Saturday, February 21, 2015

2015: Europe's Year of Living Dangerously?

I don't claim to be an expert on European matters, but I am living here most of the time at present and can't help noticing some of what is going on.  This post is meant to be the first of a 3-part series:  in the second I will move beyond Europe's borders to world affairs nearby, then bring it back home to America in the third. 

The Inflammation and Its Causes
Europe is inflamed, by which I don't mean that it's in flames (not at all), but there is a persistent irritation in its political being. As a matter of personal health, inflammation  is underrated by us non-medical people as a malady; recent studies suggest that prolonged irritants are a leading cause of cancer.  So we should take this inflammation in the continent seriously:  It can endanger the Euro, even the European Union, if it is not treated properly.

The dissatisfaction with Europe (by which I mean the EU) is widespread, and it seems to be growing in its extent and its severity.  The discontent is primarily, but not exclusively, economic; therefore, it naturally tends to focus on the policies of the European central bankers, and on the Euro as the most identifiable target.

The acute problem is economic inequality, within the nations of Europe and across them as well. Nothing new, of course, but the high overall unemployment in many of the countries, and the exceptionally high level among the young, are disturbing facts, ones that have remained in place in many of the countries since the 2008-09 global economic crisis, or even before then.  More disturbing is the absence of movement, of any effective plan on the horizon to address the inequality.

It has taken the European Central Bank several years of watching the apparent success of the US Fed's Quantitative Easing program, which provided monetary stimulus through massive bond purchases, for the ECB to move now in that direction, hesitantly and over dug-in opposition. Economic theorists generally don't seem to anticipate that the program will work as well in Europe as it did in the US because of technical differences in the bond markets, but most have come out in favor of it as at least being some action that the EU can take to promote growth.  The irony is that, according to a journalistic analysis in the Wall Street Journal, the European countries that will likely benefit the most from QE are the Netherlands and Germany.  The German bankers have fought the initiation of the program particularly hard, and Germany and Netherlands probably need the stimulus the least of any of the countries.

The general problem of the countries with the Euro is the "one size fits all" nature of the fiscal discipline required for all nations admitted into that group.  Upon joining, these countries surrendered a piece of their sovereignty; now they are required to cap budget deficits (at 3% of GDP) and the cumulative governmental debt as a function of GDP, as well.  The way this plays out is that countries like Germany with strong economies and good fiscal discipline don't mind the strictures, while the ones with a history of poor tax collection and inefficient government spending, which also tend to be the ones with slow growth and high unemployment, are blocked from deficit spending,  To make matters worse, the markets can ignore the supposed unitary Euro marketplace when it comes to the price of nations' sovereign debt, so those weaker markets are penalized with higher interest rates, making the challenges even harder.  

A Sensible Tumor
Grease is the time, is the place, is the motion/ Now grease is the way we are feeling
--Barry Gibb

(I never really got the point of this particular part of the song lyric, and to the extent I did, I rejected it totally.  If there's one kind of nostalgia I can't stand, it's for the Fifties.  However, change some of the letters, keep the pronunciation, and the lines resonate today Try to get that Frankie Valli voice out of your head, though--it will make you crazy.)

I will push the analogy further and accept the notion that there is a tumor that has grown with the European body politic, and it is the weakness of the Greek economy within the Euro.  I would argue that, at this point, it is a benign tumor--though growing--and can be treated successfully.  Without surgery.

In this case, the tumor arises both from inflammatory and from genetic causes.  With the original rules that had been set up for entry into the Euro, Greece should never have been admitted--it was a major fudge.  I was in Greece in the days before the Euro officially began, and there was a lot of enthusiasm for what it would bring, and in the early days, before the major economic crisis of 2008-09, it helped with the modernization and efficiency of the economy.  The problem was building, though, in the form of the imbalance in the nation's budget and the level of the nation's debt, both of which were pushing the Euro market's established limits.  Then, when the recession hit, and the GDP dropped, the debt level (measured as a % of GDP) broke the boundaries, which caused a crisis in 2011-2012 about the soundness of the country's sovereign debt.  The solution then was sharp cuts in government spending--which has exacerbated the recession there--and refinancing of the debt (with a reduction in their value) with a European guarantee.

