Tag Archives: Italy

Asynchronous Cycles and European Convergence.

Perry Gogas 15xx (2)Dr. Periklis Gogas is a frequent contributor to The Business Thinker magazine. He is an Assistant Professor of Economic Analysis and international Economics, Department of International Economics and Development, Democritus University of Thrace, Greece


Ioannis Pragidis
Dr. Ioannis Pragidis is a co-author for the Business Thinker magazine.
He is a Lecturer of Economic Analysis at the  Department of Business Administration, Democritus University of Thrace, Greece


Towards Consolidation
After the crisis of 2008, governments and investors have been looking forward to the next day. After four years of fighting hard to restore liquidity in the global system, we face the difficulties arising from the slow growth of the real economy in almost all developed countries. The financial analysis of the Eurozone crisis gives way to the need to develop and implement a long-term economic policy. After 11 years of the euro crisis and with strong data in hand, we can factor in a satisfactory degree of certainty with some useful conclusions on the functioning of the euro area economy. In addition, the zone’s future now perhaps for the first time since the outbreak of the crisis is expected to be less dark and uncertain.

Asynchronous Cycles
The million dollar question is how will the countries of the South and North manage to cope together with the challenges in a common currency area. The common view is that the lack of national exchange rate policy will lead to a further recession for the countries of the South, since the main objective is the depreciation of the euro in order for these countries to regain their competitiveness. On the other hand, the hard core countries advocate a tougher euro so as not to disturb the market’s confidence for the common currency and to avoid the problem of imported inflation with negative consequences for the competitiveness in international markets. The production is mainly based on the usage of intermediate goods, the cost of which will increase as a consequence of a devaluation; this will drag up the cost of the production of other goods and services and thus lead the economies toward inflation and a loss of competitiveness. In International Monetary Theory, this is known as the problem of “asynchronous business cycles“. In this case, in the context of a monetary union such as the euro zone, a serious problem is being created regarding the effectiveness of monetary policy when some member states are being developed while others are in a recession. This is the reality being faced in recent years by the European Central Bank. In the northern countries, where competitiveness is high on the international level, the real economy is growing steadily. The main concern of monetary policy should be curbing inflationary pressures from the booming economy resulting in increased income and effective demand. In order for this to be achieved, a contractionary monetary policy should be implemented to limit the growth of the money supply. This is achieved by raising interest rates, reducing credit and the sale of debt through “open market operations“. However, for countries facing severe financial problems that are in a recession or crisis as a result of low productivity and hence low competitiveness, the appropriate monetary policy is to increase the money supply, reduce interest rates in order to stimulate new investment, and buy government bonds in open market operations in order to increase liquidity in the banking system; all of this will lead to credit expansion through the financing of new investment projects and through consumption, which is needed for the economy to be stimulated. It is obvious that in such a case there is not a monetary policy that is effective for all countries involved in this monetary union. In the case of Europe, it is logical that the European Central Bank designs and implements a monetary policy that is beneficial for countries whose GDP accounts for more than 70% of total output in the Eurozone. Thus, we experience the implementation of a strict monetary policy where inflation is the word missing from the vocabulary of the experts. Of course plays an important role here the mandate that aims to implement the ECB in contrast for example to the U.S. Federal Reserve. The ECB under the Statute has as its main objective the so called ‘monetary stability’, in other words avoiding inflation. The Fed on the other hand has two objectives: monetary stability and full employment. Naturally, these two objectives can often be conflicting. However, this difference gives significant leeway to the Fed as opposed to ECB. This discrepancy in economic priorities leads many economists and politicians to expect the breakup of the Eurozone. Careful observation of the data of the last decade may show a different reality which is much more optimistic.

