Greece keeps pushing the currency union envelope. Mr. Tsipras, the socialist prime minister, is driven by his ideological convictions and therefore plays a different game than the leaders in Brussels with whom he is negotiating to keep his country afloat. The problem for the European leadership is that it seems incapable of understanding what role Tsipras’s ideology plays for his actions – Tsipras wants full independence for Greece so he can build his version of the socialist dreamland that now-defunct Venezuelan president Hugo Chavez created.
Rational arguments such as “property rights no longer exist in Venezuela” or “they have 60 percent inflation” and “crime is rampant and there is a shortage of almost every daily necessity” do not work on ideologues like Tsipras. That is the very problem with them. Therefore, you cannot reason with them as though they were swayed by the same type of “sensible” arguments that you are. But more importantly: so long as the EU leadership does not understand that politicians like Tsipras are ideologically opposed to everything that the EU stands for, they will not be able to have a rational conversation. There will be constant discords, where the EU leaders try to set goals that will help Greece stay inside the euro zone – and ultimately the EU – while Tsipras and others like him (think euro skeptics in Italy and Spain) will try to create circumstances that allow them to get what they want, namely out of the euro zone (and eventually the EU).
The biggest danger with this discord is that once the euro zone starts breaking apart, the retreat from the common currency will be disorderly. There is no doubt that the Bundesbank in Germany has a contingency plan for that disorderly dissolution, but it is far from certain that their plan will work. There are so many uncertain factors in this game that an even reasonably confident prediction is out of the question.
That said, there are some fixed points that can be put in the context of macroeconomic reasoning. That in turn should at least provide some insight into the best and worst case scenarios.
Before we get there, though, an update on the Greek situation, as reported by the EU Observer:
The stand-off between Greece and its lenders deepened over the weekend ahead of a meeting of euro finance ministers on Friday (24 April), with both sides exchanging barbs over the risk of a Greek default and its consequences for the eurozone. On Friday, Eurogroup president Jeroen Dijsselbloem said both parties should avoid “a game of chicken to see who can stick it out longer. We have a joint interest to reach an agreement quickly”.
An agreement about what? If Greece secedes from the euro it can, at least theoretically, run away from its bailout-related deals. In practice, the EU would still want to enforce loan contract, but it is much more difficult with a country that has a currency of its own – a currency that in all likelihood will be depreciating rapidly.
As for the IMF, Greece would have to deal with them separately, but it could do so much more so on its own terms once outside of the euro zone.
In fairness, though, it looks like the full extent of the Greek situation is beginning to dawn on at least some EU leaders. The EU Observer again:
EU and International Monetary Fund (IMF) leaders warned that Greece had to make quick progress to finalise a list of reforms that would enable it to receive a €7.2 billion loan. But they hinted that a Greek default could be managed by the eurozone. “More work, I say much more work is needed now. And it’s urgent,” said European Central Bank (ECB) chief Mario Draghi in Washington, where he was attending the IMF’s Spring meeting. “We are better equipped than we were in 2012, 2011, and 2010,” he added, referring to the years when fears of a eurozone break-up were at a high. “Having said that, we are certainly entering into uncharted waters if the crisis were to precipitate, and it is very premature to make any speculation about it,” Draghi also said.
So what would happen if Greece seceded from the euro? Well, the EU Observer article brushes on that subject:
Greek finance minister Yanis Varaoufakis, for his part, warned that his country’s exit would cause major problems for the rest of the region. “Some claim that the rest of Europe has been ring-fenced from Greece and that the ECB has tools at its disposal to amputate Greece, if need be, cauterize the wound and allow the rest of the eurozone to carry on,” he said on Spain’s La Sexta channel “Once the idea enters peoples’ minds that monetary union is not forever, speculation begins … who’s next? That question is the solvent of any monetary union. Sooner or later it’s going to start raising interest rates, political tensions, capital flight.”
This is a key statement. Some would interpret it as Greek leverage in negotiations with Brussels. However, the correct way to read it is as a blunt warning of what is to come: sooner or later Greece will leave the currency union, and it will do so like the men who escaped Alcatraz in 1962. Once someone has done what everyone thought was impossible, then just as Mr. Varaoufakis says, the only question on everyone’s mind will be: who’s next?
British Member of the European Parliament for the UKIP, Mr. Nigel Farage, made a great point recently when appearing on BBC (at about 2:25 into the video): the initial effect of a Greek currency secession is going to be a boost in growth as the currency depreciates. This growth spurt will inspire other struggling euro-zone states to consider a return to their national currency. Once the secession movement gets off ground, it is uncertain how many states will actually reintroduce their national currency, but it would be reasonable to expect a first round of secession to sweep from Athens to Lisbon.
The short-term financial turmoil aside, the most likely effect will be a southern European currency war. The four countries that have historically had weak currencies will find themselves returning to that position, only with an even deeper macroeconomic ditch to climb out of. The only moving part of their economies is, actually, exports, which will get a boost from a rapid currency depreciation. At the same time, that depreciation will be a major conduit for imported inflation, which in turn will eat its way into the economy a bit after the exports boom has gained momentum. The more the currency depreciates, the stronger the imported-inflation effect will be.
Inflation will have major consequences for the government budget. Depending on what type of inflation indexation is built into the welfare state’s entitlement programs, the cost of government spending will rise more or less with inflation. While inflation can also be beneficial to the revenue side of the state budget, it negatively influences the purchasing power of households and generally (but not always) depresses business profitability. As a result, domestic economic activity slows down, causing the tax base to stagnate.
And this is where the major test comes for currency secessionists: how will they handle their budget problems? With weak currencies they will have a hard time selling their treasury bonds on the international market; they can load up their banks – a likely scenario in Greece where a Syriza government could even go as far as to nationalize banks – but as the Great Recession demonstrated, leaning on banks for funding a government deficit is a particularly bad idea. When banks are overloaded with bad government debt in the midst of a macroeconomic crisis, then suddenly it is 2009 again.