Jump ahead to the present.  The discontent in Greece has finally led to the political victory of a left-wing alliance, Syriza, which pledged an end to austerity and a better domestic deal on debt repayment.  Contrary to what some may think, Syriza has never advocated withdrawal from the Euro--which would be unpopular in Greece in any case--but is pushing the boundaries of what can be tolerated by its opponents (the central bankers, representing the bondholders' interests) by proposing to break agreements on budget deficits and debt servicing. Syriza could fairly be accused of some demagoguery--advocating unwise policy in telling the people what they want to hear--but there are two other key points:  1) they are absolutely correct that the austerity policy has failed Greece, was always incorrect, and must end; and 2) Syriza's success is primarily the result of the abject failure of the major parties in the country.

The European bankers at this point couldn't care less about Greece, and its fellow traveler on the edge, Cyprus, but there are two critical issues in telling them either to pay up or face dire consequences.  The first is the potential harm to the Euro, and the European Union  (Greece would probably go all the way out if negotiations collapsed) by creating a bad precedent, if they held the line and forced Greece out.  The second is the potential harm to the Euro and the EU if they don't hold the line:  Greece is the more acute case, but many or all the same problems apply (including the failure of the major parties): in Spain (the non-conformist party Podemos is on track to lead Spain down the track Greece has elected), in Italy (only one traditional party, Renzi's, retains any broad respect), and even in France (which has had a recent downturn in its economy).  Even in the U.K. (see below), though of course it's not in the Euro.  These countries do matter in Europe.  In other words, the Greek tumor can not be allowed to metastasize. *

Fear not--the ailment is treatable, I believe.  The two hard lines which the German bankers will not allow are an additional write-down of the debt and infinite postponement of repayment; thus, a formula to postpone repayment further, within limits, can be found and negotiated, assuming the goodwill remains on both sides.  The big concession, one on which the Italians, Spanish, and French will fully back the Greeks, is the change in the Fiscal Compact requiring a maximum budget deficit (after adjustments) of 3% of GDP.  This rule will be changed to allow countercyclical fiscal stimulus--it's just a matter of time (in Europe, it all moves slowly).  Wall Street is right in taking a cautiously optimistic view of how this will all play out.

The Chronic Issue 
The problem that is not going to be solved, either through easing monetary policy or fiscal policy, nor by solving in a more general way the inequality of credit ratings among the various semi-sovereign nations of the EU, is a demographic problem.  Most of the European nations' governments have social benefit programs that are extremely generous and expensive by US standards, whether one is speaking of education, welfare, healthcare, or retirement.  Tax rates are high, for the most part, but Europe partially compensates by spending a whole lot less on defense (read: military) programs. Fine for them, though perhaps not sustainable (President Obama is starting to lean on some of the larger European countries to pull their weight more, though it should be emphasized that the EU and the non-US membership in NATO are not congruent.)

No, the real problem for Europe is an aging population and low birthrates.  In the long run, something will have to change.  They will need to lower benefits, increase births, increase taxes (not much room for that), or allow more immigration, which contributes to maintaining the nations' economies because of a tendency for immigrants to be younger, working-age people.  The US has the same issues, but to a lesser extent, precisely because of the growth in immigrant and minority populations, which makes it less a necessity to consider benefit reductions or tax reductions, at least for awhile.

The idea of increasing immigration to the European bloc makes many there uncomfortable, for reasons that are economic, political, and cultural.  The economic issue is also an intra-Europe one, as the requirements for the free movement of labor has led to generalized resentment and frequent low-level violence. Political movements which have as central policy the reduction of outsiders have gained traction in most countries now.  Often, but not always, these movements emphasize in particular Islamophobia, frequently conflated with fear of terroristic elements. Of course, there have been significant acts of terrorism in Europe, most of which can be traced to people who professed adherence to Islam.   The ongoing challenge will be the degree to which Europe can successfully assimilate non-European populations, such as the North Africans in France and Italy, Indians and Pakistanis in the U.K., and Turks in Germany and elsewhere, without being overwhelmed by them (which is what the nativist parties fear).

