social democracies'. So Alan comes out as an unexpected fan of large public sectors, high and progressive taxation, and strong trade unions. Who knew?

The counterpart of course is Southern fecklessness. Here we go back to a common refrain of blaming poor economic performance on climate. Greenspan cites approvingly the following words from Kieran Kelly:

if I lived in a country like this [Greece], I would find it hard to stir myself into a Germanic taxpaying life of capital accumulation and arduous labour. The surrounds just aren’t conducive.”

Never mind that the average yearly working hours of a Greek employee are the highest in Europe. It's just so hot, how can they ever do any work? A notion that nobody ever applies to Texas or Florida.

It's barely worth the effort of outlining all the ways in which Greenspan is wrong. But the fact that this kind of sub-racist nonsense can be given space in one of the best newspapers around is a sign of the times. The times are ugly, and what we thought was true wasn't. So why not just blame problems on those suffering them? It's a lot easier than trying to work out what went wrong, and admitting that powerful men like Greenspan didn't have the faintest clue what they were talking about.

Friday, October 7, 2011

The economy is a morality play

Today Krugman ('Notes On The Eurobubble') gives Alan Greenspan another well deserved kicking for blaming the Euro crisis on profligate Southern Europeans getting their just desserts. Krugman points out that huge capital flows from Northern European pushed up demand, output and employment in Spain and other countries, leaving them high and dry when the bubble burst. To blame the Southern Europeans for their plight is therefore misleading moralizing.

Krugman has been berating conservative economists for some time for the tendency to see the economy as a morality play. The trouble is, the political economy is a morality play. Economic behaviour is deeply embedded in social systems within which moral claims, as well as material desires, drive human behaviour. The Eurozone could well collapse entirely because Germans find it so hard to cope with the idea that their supposedly virtuous behaviour will not bring its own reward. Krugman is right in terms of the models, but the very real presence of moral reasoning in the politics of the crisis is precisely why economic modelling alone cannot give us the answers.


Tuesday, October 4, 2011

Panem et circenses

Italy gets another downgrade, its Finance Minister blames it on his own government not calling early elections and instead hanging lifelessly onto power, yet most attention seems to be focused on Amanda Knox.

What was that about bread and circuses? Italy is currently suffering from a form of paralysis, apparently unaware that it is about to become an over-sized Greece.


Monday, October 3, 2011

Munchau loses it

Wolfgang Munchau, in his article Eurozone fix a con trick for the desperate, describes the latest solution for the Eurozone crisis as "the equivalent of putting explosives into a can, before kicking it down the road". The grounds for this are that the leverage involved in turning the European Financial Stability Facility into something powerful enough to hold back the markets turns it effectively into a CDO.

Munchau used to be a measured, cautious and conservative commentator. The fact that he is using such strong language these days totally freaks me out.

Sunday, October 2, 2011

How To Save Europe


The Baseline Scenario has a neat piece on the Eurozone crisis. The key passage is the following:


Greece and some other countries have serious budget difficulties. But most of the European periphery also faces a current account crisis – something has to be done to increase exports or reduce imports or both. If the exchange rate can’t depreciate, wages won’t be cut, and “fiscal devaluation” proves unworkable, activity in these economies will need to slow down a great deal in order to reduce imports and bring the current account closer to balance – unless you (or the Germans) are willing to extend them large amounts of unconditional credit for the indefinite future.
And as these economies slow down, their ability to pay their government debts will increasingly be called into question.

So, it's a colossal loan or the end of the Euro. Johnson identifies Italy in particular as a problem, since under low growth and high interest rates its debt could grow pretty quickly, and it's already at the upper limit of what's sustainable. But how happy will Germans be to bail out Italy under its current leadership?


Monday, September 26, 2011

A new stability pact

In view of the previous post, it should be clearer than ever that the talk of balanced budgets is entirely missing the point (even forgetting for a moment how stupid such rules are in practice). A real stability pact would call governments to account if their current account balances exceeded a certain share of GDP - hey, why not 3%? And by this I mean in either direction - creditor nations and debtor nations would both have to act.

This of course will not happen, because the prevailing ideology is still that financial markets are rational and not prone to the damaging bouts of euphoria and gloom which come close to destroying the Eurozone. The only certainty is that the current approach will fail. What happens after that is anyone's guess.

Friday, September 23, 2011

The Euro crisis is nothing to do with budgets

Krugman and Mansori on the Origins of the Euro Crisis: it's all about capital flows. The countries now in trouble were not all running fiscal deficits, but they were all running trade deficits, and that seems to be the best predictor of sovereign debt crisis.