Very briefly, then: once the euro zone starts falling apart the first ones to leave will face very difficult challenges. That is not to say that the remaining euro zone countries will have a better life – it is very likely that the euro zone itself won’t survive the 2017 French presidential election – but once the Southern Rim has left the euro zone the remaining countries will have a somewhat easier time following an orderly retreat plan. In fact, it would not be surprising if Germany, Austria and the BeNeLux countries remained in a “core” currency union – a Gross-Deutsch Mark, if you will. That currency could actually become a stabilizing point for a post-euro EU.
Still, even with an anchor currency in the heart of the EU, an implosion of the euro will have major negative effects for the European economy. What will those effects look like? That is a subject for another article.
Today it is time to review in more detail the latest national accounts data from Eurostat. A disaggregation of the spending side of GDP reinforces my long-standing statement: the European economy is in a state of long-term stagnation.
To the numbers. We begin with private consumption, which is the driving force of all economic activity. It is not only a national-accounts category, but an indicator of how free and prosperous private citizens are to satisfy their own needs on their own terms. It is a necessary but not sufficient condition for economic freedom that private consumption is the dominant absorption category.
Once consumer spending starts ticking up solidly, we can safely say there is a recovery under way. However, little is happening on the consumption front: over the past eight quarters (ending with Q3 2014) the private-consumption growth rate for the EU has been 0.3 percent per year. While the increase was stronger in 2014 than in 2013, only half of the EU member states experienced a growth in consumer spending of two percent or more in the last year. The three largest euro-zone countries, Germany, France and Italy, were all at 1.2 percent or less.
One bright spot in the consumption data: Greece, Spain and Portugal, the three member states that have been hit the hardest by statist austerity, now have an annual consumption growth rate well above 2.5 percent. Portugal has been above two percent for three quarters in a row; a closer look at these three countries is merited.
Overall, though, the statist-austerity policies during the Great Recession have caused a structural shift in the European economy that may be hard to reverse. From having been a consumer-based economy with strong exports, the EU has now basically been transformed into an exports-driven economy. On average, gross exports is larger as share of GDP than private consumption.
In theory, one could argue that this is a sign of free-market trade where people and businesses choose to buy what they want and need from abroad instead. I would be inclined to agree – but only in theory. In practice, if households and businesses freely made their choices on a global market, then rising exports would correlate with rising imports and, most importantly, rising private consumption. However, that is not the case in Europe. On average for the 28 EU member states,
- Exports has increased from an unweighted average of 59 percent of GDP in 2007 to an unweighted average of 70 percent in 2014;
- Net exports has also increases, from zero in 2007 (indicating trade balance) to six percent of GDP in 2014 (indicating a massive trade surplus).
If the rising exports had been a sign of increased participation in global trade on free-market terms, then either of two things would have happened: consumption would have increased as share of GDP or imports would have increased on par with exports. In reality, neither has happened, which leads to one of two conclusions:
- There has been a massive increase in corporate investments, which if true would indicate growing confidence in the future among Europe’s businesses; or
- Exports is the only category of the economy that is allowed to grow because it is not subject to the tight spending restrictions imposed by austerity.
Gross fixed capital formation, or “investments” as it is often casually referred to, was an unweighted average of 26 percent in the EU member states in 2007. Seven years later it had fallen to 21 percent. This is clearly a vote of no confidence from corporate Europe. Therefore, only one explanation remains: the discrepancy between on the one hand the rise in gross and net exports and, on the other hand, stagnant private consumption and a declining investment share, is the result of a fiscal policy driven by statist austerity.
The purpose of fiscal policy in Europe since at least the beginning of the Great Recession has been to balance the government budget at any cost. If this statist austerity leads to a painful decline in household consumption or corporate investments, then so be it. As shown by the numbers reported here, years of statist austerity have depressed corporate activity. In fixed prices, gross fixed capital formation in the EU has not increased since 2011:
- In the third quarter of 2011 businesses invested for 607.8 billion euros;
- In the third quarter of 2014 they invested for 602 billion euros.
The bottom line here is that the only form of economic activity that brings any kind of growth to the European economy is – you guessed it – exports. But it is not just any exports. It is exports outside of the EU. How do we know that? Because of the following two tables. First, the average annual private-consumption growth rate, reported quarterly, for the past eight quarters (ending Q3 2014):
|Private consumption growth|
With private consumption growing at less than one percent in 19 out of 28 countries, households in the EU do not form a good market for foreign exporters.
Things a not really better in the category of business investments:
|Gross fixed capital formation|
What this means, in plain English, is that the European economy still is not pulling itself out of its recession.
But is it not possible that things have changed recently? After all, the time series analyzed here end with the third quarter of 2014. There is always that possibility, but one indication that the answer is negative is the latest report on euro-zone inflation. From EU Business:
Eurozone consumer prices fell by a record 0.6 percent in January, EU data showed Friday, confirming deflation could be taking hold and putting pressure on a historic bond-buying plan by the ECB to deliver. The drop from minus 0.2 percent in December appears to back the European Central Bank’s decision last week to launch a bond-buying spree to drive up prices. Plummeting world oil prices were largely to blame for the fall in the 19-country eurozone, already beset by weak economic growth and high unemployment, the EU’s data agency Eurostat said.
If the EU governments let declining oil prices trickle down to consumers – and avoid raising taxes in response – there could be a positive reaction in private consumption. However, lower gasoline and home heating costs will not be enough to turn around the European economy.
More on that later, though. For now, the conclusion is that Europe is going nowhere.
The stagnant European economy does not need more bad news. Unfortunately, there is more coming. Business Insider reports:
The amazing collapse in German bond yields is continuing. Today, five-year bonds (or bunds) have a negative nominal return for the first time ever. That means that investors buying a 5-year bond on the market today will effectively be paying the German government for the privilege of owning some of its debt. This has been happening for some time now. In 2012, people were amazed when 6-month bund yields went into negative territory. In August, the two-year yield went negative too. Less than a month ago, the same thing happened with the country’s four-year bunds.
