Options for Europe – Part 41

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[NEW MATERIAL TODAY WITH FIRST FEW PARAGRAPHS REWRITTEN FROM YESTERDAY]

The Assizes – Intergovernmental Conference – Rome, December 1990 and the year that followed

Intergovernmental Conferences are designed within the European political context to be vehicles for proposing treaty changes. Decisions taken at these conferences have to be reached unanimously by the Member States and, become formal additions to the treaty once they are ratified by the Member States individually,

The Intergovernmental Conference in Rome – or the Assizes (‘assises’ in French) as it became known – was hosted by the Italian parliament as part of Italy’s six-month presidency of the European Council. The meetings were tasked with preparing the changes to the Treaty of Rome that would facilitate, among other things, the achievement of an economic and monetary union. The proposed treaty changes would then be ratified at the meetings in December 1991 to be held in Maastricht.

The deals had been done by the time the Member States converged on Rome in December 1990. The Committee of Governors of the Central Banks had rubber stamped the sections of the Delors Plan relating to the creation of an independent central bank in a report delivered on November 27, 1990. Germany had won. It demanded that that if it was to surrender the Deutsche Mark and relegate the Bundesbank to being part of the European System of Central Banks with the newly created European central bank at the helm, then the latter would have to be constituted and act as if it was the Bundesbank – independent of the politicians, singularly focused on price stability, and unable to offer any funding assistance to the Member States in economic strife. The resistance to this by the French had faded in the 1980s as its policy makers had been seduced by the now dominant Monetarist views among macroeconomists and monetary theorists. Even the French hope that Ecofin might be bolstered to act as a European fiscal authority was abandoned because the Germans considered this would compromise the focus of the new European central bank on inflation control. Thus, fiscal policy was left as the responsibility of the Member States, albeit with the plan to impose tight ‘binding’ limits on what the national governments could do (Gerbet, 2014). These limits would bias Europe towards stagnation, but that wasn’t fully revealed until the Global Financial Crisis and is still not widely understood or admitted.

The first several months of 1991 were busy ones for the Finance Ministers of the Member States supported by a phalanx of treasury bureaucrats and other relevant committees within the European Commission. The Economic and Social Committee of the European Community held a meeting on February 21, 1991, which released an ‘Opinion’ on the plan for an economic and monetary union (Economic and Social Committee, 1991). The ‘Opinion’ noted that while there had been progress towards the goal of an economic and monetary union up until then, there were “still considerable objections and doubts to be overcome” (emphasis in original) (Economic and Social Committee, 1991: 31).

They documented the fact that there was a lack of political will among Member States to surrender sovereignty to the extent required to make the system function. They noted the wide variation in inflation rates among the EMS nations and the fact that some “Member State budget deficits which continue to be financed by central bank borrowing can only be successfully tackled by addressing national resource allocation problems” (emphasis in original, p.32). They also questioned whether it made any sense to pursue a common monetary policy across twelve countries (Denmark, Netherlands, Germany, Ireland, France, Belgium, Italy, Luxembourg, Spain, Britain, Portugal and Greece):

there is no tangible proof either that the economic policies of the twelve different countries can actually be subordinated to common guidelines or that the national measures deemed necessary to successfully overcome unemployment, structural weaknesses and regional imbalances are in fact compatible with the common goal of general price-level stability. (emphasis in original) (Economic and Social Committee, 1991: 32)

They also documented the concerns that an ‘independent’ monetary policy would have for “democratic accountability’ (p.32).

Somewhat pointedly they noted that these “objections and doubts are largely unknown to the wider public in the majority of Member States. The discussion of economic and monetary union options is often over-simplified and frequently limited to the question of timing and institutional arrangements” (emphasis in original) (Economic and Social Committee, 1991: 32). The public could not appreciate the disadvantages of proposed union, which were “not explained clearly enough in the Commission’s report” (p.32). In particular, the public could not appreciate the costs to nations of abandoning their currencies and accepting a common monetary policy. Further, the abandonment of the capacity of central banks to fund deficits “would be painful for many countries” (p.32). By painful, they meant, higher than necessary unemployment, inability to provide essential public services and increased poverty rates and social exclusion. All of which have come to pass in the recent years.