So it turns out that the 'recklessness' that Southern Europe supposedly engaged in was allowing German and other Northern European savers to invest their money there. Doesn't quite have the same ring as the morality tale about budgets.

Thursday, September 22, 2011

That sinking feeling

Global growth fears sink world stocks - FT.com:

Irony of ironies: this is probably our best bet for a policy change in the right direction. Ultimately, markets do want austerity, but in the Augustinian sense: they also want growth, and if growth requires printing money and running deficits, they want that too. Just not printing money and running deficits in currencies they're holding.

If investors show their lack of confidence in a policy that is designed purely to give them confidence, then policy change is the only response that makes any sense.

Greece to stay in the Eurozone by destroying its economy

Greece slashes more jobs and spending as it vows to stay in eurozone | Business | The Guardian:

That should do the trick... But seriously, exactly how does this help Greece stay in the Eurozone? The inevitable consequence of this policy is a deeper recession, and markets know this and will price Greek debt accordingly. Since austerity will neither reduce the deficit (because of its devasting effect on the denominator) nor reassure the markets, how does it help Greece stay in the Eurozone?

My suspicion is that the only 'positive' effect of this austerity to reassure German voters that Greece is truly suffering, and therefore not escaping its due punishment for fiscal misdeeds. If that is indeed the mechanism, then we have officially installed a penal system in place of a monetary union.

Thursday, September 8, 2011

The endgame

Greece is now at the point where default is an inevitability - market prices suggest 91% probability of default within 5 years, at which point the game is over. I've no idea what Schauble and the others are thinking of doing, but the threat of contagion to Italy is even more terrifying, as one observer points out: "If Italy defaults, nearly every bank in Europe would feel the impact or go bust, either because they own debt or they are counterparties to debt".

Yet we're still involved in this silly game about deficits and fiscal targets. That way lies madness. Money has to be brought under political control here, or the whole financial system will collapse. Moreover, that political control cannot be the creditor nations bossing the others around - they're are as much to blame as anyone else.

Europe's Shotgun Wedding

Here's a longer than usual post on Europe:


Europe’s Shotgun Wedding

It is difficult to deny the parlous state of the European project. The sovereign debt crisis in the Eurozone periphery is placing enormous strain on the institutions of the European Union and on the relationships between member states. The powerlessness of the EU’s executive and legislative institutions has been set in stark relief by the activism of the barely accountable European Central Bank, which is reaching way beyond its mandate to keep European banks and sovereigns afloat. Meanwhile the hostility of Germans and Finns to the bailouts of the peripheral countries is matched by the resentment felt by those suffering the spending cuts demanded in return. The European project appears to be falling apart.

And yet, there are good reasons for believing that European integration could be about to accelerate. Not of course, because of any putative sense of European solidarity and togetherness on the part of voters or political elites: appeals to national self-interest have rarely been so popular. Further integration may not be desired by anyone, but it could be forced upon Europeans by the consequences of its decision two decades ago to adopt a common currency. Europe has often moved forward through an inexorable logic in which past decisions to pool sovereignty have consequences which necessitate further moves in an integrationist direction (the so-called ‘spillover effects’). Monetary union may prove yet another example of this. The decision to create a single currency has, in the space of just a decade, generated its own (catastrophic) spillover, and the logical, perhaps the only, response is to enhance the role of European institutions to resolve the second order effects of the creation of the Euro.

Critics of the EMU project argued back in the 1990s that the Eurozone was not an ‘optimal currency area’, and that monetary union without the development of supranational institutions to manage fiscal and redistributive policies would prove disastrous. Ignored at the time, this argument appears close to unanswerable in hindsight. Monetary union not only failed to bring about a convergence in inflation rates between Eurozone nations, it achieved the opposite effect, as destabilizing capital flows from surplus countries (chiefly Germany) led to an economic boom in Ireland, Greece and Spain. The resulting trade deficits run by periphery countries in the 2000s proved unsustainable, and the post-2007 credit crunch slammed their economies into reverse, wrecking their fiscal balances and spooking bond markets.

Although well understood by economists, the current account balances inside the Eurozone have been almost entirely ignored in the public debate, in favour of a simplistic narrative in which spendthrift Southern Europeans are entirely responsible for their current debt problems. In the case of Greece, this narrative clearly has some merit, with successive governments running structural deficits in good times while concealing the true state of public finances. But Spain ran a substantial budget surplus in the years preceding the crisis and had a debt to GDP ratio almost half that of Germany. There was no reason at all for Spain’s leaders to fear an abrupt descent into the fiscal abyss, and the markets took the same view, pricing Spanish bonos as barely any riskier than German debt. Even Italy, despite carrying the third largest public debt in the world, had in fact stabilized its public accounts before Euro entry and ran consistent primary surpluses right until the credit crunch. German and French breaches of the Stability and Growth Pact confirmed that the GIIPS (the four Southern European member states and Ireland) were, on the whole, no more inept at managing their public finances than the Northern Europeans.