While there is a downward trend in bond yields in most euro-zone countries, there is a clear discrepancy between first-tier and second-tier euro states. Ten-year treasury bond yields, other than Germany:
- Austria, 0.71 percent, trending firmly downward; France, 0.83 percent, trending firmly downward; Netherlands, 0.68 percent, trending firmly downward; Italy, 1.87 percent, trending firmly downward.
A couple of second-tier examples:
- Ireland, 1.24 percent, trending weakly downward; Portugal, 2.69 percent, trending weakly downward.
Greece is the real outlier at 9.59 percent and an upward yield trend. But Greece is also a reason why Germany’s bond yields are turning negative. Although the Greek economy is no longer plunging into the dungeon of depression, it is not recovering. Basically, it is in a state of stagnation. Its very high unemployment and weak growth is coupled with an ongoing austerity program, imposed by the EU, the ECB and the IMF.
Add to that the political instability which, in late January, will probably lead to a new, radically leftist government. Syriza’s ideological point of gravity is the Chavista socialism that has been practiced in Venezuela over the past 10-15 years. They are also vocal opponents to the EU-imposed austerity programs, an opposition they would have to deliver on in case they want to stay relevant in Greek politics.
If Greece unilaterally ends its austerity program, it de facto means the beginning of their secession from the euro. That in turn would raise the possibility of other secessions, such as France, where a President Le Pen would begin her term in 2017 with a plan to reintroduce the franc. When that happens, the euro is history.
There is no history of anything similar happening in modern history, which makes it very difficult for anyone, economist or not, to predict what will happen. Europe’s political leaders will, of course, want to make the transition as smooth and predictable, but without experience to draw on there is a considerable risk that the process will be neither smooth nor politically controllable. Add to that the inability of econometricians to forecast the transition; based on the numerous examples of forecasting errors from the past couple of years, there is going to be little reliable support from the forecasting community for a rollback of the euro.
That is not to say the process cannot be a success. But the window of uncertainty is so large that it alone explains the investor flight to German treasury bonds.
This uncertainty is also throwing a wet blanket over almost the entire European economy, an economy that desperately needs growth and new jobs. Since 2010 the EU-28 economy has added 800,000 new jobs, an increase of 0.37 percent. For comparison, during the same time the American economy has added eleven million jobs, an increase of a healthy 8.5 percent.
As those Europeans who still have a job return after their summer vacation, they find a news feed that increasingly looks like it did before the summer – and last fall, and the spring before that…
In short: the European crisis continues. Today we get an update from deeply troubled Portugal, courtesy of EUBusiness.com:
Portugal’s creditors arrived back in Lisbon Monday to assess the country’s progress under its 78-billion-euro bailout as Brussels signals it will not cede to a request for the country’s fiscal targets to be relaxed. Payments of the next tranche of bailout loans to Lisbon will depend on a successful review by Portugal’s “troika” of lenders — the International Monetary Fund, the European Commission and the European Central Bank — of its progress in implementing economic reforms agreed in exchange for the financial aid.
“Reforms” is a code word for draconian tax hikes and panic-driven spending cuts that are facing fierce legal challenges all the way up to the Portuguese Supreme Court. The higher taxes obviously won’t help the economy one iota – on the contrary, they add extra weight to the private sector and will very likely put the Portuguese GDP growth rate well below Eurostat’s predicted 0.9 percent, on average, for 2013 and 2014.
The efforts to cut spending are obviously failing under legal challenges. This tells us two things: they were ill designed and they were forced through under sheer fiscal panic. Cutting government spending is a very good idea, but it has to be done right. In addition to avoiding legal challenges, the cuts must be structural in kind and designed so that they easily and quickly let private entrepreneurs step in and replace terminated government programs. None of this has happened in Portugal, primarily because the Eurocrats pushing the Portuguese government into destructive austerity are not interested in structurally sound reforms. All they want to do is preserve the welfare state and make it fit a smaller, tighter tax base.
So long as the same motives are behind the same austerity measures, we should not expect any change in the outlook for the Portuguese economy. The big question is what happens next year when the current bailout program ends. It is very unlikely that Portugal has even come close to meeting the budgetary requirements under the current bailout program. As the EU Business article hints at, this may lead to a new bailout program in 2014:
The rescue programme is scheduled to expire in mid-2014. Portugal is struggling to meet its deficit target of 5.5 percent of gross domestic product for this year as government reforms aimed at streamlining the government repeatedly get bogged down by legal challenges. Portugal’s Constitutional Court last month struck down a reform allowing civil servants to be laid off if they fail to requalify for a new job. It was the third time that the court has restricted the scope of a government austerity measure. The ruling has helped push Portugal borrowing costs to levels near which it was forced to seek international aid two years ago. The yield on Portuguese government 10-year bonds stood at 7.4 percent on Monday.
This is the level that caused utter panic in Greece and Spain. And so for good reasons: if Portugal had to refinance its entire government debt at 7.4 percent interest, at the current debt level, then its annual payments on its debt would be equal to 9.1 percent of the country’s GDP!
This is not a road to serfdom. It is worse than that. This level of uncontrollable government paves the way to political chaos, economic instability, social turmoil and very likely the destruction of Portugal as a parliamentary democracy.
That point is closer in time than most people think. EU Business again:
Deputy Prime Minister Paulo Portas last week urged Portugal’s international lenders to ease its 2014 public deficit reduction target from 4.0 percent to 4.5 percent of GDP. The appeal got a cool response from Brussels, with the head of eurozone finance ministers, Dutch Finance Minister Jeroen Dijsselbloem, saying Lisbon should stick to the deficit reduction targets already agreed. … “Someone has to explain to us how we are going to be able to go from a deficit of 5.5 percent in 2013 to a deficit of 4.0 percent in 2014. We have never seen such a strong reduction in the deficit,” said Antonio Saraiva, the head of the Portuguese Industry Confederation, after meeting with Portas on Monday.