The hard-lined Monetary Committee of the European Communities, a major source of the ‘over-simplified’ and ‘process-oriented’ information that was pumped out to the unknowing public as part of the political massaging of the move to economic and monetary union, had no such reservations. They released a report on April 12, 1999, which signalled their agreement on the “criteria for excessive deficits” (Monetary Committee, 1991: 1), that is, the binding rules that would stop Member States, subsidiarity principle notwithstanding, from running deficits beyond a certain limit. They said their had been “considerable” but not “unanimous” support (p.2) for “three independent criteria” (p.2):

1. A “Debt-to-GDP ratio in excess of a reference value with inadequate action to stabilise or reduce it”, or

2. “Breach of the golden rule and a deficit-to-GOP ratio in excess of a (low) reference value”, or

3. “Deficit-to-GDP ratio in excess of a (higher) reference value”.

The number 60 per cent was noted as the reference value under Criterion 1, while 0.5 per cent and 2 per cent were bandied about for Criterion 2 and 3, respectively. The discussion that followed was a labyrynthic exercise in how many “fish” they would “catch” in the excessive deficit “net”. There was no discussion of the role of fiscal policy and the context in which it might be exercised to keep unemployment low in the face of significant shifts in private spending. The concerns of the Economic and Social Committee’s ‘Opinion’ were well founded. The econocrats on the Monetary Committee were happy to play around with spreadsheets inserting different levels of the respective ‘reference values’ to work out the “fish” harvest (where the fish were nations where humans lived and worked.

The Report’s Annexe documented the scale of nations in breach at various ‘reference values’ and in some simulations, with extremely modest ‘reference values’ 9 of the 12 nations would be in breach of the rule if implemented. The reality was that there was a wide disparity in deficit outcomes across the original EMS nations, which became larger if the 12 nations in question were the focus. For example, in 1990, France’s was running a deficit of 2.5 per cent of GDP and so were comfortable advocating a 3 per cent rule for a deficit to GDP ratio. Of the original EMS nations, Belgium recorded a deficit of 6.8 per cent of GDP in 1990, Denmark 1.3 per cent, Germany 2.9 per cent (which would soon rise sharply as a result of the re-unification outlays), Ireland 2.8 per cent, Italy 11.4 per cent, Netherlands 5.3 per cent and the United Kingdom 1.5 per cent. Luxembourg was an exception and was recording a fiscal surplus in 1990 of 4.3 per cent of GDP.

But unemployment was elevated in all these nations relative to the situation encountered at the beginning of the EMS in 1979. An understanding of the role of the fiscal policy clearly indicated at the time that these deficits were not large enough given the rising unemployment across these nations. But with Monetarism blurring this understanding and, instead promoting a series of myths about fiscal deficits, policy makers were blithe, if not blind, to that reality. The Monetary Committee seemed to be focused on whether the sanctions for breaching the proposed rules would be automatic or not and other arcane matters of process within the punitive regime they were designing and forgot that there is a direct link between the size of the deficit and unemployment.

The discussions mostly concerned what could be done about Italy (with concern over Belgium and the Netherlands simmering). Concerns were also focused on the new EMS entrants included the Peseta (entered June 19, 1989); the Pound (October 6, 1990) and the Escudo (April 4, 1992) and the prospect that Greece would join the other eleven nations that would form the economic and monetary union. On July 4, 1991, The European Commission published an updated “Communication” to the European Council, which expressed the concerns that the Commission had for the lack of progress towards economic convergence given that Stage II of the transition to economic and monetary union was “only two and a half years away” (European Commission, 1991: 1). The “worrying set-backs” among some countries were defined in terms of rising deficits in the face of an acknowledged “less favourable economic situation” (p.1). Extraordinarily, the Commission claimed that it was appropriate for Member States to enact harsh fiscal cutbacks in this recessed environment because “the policies required to strengthen growth fundamentals are also those necessary to improve convergence”. This is an early statement of the “fiscal contraction expansion” mantra that has been at the forefront of the imposition of fiscal austerity during the current crisis. The neo-liberals claim that cutting spending is the way to get higher spending.