Empirical Evidence Convergence
Economic data shows that there is a convergence of business cycles between the economies of the Eurozone. More specifically, a recent study to be published shortly in the journal of the OECD (Gogas 2013, Journal of Business Cycle Measurement and Analysis) shows that after the introduction of the common currency in 1999 (by pegging the national rates with the euro) Eurozone countries generally showed more synchronized cycles than the previous season. Certainly this synchronization as indicated in the study “should not be interpreted as an indication of general economic convergence. Although economic cycles appear more synchronized after the euro, the fundamentals of member countries such as productivity and competitiveness may not have converged. This can result in problems such as the recent debt crisis that threatens even the existence of the eurozone.” After the adoption of the euro, most of the peripheral economies faced cumulative competitiveness problems. Being in a monetary union and helpless to offset the high cost of labor and production, which is mainly a result of differences in labor productivity, with a devaluation they relied solely on deficits and increases in debt trying to finance their growth and their imbalances in current account transactions. The period before the crisis, i.e. before 2008, shows that apart from the convergence of business cycles in the Euro area countries, there was a convergence of nominal wages, as well as the price level in the unit labor costs. Inflation in the southern countries (Greece, Spain, Portugal, Italy) were consistently above the Eurozone average, which indicates convergence of the price levels of countries that had lower prices in the launch of the Euro. Moreover, it appears that the increase in prices was caused by higher prices of non-tradable goods and services, i.e. those not participating in the trade balance of countries. On the other hand, labor productivity tends not to be at the same levels between countries, especially those countries that had low labor productivity before their integration in the Euro area and that continued to move toward lower levels.

The Euro
The effects of the introduction of the new currency was not uniform in all member countries. In Greece, for example, the adoption of the Euro has led to significant price increases that reduced competitiveness. In Greece, this sharp increase in prices was believed by consumers to be what economists call a “temporary shock“ (transitory) or a “transient effect on income.” So this was incorrectly treated as a temporary reduction in real income. According to the “permanent income hypothesis” of Milton Friedman, households and businesses react to such a temporary shock by trying to compensate its effect through lending. According to this theory, consumers do not like sudden short-term changes (and downwards and upwards) in consumption and try to compensate by dispersing the result of temporary changes throughout many periods in the future so that there is little change in consumer behavior. This is exactly what happened in Greece. Households began to accumulate debt hoping to repay it when economic conditions improved. The optimism of the participation of Greece in the Eurozone, the steady growth, and other purely emotional and psychological factors such as the assumption of the Athens Olympic Games in 2004, created a great feeling of confidence that things would get better. This situation was fueled mostly by the unprecedented credit expansion in early 2000. This credit growth was supported by the ease with which the Greek financial institutions had access to capital from a broader and more integrated European capital market. The banks thus exacerbated their balance sheets through financial leverage. This proved disastrous as we have recently seen. Greece, just like other peripheral economies of the Eurozone faced a productivity gap relative to the central economies. For a monetary union to be successful, the economic convergence was essential both to the state budget (deficit, debt) and to the economic performance of the private sector (productivity, innovation). The unjustified euphoria that followed the introduction of the euro with “easy money” (easy but borrowed) created an illusion of wealth that misled both the private sector and governments from focusing on growth and on the reduction of the productivity gap from our European partners. Even worse, the differences in productivity and asymmetric business cycles encountered no substantial and structural measures, only new borrowing. As mentioned above, the ECB’s monetary policy is necessarily designed to serve the “big” EU countries, as they produce the overwhelmingly majority of the European GDP. To the extent that some of the smaller economies face adverse movements in GDP, since they are not synchronized with the so-called “big” countries, the only tool you can use is fiscal policy. Greece, along with other small regional economies in the EU have tried to address these asymmetries by creating deficits and increasing public debt, thus causing the debt crisis facing the Eurozone.

The Trade Balance and Exchange Rate
The difference in real wages between countries , as shown by recent studies on the case of the Eurozone (IMF, 2012), are due largely to a productivity gap, rather than sizes belonging to the narrower term core of competitiveness such as price and unit labor costs. The general elements of the course of the Euro show a lack of convergence of the countries of the Euro area work efficiency as expressed through technological improvements, education, infrastructure, etc. It is also important to note that the Euro as a single currency is not largely responsible for the level of unemployment in the countries of the Euro area, since from the first year of its adoption and through 2007, there was a convergence of rates between Eurozone countries.
If we pay attention to the entire Eurozone, we see with few exceptions that trade surpluses were achieved in all years (of course with the bulk coming from exports of Germany). The Eurozone manages to compete in international markets. During the same period, the euro-US dollar was high for the Euro levels. That is, the stable Eurozone trade surplus was not due to a devalued Euro. Paradoxically, the same picture applies across countries in the Eurozone. The relative level of prices of tradable goods and services is not the main determinant of imbalances in trade balances. Moreover, the current account of the U.S. was firmly in deficit throughout the decades of the ’90s and ’00, while the dollar depreciated between 2004 and today against the major currencies. In other words, the reduction in the price of U.S. goods abroad has not helped to eliminate the deficit. The reason in the case of the U.S. is mainly due to the preference shown by most countries to invest in financial products from the U.S.; this is because the development of the financial sector in many developing countries are not strong enough (that also explains the low interest rates in the U.S.). Of course, some of this deficit is financed by investments of U.S. firms abroad, which has particularly increased in recent years.