Since legal challenges successfully prohibit or reduce the amount of spending cuts, there is a growing risk that the Portuguese government will choose to rely on tax hikes instead. Tax increases earlier this year have already robbed Portugal’s taxpayers of a month’s salary, on average, in part through a rise in income taxes from 24.5 to 28.5 percent. More tax hikes would plunge the country’s economy into a full-blown depression.
Perhaps the current prime minister, Mr. Coelho, is aware of this. This would explain why he tries to push yet more austerity measures on the economy, including, EU Business reports…
an average 10 percent cut in the pensions of most government workers, which have been loudly opposed by unions.
Imagine the federal government slashing Social Security payments by ten percent across the board. That alone would be unthinkable in the United States, yet unless we start getting serious – very serious – about the federal debt, we are heading in that direction.
As for Portugal, the future is very uncertain except for one thing: we can surely expect the country’s tumultuous political climate to remain. Radical leftist parties hold a larger share of the parliamentary seats in Portugal than in most other European countries. Their strong presence in the legislature is a formidable hindrance to any effort at rolling back government, eliminating entitlements and massive tax cuts. As a result, political instability, economic decline and social stress will continue to escalate.
What will this lead to? I have said it before, and I will say it again – the one word that captures Europe’s fatal decline:
Europe’s austerity battle continues. The latest skirmish took place in Portugal’s Supreme Court, which, according to Reuters…
on Friday rejected four out of nine contested austerity measures in this year’s budget in a ruling that deals a blow to government finances but is unlikely to derail reforms two years after the country’s bailout. The measures rejected by the court should deprive the country of at least 900 million euros ($1.17 billion) in net revenues and savings, according to preliminary estimates by economists.
Obviously, “net revenues” means tax increases and “savings” means spending cuts. The curious part of this is how a supreme court of a country can find it within its jurisdiction to pass judgment on individual spending items in a government budget, as well as individual taxes. That, however, is a topic for a separate story. This one from Reuters is primarily concentrated on the policy battle over austerity, and the amazing thing about this story is that it is completely void of context. Greek context, that is:
Debt-ridden Portugal agreed to a 78 billion euro bailout in 2011 from the European Union and International Monetary Fund. The entire package of austerity measures introduced by the 2013 budget is worth about 5 billion euros and includes the largest tax hikes in living memory, which were mostly upheld.
Back in January I explained the draconian nature of those tax hikes. What is unfolding now in Portugal is essentially the sequel to Greece.
However, as Reuters reports, not everyone seems to understand this:
“It’s a lesser evil. … Putting it into perspective, a good manager and leader should not have difficulty finding room in a budget to accommodate this cut,” said Joao Cantiga Esteves, economist at the Lisbon Technical University. “We are talking about an impact of only 1.2 to 1.3 percent of Portugal’s total spending,” he added.
That’s what they said in Greece, too. But 1.3 percent three years in a row accumulates to more than four percent of GDP, with compound interest in the form of negative multiplier effects. Apparently, Mr. Esteves has not kept up to speed with either the events in Greece or the IMF’s new research on the accelerated negative effects of austerity (he might also want to read my paper on austerity to get the rationale behind the IMF’s findings). Government spending cuts cause a faster multiplier reaction than government spending increases. This is a major piece of the puzzle in explaining why austerity has been such a nightmare for Europe’s debt-ridden economies.
It is notable how this perspective is entirely absent in the reporting on Portugal. Reuters is no exception:
The government … has to cut the budget deficit to 5.5 percent of GDP this year from 6.4 percent in 2012, when it missed the goal but was still lauded by its EU and IMF lenders for its austerity efforts. Analysts consider the outcome manageable and say the government should be able to cover the shortfall with additional spending cuts it has been working on at the request of lenders. Analysts say the lenders could also give Portugal more leeway in terms of budget targets. Earlier in the day, Bank of America Merrill Lynch analysts wrote in a research note that even a negative ruling was likely to be “in line with our muddling through outlook,” expecting Lisbon to resume negotiations with its lenders as a result.
The analysts at Merrill Lynch, the university professors interviewed, and the journalists reporting, all take an attitude of business as usual. It is as though the Greek disaster, with one quarter of GDP being wiped out in four short years, has nothing to do with austerity.
Perhaps the parties involved are turning a blind eye to Greece because they don’t want to see the repercussions for the cost of the government debt. Zerohedge notes this:
…the government warning that the court’s decision would put into question the country’s ability to fulfill its €78 billion international bailout program … would send bondholders of Portuguese sovereign debt scrambling for the exits as suddenly the country may find itself in the ECB’s “dunce” corner, with Draghi preparing to pull a “Berlusconi” on a government which can’t even whip its judicial branch in line.
Then comes this comment:
However, of more immediate concern is how will the government now plug a hole of up to €1.3 billion in its €5.3 billion 2013 budget. A solution has, luckily, presented itself: bypass the unconstitutional provisions by paying government workers not in cash, but in government bills!
This is a startling statement, but Zerohedge has a source, namely none other than the Wall Street Journal (subscription required):
The Portuguese government is considering a plan to pay public workers and pensioners one month of their salary in treasury bills rather than cash after a high court ruled out wage cuts, a person familiar with the situation said Sunday. “This is one of the ideas being considered,” the person said. By paying one month of salary in T-bills to public workers and pensioners, the government would save an estimated €1.1 billion in expenses, narrowing the budget gap significantly.
In all honesty, is this really what the defense of the welfare state has come down to – paying employees in IOUs? Is the Portuguese government so desperate that it is ready to resort to this kind of accounting trickeries??
The California state government has from time to time resorted to “paying” some bills with IOUs, which has caused little more than grumbling among those whom the state owed money. I doubt that the same would be the case in Portugal – especially if they are going to pay their government employees with promises instead of cash. This could contribute to a further destabilization of the country’s economy and, even more so, political landscape.
All, again, caused by austerity in an attempt to defend an indefensible welfare state.
After Italian voters voiced their anti-austerity sentiments in the election recently, the EU leadership has vowed to double down on their supprt for austerity. The Eurocrats want more of the same combination of higher taxes and lower spending that has destroyed one quarter of the Greek economy, that has driven scores of Spaniards to become food scavengers and brought the Italian economy to its knees.