The budget deficits facing the peripheral countries are largely a consequence of the crisis, not its cause. They are a reflection of the collapse in internal demand resulting from an unexpected correction in Eurozone current accounts. The unexpected end to the capital flows from Northern Europe which had financed large trade deficits in the first years of monetary union caused a dramatic collapse in investment and output, tearing a hole in tax revenues and forcing up government spending. Exhorting periphery states to embrace austerity is only likely to make deficits worse, because there is no alternative source of demand to drive economic activity.  Potential export markets are themselves depressed, and cutting wage levels in the periphery to regain competitiveness, in the absence of Eurozone inflation, would have brutal contractionary effects even if were at all politically feasible. Even without the complication of sovereign debt risk, the prospects for the periphery would have been a grim menu of deflation and a long wait for external demand to appear from somewhere. But doubts about government solvency in the periphery remove even that unattractive option.

So the recent attempts to repair the damage within the existing framework of monetary union, through limited bailouts from Northern taxpayers in exchange for austerity packages in the debtor countries, appear doomed. The costs of the bailout strategy have spiralled as more countries have been dragged into the self-fulfilling prophecy of sovereign default risk. Greece, Portugal and Ireland, amounting to only 7 % of Eurozone GDP, could perhaps have been rescued by decisive action, but the addition of Spain and the Italy to the danger list makes the bailout strategy entirely incredible, with predictable consequences in the bond markets. With the spreads of both of the larger GIIPS heading north, two much more radical scenarios, with entirely opposite implications, have emerged.

The first scenario is disintegration: the reversal of the process of ever greater European economic integration and cooperation.  In this scenario neither core nor periphery member states are prepared to meet the costs of staying together: German, Dutch and Finnish taxpayers refuse to sign up to the rescue of the profligate South, whilst in the periphery austerity packages founder on the rocks of collapsing output and/or political instability. The result is sovereign default in Greece, and some or all of the other periphery countries. But this would not in itself solve the crisis, since the competitiveness problems would remain, and periphery governments would still face the problem of financing budget shortfalls without the help of the private markets. If we add to this the resulting chaos in the Eurozone financial system, default could well lead to the exit of Greece and others from the Euro itself.

There are very strong reasons for believing that European leaders will avoid such an outcome at all costs, since it damages everyone. The periphery countries would benefit enormously from having their own currencies, since it would make the price and wage adjustment they require economically feasible and politically survivable. The example of the UK, which suffered a far worse financial crisis than any of the Eurozone states but avoided (so far) a run on its debt, is an appealing one. However the GIIPS cannot easily emulate the UK because they have to extract themselves from the Euro first, and doing so would likely cause such financial disruption as to outweigh the benefits of competitive devaluation. Perhaps more importantly, the creditor countries also have every incentive to avoid Euro exits. Germany is on the hook in two ways: first its trade surplus is almost entirely with the Eurozone, so Euro exits would undermine its main export markets. Second, German and French banks are exposed to periphery government debt to the tune of hundreds of billions of Euros. Default and or/exit would bring down the German banking system, requiring colossal bailouts at a time of declining growth prospects. In this respect, it is worth remembering that Germany’s own debt/GDP ratio is already a far from virtuous 81 %.

The incalculable risks of this first scenario mean that the alternatives, however unpalatable, will prove more appealing. A second scenario can be traced, in which further integration provides the Eurozone with the necessary policy instruments to address the imbalances and weaknesses revealed by the crisis. What exactly would this integration involve? The most immediate problem – the risk of sovereign default in the periphery – will inevitably require a degree of burden-sharing and risk-pooling, most likely through the emission of Eurobonds backed by the governments of the entire Eurozone. In this solution, demanded insistently by Italian Finance Minister Tremonti, peripheral government debt would be backstopped by German’s fiscal credibility, reducing debt servicing costs (whilst raising yields on German debt). Whatever form this pooled sovereign risk involves, EU institutions will have to be redesigned in order to manage it, enhancing supranational authority.