The conclusion, however, is that the monetary aggregates (such as commodity prices, exchange rates, etc.) do not affect long-term developments in the real sector of the economy such as output and employment but are only affected in the short term. This principle is known as the “neutrality of money“. Based on this, the assumption seems to be gaining ground that trade deficits were created primarily because of low interest rates after the adoption of the Euro and by the expectation of convergence and not because of a lack of competitiveness of the countries of the region toward the the North.
Therefore, the challenge for the Eurozone is the next day: the development of the real economy and the reduction of unemployment through a reduction of trade deficits of weak states.
On this basis we conclude that a central economic policy which favors inflation with simultaneous investments in increasing labor productivity can be the driver to exit the crisis. Inflation seems to create far fewer problems than it solves, for example, the gradual reduction of the nominal debt, while not exacerbating the trade deficit to the extent that until today most economists believed. Of course, these measures cannot replace the need for federalism in Europe or the lack of sectoral policy among countries nor can it replace the rationalization of government spending and the creation of primary surpluses.

Europe, Unemployment and Instability

G.FriedmanMr. George Friedman is Founder and Chairman, Stratfor, a private intelligence company located in Austin, TX.

This article is published here in by permission of Stratfor.

The global financial crisis of 2008 has slowly yielded to a global unemployment crisis. This unemployment crisis will, fairly quickly, give way to a political crisis. The crisis involves all three of the major pillars of the global system — Europe, China and the United States. The level of intensity differs, the political response differs and the relationship to the financial crisis differs. But there is a common element, which is that unemployment is increasingly replacing finance as the central problem of the financial system.

Europe is the focal point of this crisis. Last week Italy held elections, and the party that won the most votes — with about a quarter of the total — was a brand-new group called the Five Star Movement that is led by a professional comedian. Two things are of interest about this movement. First, one of its central pillars is the call for defaulting on a part of Italy’s debt as the lesser of evils. The second is that Italy, with 11.2 percent unemployment, is far from the worst case of unemployment in the European Union. Nevertheless, Italy is breeding radical parties deeply opposed to the austerity policies currently in place.

The core debate in Europe has been how to solve the sovereign debt crisis and the resulting threat to Europe’s banks. The issue was who would bear the burden of stabilizing the system. The argument that won the day, particularly among Europe’s elites, was that what Europe needed was austerity, that government spending had to be dramatically restrained so that sovereign debt — however restructured it might be — would not default.

One of the consequences of austerity is recession. The economies of many European countries, especially those in the eurozone, are now contracting, since austerity obviously means that less money will be available to purchase goods and services. If the primary goal is to stabilize the financial system, it makes sense. But whether financial stability can remain the primary goal depends on a consensus involving broad sectors of society. When unemployment emerges, that consensus shifts and the focus shifts with it. When unemployment becomes intense, then the entire political system can shift. From my point of view, the Italian election was the first, but expected, tremor.

A Pattern Emerges in Europe

Consider the geography of unemployment. Only four countries in Europe are at or below 6 percent unemployment: the geographically contiguous countries of Germany, Austria, the Netherlands and Luxembourg. The immediate periphery has much higher unemployment; Denmark at 7.4 percent, the United Kingdom at 7.7 percent, France at 10.6 percent and Poland at 10.6 percent. In the far periphery, Italy is at 11.7 percent, Lithuania is at 13.3 percent, Ireland is at 14.7 percent, Portugal is at 17.6 percent, Spain is at 26.2 percent and Greece is at 27 percent.