It is going to be increasingly difficult for the Eurocrats to continue to push for these reckless policies. The Italian protest vote was just one example of the frustration felt by up to a hundred million low-and-middle income Europeans, who depend critically on the welfare state and are forced by austerity policies into the dungeons of poverty. There will be more protests.
In fact, there already are more protests. According to Reuters, the Portuguese are marching again:
Hundreds of thousands of Portuguese poured into the streets of Lisbon and other cities on Saturday to demand an end to austerity dictated by an international bailout and the resignation of the center-right government. The rallies, which follow the introduction of the biggest tax hikes in living memory, mark the greatest public show of discontent since demonstrations last September forced the government to adjust some of its austerity measures.
I reported on those tax hikes in January. In September I noted that the Portuguese economy has effectively been at a GDP growth standstill since at least 2008. I also explained how the widespread spending cuts already enacted in Portugal were contributing to social unrest. Therefore, I am not surprised to see this story from Reuters, which continues with reports large numbers of protesters:
More than 200,000 protesters in Lisbon packed the vast imperial Praca do Comercio square, home to the Finance Ministry, and surrounding streets, chanting: “It’s time for the government to go”. Organizers said as many as 500,000 people took part in the rallies around Lisbon, which would make the protest bigger than in September, but the numbers could not be independently confirmed. Police, as is customary, would not provide estimates. Many carried banners with slogans such as “Austerity kills” and “Screw the troika, power to the people!”, aimed at the so-called troika of lenders from the European Commission, European Central Bank and International Monetary Fund.
A good part of the frustration expressed in these mass protests has to do with the terrible job market. The Portuguese economy was leaving more and more people behind already before the recession: according to Eurostat labor market data, the rate of employment among 15-64-year-olds fell from 74.1 percent in 2002 to 70.5 percent in 2010. In 2011 youth unemployment stood at 30.1 percent, compared to 17 percent in the United States.
In its latest GDP growth forecast, Eurostat has downgraded Portugal from a previously expected 0.3 percent growth in 2013 to a full percent decline in GDP.
Welcome to austerity paradise.
Reuters again – and this is worth taking seriously:
“Grandola”, the signature tune of the 1974 “Carnation revolution” that overthrew the fascist dictatorship of Antonio Salazar after the army rebelled, reverberated through the crowds in Lisbon, which has a population of about 3 million, and elsewhere where protesters gathered. Many cried as they sang. Protesters have used the song increasingly in the past month to interrupt government ministers speaking at public events. “We are in a new dictatorship. Everything that the revolution achieved is being destroyed,” said one elderly protester in Lisbon who did not give his name.
First you make people dependent on the welfare state. Then you destroy their opportunities to feed themselves independently by raising taxes to pay for the welfare state. Then you use austerity to destroy the welfare state.
And then you are surprised when people set your government on fire.
Back to Reuters, which reinforced my point that the forecast for the Portuguese economy is being adjusted downward – only this one is even worse, predicting almost twice the contraction in GDP that Eurostat published earlier this year:
The forecast 1.9 percent decline will further deepen the worst recession since the 1970s, already in its third year.
Actually, the Portuguese economy came to a screeching halt in 2008 with a perfect zero in GDP growth.
Tax hikes and spending cuts ordered by the terms of the 78 billion euro ($101.3 billion) bailout agreed in mid-2011 have slashed consumer demand and pushed unemployment to record levels of 17 percent, causing thousands of small businesses to go bust. … Veronica Pereira, an unemployed mother who says she has no means to send her daughter to college said: “Our people have the habit of letting things happen, but I think this is changing radically now. We need to protest to change things,” she said. … Portugal had shown a tolerance for austerity compared with countries like Greece with its frequent protests and strikes, but opposition has begun to rise in recent weeks as the economic outlook has worsened.
The question is not whether these protests will lead to a radicalization of politics in the countries hit by austerity. It is quite clear that they will. Greece is already at a point where anti-democratic parties are on the doorstep of executive political power. The Italian people, who voted against austerity, are probably going to get tricked into more austerity by crafty coalition welders. In response they may throw their votes after increasingly radical alternatives. In Portugal, radical socialists already have a strong opposition role in parliament and could easily leap to power, riding on the massive dissatisfaction with austerity.
Again, the question is not whether there will be a political radicalization in austerity-hit nations. The question is what country is next on the list.
The Netherlands? Hardly! It’s such a stable, sensible, tolerant smiley-face kind of a country.
Well, don’t hold your breath on that. The Financial Times reports that the Netherlands is in some persistent fiscal trouble, resembling a south European crsis opening:
The Netherlands will make no attempt to bring its 2013 budget deficit under the EU limit of 3 per cent of gross domestic product, an ironic outcome for a country that was one of the toughest proponents of the deficit limits at European summits during the euro crisis. After seeing its economy shrink nearly 1 per cent in 2012, one of Europe’s wealthiest countries is now poised to miss the very deficit target it backed.
As we say here in America: “kharma is a bitch”.
Then comes an interesting little observation:
That became clear after a report by the Netherlands’ official Central Planning Bureau on Thursday projected the country’s budget deficit will come in at 3.3 per cent of GDP in 2013, with the economy expected to contract by 0.5 per cent. The government, a coalition between the centre-right Liberals and the centre-left Labour party, had been waiting for the CPB report before deciding whether to pursue further austerity measures to meet the 3 per cent limit. With the report out, the parliamentary leaders of both parties ruled out any further budget cuts or tax rises for 2013, while leaving the door open for further austerity in 2014.
Did you catch that? The Dutch government, which has been clearly in favor of tough austerity measures on southern European economies where the deficit exceeds the three-percent limit, now suddenly recognizes that austerity is bad for GDP growth. To play on another American proverb, life is not as fun when the austerity chickens are coming home to roost.