Simply staving off default will not end the crisis. The Eurozone also needs to resolve the imbalances which left the periphery so exposed after the credit crunch. The German economic model, based on high savings rates, wage moderation and fear of inflation, interacted fatally with a periphery lacking a sound basis for converting capital flows into productivity gains. The result was a brutal shock for the GIIPS when the money dried up, without the appropriate policy instruments (monetary policy, competitive devaluation) to allow for adjustment of relative wages. If Germany will not countenance the higher German and Eurozone inflation needed to accelerate the process of adjustment, then some way needs to be found to channel German surpluses to the periphery. Some kind of pooled fiscal sovereignty, on a far larger scale than anything so far attempted in the EU, would appear the most effective way of achieving this.

Why on earth should Germany accept an increase in debt servicing costs, an increase in domestic inflation, and tax increases to pay for economic recovery in the South? Because the alternative is worse. German virtue is the flip-side of the periphery’s vices: Germany’s trade surplus is the counterparty to the periphery’s trade deficits, and the excessive debt taken on by the GIIPS was loaned in large part by German banks. The collapse of the Eurozone would mean insolvency for German financial institutions accompanied by job losses in the manufacturing sector. European integration means that no member state can isolate itself entirely from problems in another. The more serious the problem, the more grief is shared amongst states whose economies are deeply inter-connected.

Of course, it is one thing to recognize the nature of the problem, another entirely to adopt the appropriate solutions, particularly when none of them are remotely appealing. Further integration has all the features of a shotgun wedding, the core and periphery tying the knot out of desperation rather than desire. For the wedding to go ahead, European leaders and voters need to be convinced that the alternative would be even worse. At the moment there is no evidence that we are close to this realization. European leaders, Mrs Merkel in primis, have an awful lot of explaining to do.

Monday, August 8, 2011

Trichet to the rescue

Looks like the ECB will act to try and calm the flight from Italian and Spanish debt. In the short term, some impact can be achieved with a relatively small outlay, but in the longer term - ie if the short-term fix doesn't calm the markets - the funds involved start to get scary, with Italy, Spain and the smaller debtor nations amounting to a third of Eurozone GDP, and Italian debt alone amounting to rather more than €1 trillion.

Krugman usefully points out that Italy has a large debt, but its deficit is far more stable than the others, and therefore ECB intervention may do the trick. In the other cases, deficits are larger and the result of economic collapse, and therefore the medium term prospects will require greater intervention.

Thursday, August 4, 2011

Way down in the hole

The bond markets have finally decided to start bullying Italy, and are now doing so with a vengeance. The spread with the Bund is close to 400 bpts, which means that a third of the Eurozone is now facing sovereign debt distress. The ECB has to start wielding a big stick quickly if this is going to stay together.

But Italy and Spain are facing political vacuums too - Zapatero has thrown in the towel and called for new elections in November, in which he will not stand. Berlusconi's government is by now close to zombie status, but removing him and finding a credible alternative will take months, possibly years. So, there is a space of a few months for all this to get much worse before any political response can emerge.

Thursday, July 28, 2011

Italy: Social partners move against the government

The lack of credibility of the Berlusconi government has led to an unprecedented degree of unity amongst the social partners in calling for a change in policy, and implicitly in leadership. The main trade unions and employers associations signed a joint document appealing for 'discontinuity' and a 'pact for growth' drawn up with the social partners. The Uil union (close to the ruling party) didn't sign.

This is an interesting move, suggesting Berlusconi's support base is slipping away. Some commentators are drawing parallels with 1992, when a financial and fiscal crisis ushered in a wholesale change in the political establishment (ironically, hastening Berlusconi's rise to power).

Wednesday, July 27, 2011

Southern Europe Crisis: An Introduction

I've been blogging for a while now, over on Unpublishable Thoughts, but decided to set up this new blog on the economic and political crisis of Southern Europe, as a place to post thoughts, analysis and speculation on where the Eurozone's southern periphery is heading.

Most comment on the Southern European crisis has up to now focused on the very real economic weaknesses of Greece, Italy, Portugal and Spain, and the difficulties involved in maintaining their fiscal stability. But relatively little attention has been paid to the political dimension of the crisis, with the exception of some superficial reporting of strikes and demonstrations in response to the austerity package in Greece. My guess is that the politics of Southern Europe is about to get a lot more complicated, and that in turn will have powerful ramifications for the management of the Euro crisis.

My background (see CV here) in the study of democratization, political parties and electoral politics in Southern Europe (principally Spain and Italy), and my recent comparative research on economic and social policy, make these developments a central concern in my research. This blog is aimed at circulating some of my work to a broad audience before publication.

For more details on my work, see my LSE homepage here. For media or consultancy enquiries, please email J.R.Hopkin@lse.ac.uk.