Germany, the world’s fourth-largest economy, is at the center of gravity of Europe. Exports of goods and services are the equivalent of 51 percent of Germany’s gross domestic product, and more than half of Germany’s exports go to other European countries. Germany sees the European Union’s free trade zone as essential for its survival. Without free access to these markets, its exports would contract dramatically and unemployment would soar. The euro is a tool that Germany, with its outsized influence, uses to manage its trade relations — and this management puts other members of the eurozone at a disadvantage. Countries with relatively low wages ought to have a competitive advantage over German exports. However, many have negative balances of trade. Thus, when the financial crisis hit, their ability to manage was insufficient and led to sovereign debt crises, which in turn further undermined their position via austerity, especially as their membership in the eurozone doesn’t allow them to apply their own monetary policies.

This doesn’t mean that they were not profligate in their social spending, but the underlying cause of their failure was much more complex. Ultimately it was rooted in the rare case of a free trade zone being built around a massive economy that depended on exports. (Germany is the third-largest exporter in the world, ranking after China and the United States.) The North American Free Trade Agreement is built around a net importer. Britain was a net importer from the Empire. German power unbalances the entire system. Comparing the unemployment rate of the German bloc with that of Southern Europe, it is difficult to imagine these countries are members of the same trade group.

Even France, which has a relatively low unemployment rate, has a more complex story. Unemployment in France is concentrated in two major poles in the north and the south, with the southeast of France being the largest of them. Thus, if you look at the map, the southern tier of Europe has been hit extraordinarily hard with unemployment, and Eastern Europe not quite as badly, but Germany, Austria, the Netherlands and Luxembourg have been left relatively unscathed. How long this will last, given the recession in Germany, is another matter, but the contrast tells us a great deal about the emerging geopolitics of the region.

Portugal, Spain and Greece are in a depression. Their unemployment rate is roughly that of the United States in the midst of the Great Depression. A rule I use is that for each person unemployed, three others are affected, whether spouses, children or whomever. That means that when you hit 25 percent unemployment virtually everyone is affected. At 11 percent unemployment about 44 percent are affected.

It can be argued that the numbers are not quite as bad as they seem since people are working in the informal economy. That may be true, but in Greece, for example, pharmaceuticals are now in short supply since cash for importing goods has dried up. Spain’s local governments are about to lay off more employees. These countries have reached a tipping point from which it is difficult to imagine recovering. In the rest of Europe’s periphery, the unemployment crisis is intensifying. The precise numbers matter far less than the visible impact of societies that are tottering.

The Political Consequences of High Unemployment

It is important to understand the consequences of this kind of unemployment. There is the long-term unemployment of the underclass. This wave of unemployment has hit middle and upper-middle class workers. Consider an architect I know in Spain who lost his job. Married with children, he has been unemployed for so long that he has plunged into a totally different and unexpected lifestyle. Poverty is hard enough to manage, but when it is also linked to loss of status, the pain is compounded and a politically potent power arises.

The idea that the Germany-mandated austerity regime will be able to survive politically is difficult to imagine. In Italy, with “only” 11.7 percent unemployment, the success of the Five Star Movement represents an inevitable response to the crisis. Until recently, default was the primary fear of Europeans, at least of the financial, political and journalistic elite. They have come a long way toward solving the banking problem. But they have done it by generating a massive social crisis. That social crisis generates a political backlash that will prevent the German strategy from being carried out. For Southern Europe, where the social crisis is settling in for the long term, as well as for Eastern Europe, it is not clear how paying off their debt benefits them. They may be frozen out of the capital markets, but the cost of remaining in it is shared so unequally that the political base in favor of austerity is dissolving.

This is compounded by deepening hostility to Germany. Germany sees itself as virtuous for its frugality. Others see it as rapacious in its aggressive exporting, with the most important export now being unemployment. Which one is right is immaterial. The fact that we are seeing growing differentiation between the German bloc and the rest of Europe is one of the most significant developments since the crisis began.

The growing tension between France and Germany is particularly important. Franco-German relations were not only one of the founding principles of the European Union but one of the reasons the union exists. After the two world wars, it was understood that the peace of Europe depended on unity between France and Germany. The relationship is far from shattered, but it is strained. Germany wants to see the European Central Bank continue its policy of focusing on controlling inflation. This is in Germany’s interest. France, with close to 11 percent unemployment, needs the European Central Bank to stimulate the European economy in order to reduce unemployment. This is not an arcane debate. It is a debate over who controls the European Central Bank, what the priorities of Europe are and, ultimately, how Europe can exist with such vast differences in unemployment.