Before last year’s parliamentary election the socialists stood to make significant gains on their anti-austerity campaign. Mainly because of some crafty coalition building, more EU friendly politicians were able to build a flood wall to protect their austerity policies from popular criticism. But not even a “wealthy”, tolerant and “stable” country like the Netherlands can endure round after round of austerity. In fact, the attempts by the Dutch government to avoid more austerity in 2013 is a sign that their country may be much more vulnerable to harsh austerity measures than Greece or Portugal.
If this is the case, then what we have seen in terms of political fallout from austerity in southern Europe is only child’s play compared to what could happen further up north.
There is a good old American saying: if you’re in a hole, quit digging. That is a good lesson for everyday life, for work and for what to do when you end up in an argument with your indolent brother-in-law. Unfortunately, the people who need to listen the most are the ones who don’t seem to be paying attention at all.
Look at Europe, for example. In country after country, elected officials – and in some cases officials appointed by the EU – repeat fiscal policies that already have a proven track record of making a bad situation worse. It is not difficult to predict that 2013 is going to be no better for Europe than 2012 was.
Portugal is the latest EU member state to faithfully join the austerity ranks. That is bad, because Portugal has absolutely no room for more macroeconomic failure. Few countries in Europe can beat Portugal in terms of bad economic growth: from 2004 to 2008 the Portuguese economy grew by 1.24 percent per year, on average; from 2009 through 2012, and including forecasts for 2013, the average annual growth rate is -1.24 percent.
Essentially, the Portuguese economy has been at a total standstill for an entire decade. Their economy needs a major shot in the arm, but that is not what the Portuguese government has in mind. On the contrary. Euractiv reports:
Portuguese President Aníbal Cavaco Silva said in his new year speech that he will send his country’s controversial 2013 budget to the Constitutional Court. The move could put at risk a €78 billion bailout deal from the eurozone and IMF. “On my initiative, the Constitutional Court will be called on to decide on the conformity of the 2013 state budget with the constitution of the republic,” the President said.
That sounds like a good idea, right? Many Americans cheer at this point, wishing president Obama would do the same. Except, of course, he does not have a budget to send to anyone, because his fellow Democrats in the Senate has refused to pass a budget since Obama took office.
But American bickering aside, the point here is not that the Portuguese president submitted the nation’s budget for constitutional compliance review. The point is that the budget does some serious damage to Portugal’s economy. Euractiv again:
In his speech Cavaco Silva, who has served as Prime Minister twice and is the first elected centre-right President of Portugal since the 1974 Carnation Revolution, also said the country was in a vicious circle of austerity and recession.
So why, then…
Cavaco Silva signed the 2013 budget into law earlier on 31 December, which includes the biggest tax hikes in living memory, according to Reuters. … According to the BBC, for most Portuguese workers the tax rises that came into effect on 1 January are equivalent to more than a month’s wages.
I warned already in September that more austerity in Portugal could bring the nation’s social unrest to a very dangerous boiling point. This kind of tax increase, which more than anything is akin to macroeconomic suicide, will certainly not put a damper on strikes and other forms of public protests.
Speaking of the BBC, here is what they had to say about the Portuguese budget:
The standard income tax rate is rising from 24.5% to 28.5%. The savings are Portugal’s toughest in living memory, aimed at meeting the terms of a 78bn-euro (£64bn) bailout. … Earlier Portugal’s Finance Minister, Vitor Gaspar, admitted the tax rises were “enormous”, but were “another determined step toward recovery”.
Sure. Take away one month’s worth of money from the average family, then make the toughest spending cuts “in living memory” and now expect the economy to recover.
Given what Greece has gone through since 2009 you would expect at least some kind of “on second thought” reasoning, especially since, says BBC,
There have been big street protests against the cuts and on 14 November there was a general strike by angry workers hit by economic hardship.
A macroeconomic meltdown is the least of Portugal’s problems. The very democratic system of government is in jeopardy. As I reported back in September, 41 percent of the voters in Portugal supported one of three hard-line socialist parties. One of those parties still worships Lenin.
The road from austerity to tyranny is much shorter than our political leaders will ever understand.
Until, of course, it is too late.
Europe’s leading politicians and bureaucrats are getting increasingly desperate over the fact that their austerity policies are not turning troubled economies around. In order to fix this problem they have drafted a model for centralizing fiscal policy powers to the hands of the EU leadership. This is a bad idea for a host of reasons, one being that it further erodes what remains of member state sovereignty. Another reason is that it will apply one-size-fits-all fiscal policy to the entire euro zone (and over the long term to the entire EU). With that comes standardizing both taxes and government spending, with consequences that few if any European governments have begun contemplating.
One consequence will be a decisive drop in economic activity across the euro zone. We can already see what this means in GDP data published by Eurostat. More on those numbers in a moment; first, let us get an update on how far the Eurocrats have come in centralizing fiscal policy. EurActiv reports:
France’s Socialist-led government today (19 September) kickstarts ratification of a European Union budget discipline pact it grudgingly accepts as the next step out of the euro debt crisis. Meanwhile, another EU treaty for further political integration is already in the pipeline. Created in March by President François Hollande’s predecessor Nicolas Sarkozy and 24 other EU leaders including Germany’s Angela Merkel, the fiscal compact requires eurozone countries to slash their public deficits or face legal action and possibly fines.
This means, plain and simple, that the centralized fiscal policy authority will double down on destructive austerity policies, thus making it impossible for member states to experiment with structural reforms to their welfare states, including deregulation, outsourcing and privatization. The fiscal central heating system will be all about bringing about a static balance by means of chainsaw-style spending cuts and destructive tax increases.
Just as they have tried in Greece, Spain and Portugal, to mention only three austerity experiments gone wrong.
Its entry into cabinet on Wednesday paves the way to likely approval by French parliament in coming weeks, despite noisy dissent within Hollande’s left-leaning coalition and growing disenchantment with the European Union among a French public facing 13-year jobless highs and fearing worse to come. … The pact is due to be submitted to the French parliament in early October. It should pass through easily if, as they have stated, some of the deputies in Sarkozy’s conservative UMP party vote for it.