British Influenza
One of the major events of the year, which could have broad effect on the EU and be a good indicator how these various stresses may play out, will be the general election in the U.K. in May. Economically, the situation is completely different from the Southern European countries:  a fairly austere policy directed by the Conservative-Liberal Democratic coalition is deemed to have been fairly successful, as the U.K. economy is showing moderate growth, and the pound is strong.  That doesn't mean that the policy is popular, though; opinion polls have consistently shown Labour with a small lead.  And that, in turn, doesn't mean that Labour will win the elections:  first, Labour's party leader Ed Miliband is broadly viewed as not being up to the challenge of leading the national government.

Second, and more critically, Parliament seats are decided by the candidate with the most votes in individual constituencies (as with the US elections), so the local dynamics of the small electoral districts make the result dependent on the summation of hundreds of micro-elections. The general historical patterns of voting in each of these constituencies is known, but the outcome of many seats will be unpredictable due to the emerging dynamics of Britain's becoming increasingly a multiparty system instead of a two-party one.

The third party which has been around forever in various forms, the Liberal Democrats (LD), have lost their way.  Occupying that space between the Conservatives and Labour was sacrificed for the opportunity to participate in the last government, and the strategy has been disastrous for that party: it has no recognizable, distinctive policy positions and relies upon a handful of respected moderate names.  Still, the party has its stronghold districts and will have a few seats, despite losing a large percentage of its share of the popular vote.

The real movement has been the growth in three parties which are newly factors in the growing complexity of  political equations.  The Scottish Nationalist Party lost last year's battle for Scottish secession, but has won greater support in the region and now is expected to win most of the seats, which will cost Labour seats.  The SNP and Labour are natural allies, but the first opportunity to build a government should be expected to go to the party which wins the most seats, which (due primarily due to the loss of Scottish Labour seats) is now projected to be the Conservatives.  Two other parties, the UK Independence Party on the extreme right, and the Greens, which are on Labour's left, are showing greatly increased strength in the polls, reflecting a loss of confidence in both major parties.  Neither party will win many seats, but by taking away share of the votes they could throw off the calculations of both Labour and the Conservatives about the seats they should expect to win.

I will make a prediction, based on my feeling:  Conservatives will have about 40-45% of seats, Labour 30-35%,  SNP and LD 15% combined, and Others (UKIP, Green, Irish parties) 5-10% .  With that result the Conservatives will be forced to make a deal (after the last elections they held the majority but brought in the LD from a position of strength.) The LD should be tempted to hold out rather than readily renewing their coalition and would find themselves, despite a poor result, in a potent negotiating position this time.  One of the main elements in play is the promised 2017 referendum on continuing membership in the EU, and the LD's possible asking price for rejoining the coalition (postponing the referendum) could put stress on Conservative unity--many of its MP's would feel ideologically more comfortable in the UKIP.  The final result could be a very messy three- or four-party government (Conservative-LD-Labour-SNP) to keep out the extremists.  For that to happen, there is a major budget disagreement--the Conservatives' plan is stingy, while Labour's is spendthrift--to be settled, and there would be a clear risk of some defections to the UKIP among right-wing Conservatives unhappy with the deal.  The betting parlay I would suggest is David Cameron to continue as Prime Minister but with his party in a weakened position in the new government.

*I am struck by how many of the words used in relation to the EU crisis--including Europe itself, of course--are Greek in their origin.  Regardless if the population or economic share that Greece has in the Union is small, the EU needs Greece in order to claim to be the continental force it wants to be. 

1 comment:

Chin Shih Tang said...

OK, there was an error of substance I need to acknowledge. The rule is not that there is a maximum deficit of 3% of GDP. It is actually that there must be a primary surplus (prior to interest on debts) of 3%. Stoner regrets the error.