One answer may be that Germany’s unemployment rate will surge. That might mitigate anti-German feeling, but it won’t solve the problem. Unemployment at the levels many countries are reaching and appear to be remaining at undermines the political power of the governments to pursue policies needed to manage the financial system. The Five Star Movement’s argument in favor of default is not coming from a marginal party. The elite may hold the movement in contempt, but it won 25 percent of the vote. And recall that the hero of the Europhiles, Mario Monti, barely won 10 percent of the vote just a year after Europe celebrated him.

Fascism had its roots in Europe in massive economic failures in which the financial elites failed to recognize the political consequences of unemployment. They laughed at parties led by men who had been vagabonds selling post cards on the street and promising economic miracles if only those responsible for the misery of the country were purged. Men and women, plunged from the comfortable life of the petite bourgeoisie, did not laugh, but responded eagerly to that hope. The result was governments who enclosed their economies from the world and managed their performance through directive and manipulation.

This is what happened after World War I. It did not happen after World War II because Europe was occupied. But when we look at the unemployment rates today, the differentials between regions, the fact that there is no promise of improvement and that the middle class is being hurled into the ranks of the dispossessed, we can see the patterns forming.

History does not repeat itself so neatly. Fascism in the 1920s and 1930s sense is dead. But the emergence of new political parties speaking for the unemployed and the newly poor is something that is hard to imagine not occurring. Whether it is the Golden Dawn party in Greece or the Catalan independence movements, the growth of parties wanting to redefine the system that has tilted so far against the middle class is inevitable. Italy was simply, once again, the first to try it out.

It is difficult to see not only how this is contained within countries, but also how another financial crisis can be avoided, since the political will to endure austerity is broken. It is even difficult to see how the free trade zone will survive in the face of the urgent German need to export as much as it can to sustain itself. The divergence between German interests and those of Southern and Eastern Europe has been profound and has increased the more it appeared that a compromise was possible to save the banks. That is because the compromise had the unintended consequence of triggering the very force that would undermine it: unemployment.

It is difficult to imagine a common European policy at this point. There still is one, in a sense, but how a country with 5.2 percent unemployment creates a common economic policy with one that has 11 or 14 or 27 percent unemployment is hard to see. In addition, with unemployment comes lowered demand for goods and less appetite for German exports. How Germany deals with that is also a mystery.

The crisis of unemployment is a political crisis, and that political crisis will undermine all of the institutions Europe has worked so hard to craft. For 17 years Europe thrived, but that was during one of the most prosperous times in history. It has not encountered one of the nightmares of all countries and an old and deep European nightmare: unemployment on a massive scale. The test of Europe is not sovereign debt. It is whether it can avoid old and bad habits rooted in unemployment.

GIULIO TREMONTI: In the “Eye” of the Market and of Berlusconi. (a commentary on the Italian financial situation).

Ms. Katerina Kapernarakou is a journalist for the Greek newspaper “Kathimerini”, and a contributor to the BusinessThinker.com covering the international business, economic, and financial issues.

Giulio Tremonti seems to have received multiple attacks, finding himself in “the eye of the storm.” The Finance Minister of Italy has to handle the rising borrowing costs of the country and all the questions that the markets raise in their usual compelling manner; these questions refer to the ability of Italy to respond to its debt and fiscal deficit obligations. At the same time, Tremonti’s relations with Silvio Berlusconi, the Prime Minister, are strained, as the latter accuses him of “lack of teamwork” in his already fragmented government. Also, he has to oversee the promotion of the austerity measures he has prepared in order to prevent the bad scenario about an Italy’s bailout. Although most of the measures have been put off until after the 2013 elections, he may have to implement them hastingly in advance because of the pressures of the market. Moreover, Giulio Tremonti should face another challenge.

Italy’s Finance Minister is considered by the international financial community as the guardian of fiscal discipline in the country and is identified as the shield against Berlusconian populism and extreme expenses. However, he made an error incompatible with his overall political stance, according to which he has strongly affirmed his intention to crack down on tax evasion. Marco Milanese, Tremonti’s former close associate who is investigated on alleged corruption, has testified he had provided Tremonti a luxurious apartment in Rome on 1,000 euros rent per week.

Continue reading GIULIO TREMONTI: In the “Eye” of the Market and of Berlusconi. (a commentary on the Italian financial situation).