So what would the consequences be of centralizing fiscal policy and thus making austerity the norm for all of the euro zone? Well, let’s take a look at what Eurostat has to offer. They recently published a GDP forecast for 2012 for member states and reference countries, a total of 36 nations, as well as estimates for 2013.
Going back to 2004 we thus have ten years of macroeconomic data to review. The first five years, 2004-2008, were supposedly “good” years while the years 2009-2013 can safely be said to be recession years. Here are the average growth rates for the 36 countries for the two periods:
Table 1 – Average GDP growth, adjusted for inflation
|2004 to 2008||2009 to 2013|
Every single country has experienced a slowdown. However, some countries have suffered more than others. The five countries that have experienced the most dramatic drop in growth are: Greece, Portugal, Italy, Croatia and Spain. As we all know, Greece, Portugal and Spain have suffered dramatically under very harsh austerity pressure from the EU. Italy is also drifting in to the austerity shadowland.
In the case of Greece, Portugal and Spain, the shift from growth to GDP contraction exhibits a remarkable correlation with the implementation of austerity:
Table 2 – GDP and austerity
Austerity has been an active fiscal policy agenda in the EU, for “troubled” countries, since 2009, though the really tough measures did not reach Portugal and Spain until about a year later. Nevertheless, as these numbers clearly show, Grece has only gone from a bad growth situation (-0.2 percent in 2008 and -3.3 percent in 2009) to an outright macroeconomic freefall in ’10, ’11 and ’12. In fact, some forecasts for 2012 expect up to seven percent GDP contraction, which would obviously put 2013 in the red as well.
The Spanish economy is also contracting more after the government put austerity to work, and the Portuguese are beginning to feel the squeeze of their spending cuts and tax increases.
By contrast, let’s take a quick look at three countries that have not gone for harsh austerity:
Table 3 – GDP and absence of austerity
This does not mean that these countries are doing well overall, nor does it mean that the U.S. perennial-deficit policy is a good one. The American economy is to some degree a different animal due to its sheer size, and to the reserve currency status of the dollar. Nevertheless, these numbers show that in the choice between doing nothing about a deficit, and trying to close it with austerity, you are better off doing nothing.
Long-term, though, the American deficit is going to come back like a macroeconomic boomerang. In fact, that long-term is not very long term anymore: the U.S. credit rating recently took another beating which shows that we are rapidly maxing out our credit. Once we get to the point where borrowing is impossibly expensive, Congress will in all likelihood pull out the fiscal chainsaw.
Austerity, in other words.
That must not happen. Neither we nor the rest of the world can afford an America with an economy in Greek free-fall. Instead, we need structural reforms that permanently shrink government, cut taxes and return government-seized responsibilities – a.k.a., entitlements – to the citizens.
It can be done. It must be done. Let’s do it now.
Austerity continues to ravage Europe. After having bombarded Greece with austerity mandates, the EU, the ECB and the IMF moved on to Portugal, Italy and Spain where their measures also brought depression-like downturns in the economy. In April similar measures led to the downfall of the Dutch government, and the French chose to elect a socialist goverment over an austerity-minded center-right government.
The French solution is of course no solution. All it does is blow smoke screens and make people believe you can keep growing government with impunity. That is of course impossible, which the French will soon find out the hard way. Nevertheless, the social despair that follows in the footprints of austerity is spreading and could lead to a large-scale shift in European politics in the same direction that French voters pointed to. Let’s not forget that four out of every ten Greek voters supported authoritarian parties in the June election, and that the current administration is basically governing with razor-thin margins.
But Greece is not the only example. Spain is in trouble. Austerity has provoked social unrest and provincial separatism of a kind not seen since the years after the Franco dictatorship fell. And now Portuguese voters are expressing their frustration with yet another round of higher taxes and spending cuts. ABC News reports:
Income taxes will go up next year, Vitor Gaspar said. Public employees will lose either their Christmas or vacation bonus, each roughly equivalent to a month’s income, and many pensioners will lose both. More public employees will join the dole queue. Last year was tough enough, especially for public employees, whose salaries were cut by up to 10 percent as they lost their two bonuses. Meanwhile, property and sales taxes went up, and tax deductions and welfare entitlements went down for everyone. To top it off, the recession, which the government predicted would bottom out this year, will continue into next.
How surprising. When you subject an economy to austerity, things only get worse. But the Portuguese government does not even have to read this blog – all they need to do is look at Greece, where the economy has been tormented by austerity for three years now. That economy is now in macroeconomic free-fall, shrinking by a depression-level seven percent this year.
According to Reuters, Portugal is now also suffering its fair share of social unrest, a direct response to the government’s austerity policies:
Over 150,000 Portuguese marched on Saturday against planned tax hikes that have shattered the consensus behind austerity imposed by an EU/IMF bailout, and tens of thousands more marched in Spain, seen as the next country needing to be bailed out. The rallies in Portugal were mostly incident-free, but a young protester of about 20 was taken to hospital with burns after an attempted self-immolation during the protests in the northern town of Aveiro. RTP television quoted firemen as saying his life was not in danger. Organized via the Internet, the rallies brought together Portuguese from all walks of life, chanting: “Out of here! IMF is hunger and misery!” and calling on the centre-right government to resign. The rally ended at the vast Square of Spain near the Spanish embassy to express solidarity with protesters across the border in Spain after tens of thousands rallied in Madrid earlier on Saturday against spending cuts and tax rises. A huge rally was held in Porto and smaller ones in other cities and towns.
The real concern here is not the protests, but the radical message they carry. Just like in Greece, voters in Portugal could very well throw their support behind very radical parties. In last year’s election three leftist parties – to the left of the mainstream European social democrats – gathered 41 percent of all votes. These three parties share a disdain for the market economy and for economic freedom, with one of them being an outright Leninist communist party.
So long as the free-market economy is being blamed for the current crisis – as opposed to the welfare state which is the real culprit with its excessive spending programs – this kind of parties will continue to grow all across Europe. This just a bit more than two decades after the fall of the Berlin Wall.