Where did this sophistry come from? A basic rule of macroeconomics is that spending equals income which leads to output and employment. Someone’s spending is another person’s income. There has to be growth in spending for there to be growth in income and output. If there is unemployment it means that total spending is insufficient to generate enough output and hence jobs to satisfy the preferences for work of the unemployed. The Keynesian solution is for the government to either directly increase spending to lift sales in the private sector and stimulate further income and/or to cut taxes, which might lead to higher private spending.

The Monetarists rejected this approach claiming that government spending and deficits were inflationary and wasteful. As an alternative, they introduced a rather bizarre notion that the opposite would be the case – that is, when there is unemployment the correct strategy for government is to cut its spending (introduce what is now popularly known as ‘fiscal austerity’). This policy view was based on a theoretical notion that the arcane textbooks promote that is called ‘Ricardian Equivalence’. It sounds scientific but in simple terms refers to the assertion that during a recession when unemployment is high, private spending is weak because households and firms are scared of the future tax implications of the rising fiscal deficits that typically accompany a recession. There are two reasons why deficits rise during recessions. First, tax revenue falls and welfare spending rises as economic activity collapses. Second, governments may introduce special stimulus packages to fight off the rising unemployment. Even without the second source, deficits will rise just because economic activity is low. We will consider this issue in more detail in a later chapter.

The neo-liberals thus claim that consumers and firms form the view that the government will have to increase taxes in the future to pay back the debts it incurs as the deficit rises. As a consequence, the households and firms deliberately stop spending and save up to ensure they can pay the higher taxes. Once the government starts to cut the deficit, the theory claims that a signal is sent to the private sector that future taxes will be lower and so they start spending again. Problem solved.

There has never been any credible empirical evidence produced by anyone to show that private households and firms deliberately stop spending and increase saving when deficits rise because they fear future tax increases and want to save up to pay for them. The overwhelming evidence shows that firms will not invest while consumption spending is weak and households will not spend because they scared of becoming unemployed and try to minimise their outstanding debt obligations. Ricardian agents only exist in the rarified world of mainstream macroeconomic textbooks and have never been observed at large in the real world.

But in 1991, the European Commission was introducing this notion into the debate about economic and monetary union. The wheels were falling off back then.

[TO BE CONTINUED]

[WITHIN REACH OF MAASTRICHT NOW]

Additional references

This list will be progressively compiled.

Abeille, G. (2010) ‘A l’origine du déficit à 3% du PIB, une invention 100% … française’, La Tribune, October 1, 2010. http://www.latribune.fr/opinions/tribunes/20101001trib000554871/a-l-origine-du-deficit-a-3-du-pib-une-invention-100-francaise.html

Economic and Social Committee (1991) ‘Addditional Opinion of the Economic and Social Committee on Economic and Monetary Union’, February 21, 1991. http://aei.pitt.edu/id/eprint/41816

European Commission (1991) ‘Resuming progress towards convergence of economic policies and performances in the Community’, July 4, 1991. http://ec.europa.eu/economy_finance/emu_history/documentation/chapter13/19910704en08communconvergeneco.pdf

Gerbet, P. (2014) ‘The Intergovernmental Conference (IGC) on Economic and Monetary Union’, Centre Virtuel de la Connaissance sur l’Europe. http://www.cvce.eu/collections/unit-content/-/unit/02bb76df-d066-4c08-a58a-d4686a3e68ff/51f02a97-8ca6-4e94-a616-38b79abf9190

Monetary Committee (1991) ‘Report by the Alternates on the Excessive-Deficit Procedure’, April 12, 1991. http://ec.europa.eu/economy_finance/emu_history/documentation/chapter13/19910412en10reportexesdeficit.pdf

Personal Note

It should have been a day of rest but it wasn’t.

But at any rate, thanks to all the best wishes I received today and earlier by E-mail, Skype and telephone from friends.

Thanks to all for being so kind and thoughtful. Another year gone by!

And in all this gloom brought on by writing a book which traces the sheer, unimaginable incompetence of very high paid European politicians and government officials, who couldn’t get over World War II in a constructive way, we can have some music …

The first recording is from the original Blazing Horns album (1977) from Tommy McCook (tenor saxophone) with Bobby Ellis (trumpet). Dub doesn’t get much better than this.

And while we are on a roll here is Jack Ruby and The Black Disciples playing ‘Free Rhodesia’. Happiness.

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.