Back to the Reuters report:
“People are fed up with being robbed by this government’s policy, which now threatens to strangle us,” said bank worker Joao Pascual, 56, marching in Lisbon. Andre Pestana, a 35-year-old unemployed teacher, said: “It’s time to say enough to robbery and lies. The government has failed on all its promises … I hope this rally is the first step in the process of changing things.”
At least people are beginning to realize that government has broken its promises. The problem now is that they are drawing exactly the wrong conclusions from their analysis. They want government to restore its spending and keep its promises, when in reality those very promises where what drove the car into the ditch in the first place. Therefore, it is of great concern that the austerity policies may actually bring Portugal to a situation similar to that which earlier this year caused a new election in the Netherlands: as austerity wreaks havoc on the economy, support for the measures fades away and a fragile majority party coalition in the national parliament falls apart.
A new election, should it become reality, would have serious consequences. As the Reuters story explains, it is already now difficult to govern Portugal:
On Thursday, the main opposition Socialists threatened to end cross-party backing for the 78-billion-euro bailout by voting against the 2013 draft budget unless the government drops its planned increase in the social security levy for all workers to 18 percent from 11 percent. Broad political consensus behind austerity had until now differentiated Portugal from other euro zone strugglers like Greece, the scene of frequent unrest over austerity. The government will not present the draft budget until mid-October and many protesters said they hoped the administration would rethink its policy. Two opinion polls, including one by Eurosondagem pollsters published on Saturday, have shown support for the ruling centre-right Social Democrats falling behind the Socialists for the first time since the June 2011 election.
So long as the only alternative considered is more austerity – as opposed to structural spending cuts that reform away the welfare state – Portugal is heading down the dangerous slope of an accelerated recession, more unemployment and even tougher deficits. Some Portuguese politicians seem to realize that this means borrowing more than a page from Greece. That insight is far from sufficient to prevent Portugal from becoming a new Greece, but it might help. And even a first, rudimentary insight is a step in the right direction. After all, as France E24 reports, the Greek are now so desperate that they are begging the EU for an extension of their current austerity mandates:
Greece needs a two-year extension from its international creditors to meet fiscal pledges, and a liquidity boost from the European Central Bank, said Prime Minister Antonis Samaras. In a Washington Post interview appearing in Greece on Saturday, Samaras said the recession-hit country was determined to adopt a new austerity package worth 11.7 billion euros ($15 billion) to avoid leaving the eurozone. But he said the programme should apply over four years instead of the currently agreed timeframe of two years — his most specific extension request in weeks. “Instead of the 11.7-billion-euro package taking place over two years, it would be best if it were to take place over four years,” the prime minister said. “We are talking about an extension to 2016,” he said.
Greece and Portugal are not the only countries to keep an eye out here. Hungary is also on the list, and the Hungarians are apparently balking at austerity for “Greek” reasons. Perhaps the prospect of social unrest and political radicalization spreading to countries like Hungary is enough to explain why the EU appears ready to give Greece its extension, and thus concede that hard-line austerity comes with a price tag.
The only way to save Europe is to do away with the welfare state and build a new economy based on economic freedom. For every month of new austerity measures in new countries, this looks like an increasingly remote alternative. Instead of considering this alternative, Europe’s political leaders double down on their austerity policies. The only “relief” they are willing to consider is a slowdown of the tightening macroeconomic choke hold.
With that narrow a vision, the only future that lies ahead for Europe is spelled “Weimar”.
The welfare state is the biggest peacetime threat to freedom and prosperity that we face in our time. This blog has documented over and over again how the welfare state brings economies to their knees and – unintentionally – opens the door for totalitarianism.
Today we can offer yet another small but telling example of the economic effects of the welfare state. This story, reported by the Washington Examiner, provides a good street view of what happens when government over-promises entitlements to its citizens:
Portuguese doctors are staging a 48-hour strike to protest austerity measures they say are weakening the country’s publicly-funded health service. The government has to reduce health spending as part of deep budget cuts promised in return for a €78 billion ($96 billion) bailout last year.
Socialized, government-run, government-funded health care is one of the most dangerous features of the welfare state. See this book for an overview of the theory, and this one for a study of the malpractice, of single-payer health care. It inevitably brings about a fiscal crisis that always comes on top the contributions toward that same crisis from other welfare-state programs. The Washington Examiner story clearly indicates this when it explains that the Portuguese government had to get a bailout in the first place: the bailout was put in place because the Portuguese government has had problems paying for all its spending for many years – including health care.
Eurostat data shows beyond any shred of a doubt that excessive government spending is nothing that Portugal invented yesterday:
When a government increases its debt as share of GDP, and does so year after year, then the reason is not a recession – it is structural over-spending. That, in turn, is the very essence of the welfare state.
Other Eurostat numbers show that in 2009 welfare spending – which technically is poverty relief and only a part of welfare state spending – was at 27 percent of the Portuguese GDP, up by one third in a decade.
This spending crisis has not been helped by the fact that government obviously has to pay for its outlays with taxes. Analyzed over a longer period of time, the Portuguese economy has suffered one of the largest increases in the tax burden of any industrialized country: from 1965 to 2005 the tax burden in Portugal – taxes as share of GDP – more than doubled, from 15.9 to 34.7 percent. Only two other countries, Spain and Turkey, saw larger tax increases over that period of time.
With all this in mind, it should come as no surprise to anyone that between 2000 and 2010 Portugal’s GDP grew at the third slowest rate in the EU, only 0.7 percent per year, adjusted for inflation. With such meager growth comes equally meager growth in the tax base; if you don’t keep government spending in check you end up with runaway deficits. And you can’t keep government spending in check so long as you keep the welfare state.
The Washington Examiner also mentions that:
The government has also increased nominal charges for some services. Emergency room charges have risen to €20 from €9.60.
This is what happens when you have a government-run health care systems on top of every other entitlement program in the welfare state. The Portuguese people are not getting more health care out of paying these fees on top of the high taxes they already have to dole out for the very same health care.
This is yet another symptom of what happens when you try to save a welfare state by means of austerity.