Politicians want a rapid economic and therefore political success. What they get instead are fading economic dynamics and risk of future crises.
In mid-2013, the European Union emerged from the second recession it experienced after the global financial crisis, but economic growth is weak and does not create sufficient number of jobs to bring unemployment down. The eurozone is growing at a slower rate than the entire European Union and a number of countries experienced a decline of GDP in the last year. This includes the third largest economy of the eurozone, Italy, where GDP is now 9% lower than in 2007. Future Italian historians will probably call the 2010s “the lost decade.” Since early 2008 until late 2014 Italy registered 18 quarters with negative GDP growth and only 10 with the opposite tendency. Spain had 15 quarters of GDP decline in that period. In Greece the GDP shrunk every year from 2008 to 2013. In Portugal the economy went into reverse in 2009, 2011, 2012 and 2013.
The second-largest economy of the European Union, France, also has low dynamics. In the last seven years it has been growing at the annual rate of 0.3%, and unemployment in this country exceeds 10%. Unemployment is also hitting record levels in Greece and Spain, where a quarter of the working age population remains unemployed.
Recession and slowdown is nothing new in market economy. It was usually followed by a recovery, growth was faster and the economy entered a boom period until the next downturn. A recession purges the market of weak companies. They collapse or they are taken over by stronger, more innovative ones. Therefore growth is faster after a recession.
This time it is different and economists are speculating if this is a stable trend, the so-called “new normality,” or if perhaps economic policy is to blame.
Cheap Credit and Lack of Investment
Weak economic growth is due to a lack of sufficient investment in the economy. During a recession investment usually declines faster than the GDP, but when the recovery comes, investment becomes the engine of the economy. But despite historically cheap credit, European companies are reluctant to invest.
In 2007, all European countries spent a total of 2,913.4 billion EUR on investments, compared to 2,685.2 billion in the previous year. In real terms (that is in constant prices) investment spending in the European Union and the eurozone has fallen by more than 20% in the last seven years. Experts estimate the “investment gap”—the shortage of investment in the European Union—at 800 billion EUR yearly.
The share of investment in the GDP across EU fell from 22.6% in 2007 to 19.3% in 2014. The deepest decline occurred in the countries which before 2008 had enjoyed an artificial boom, driven by debt and an inflow of cheap capital. Ireland reduced the share of investment in the GDP by more than 11%, Spain by more than 12%, and Cyprus and Greece by more than 14%.
European (and not only European) companies are investing too little—despite the fact that they are able to debt-finance their spending at a historically low interest rate—for two reasons. The first is their high level of debt. Until the global crisis, which culminated in 2008, companies across the world, including Europe, developed through taking out successive loans. A crisis should lead to a wave of bankruptcies of the most indebted and inefficient firms. But nothing like that had happened. Cheap credit and government bailouts protected many companies from bankruptcy, but as a result their debt even increased. They persist thanks to the influx of cheap money, but they do not invest.
The other reason for low investment is the uncertainty as to continued growth. The more governments and central banks interfere in the economy, the more difficult it is for businesses to predict the effects of these interventions. In order to assess if an investment project is viable or not, you should have a reliable long-term prognosis. But today no economist is able to predict the effects of pumping trillions of dollars, euros, pounds and yens in the global economy. Businesses also wonder how and who will pay the increasing government debt.
Welfare-Happy Bureaucratic Europe
The European Union accounts for 8% of the global population, 20% of the global production and 50% of the global welfare spending. Welfare spending has been increasing in the period of rapid growth which Europe owed to its good demographic situation after World War II, an innovation wave and global development. In the late 20th century the situation began to change. Europe, like most rich countries, is aging, and financing the retirement systems alone requires more and more resources. The debt of European Union countries exceeds 85% of the GDP, and in eurozone it is more than 90%. This debt is constantly growing, despite EU regulations imposing caps on budget deficits. According to experts from the McKinsey Global Institute, by the end of the current decade public debt of the majority of EU countries will increase—unless reforms limiting spending are introduced. In Spain it will reach 160% of the GDP, in Italy 150%, in France 120%, in Great Britain 100%.
This cannot be sustained in the longer term, but politicians usually think only about the next election. Moreover, traditional parties in many European countries have to compete with populist forces promising rapid improvement of economic and social situation, not bothering about the harsh economic reality. It is no wonder that as far as further reform is concerned—or to put it bluntly, spending cuts—politicians prefer to speak about them than actually do anything.
In Italy, the left-wing Prime Minister Matteo Renzi bought the support of 10 million Italians with lower incomes by giving them tax breaks—to the tune of about 1000 EUR per year. Rating agencies punished Italy for that through lowering their debt rating, but the Italian left hopes to win the next election thanks to similar maneuvers. In the most indebted EU countries—Greece, Portugal and Spain—cuts on welfare spending led to a violent reversal of the voter sentiments. Even Germany, with its very prudent budget policy, partially withdrew from earlier reforms, based on raising the retirement age.
Low economic growth in Europe is also the result of complicated regulations, making in more difficult to compete on the common European market as well as with the emerging economic powers. In the 1960s and 1970s Europe could afford increases of labor costs exceeding the growth of productivity. On the global markets—with the exception of the United States, where the economy is focused mostly on the domestic market—European companies once had few competitors. But the last 20 years saw the economic emergence of China, as well as a number of other populous and fast developing countries. Many European industrial companies have moved to countries where labor is several times cheaper.
Although the European Commission announces consecutive plans for the removal of barriers to business development, within the Union many countries run a protectionist policy. An example of that is an attempt to eliminate transport companies from the cheapest Central European countries through imposing on them the German minimal wage and bureaucratic regulations, raising the cost of their functioning.
Opening the professions in Italy, Greece and Spain is progressing slowly and grindingly. Under pressure from trade unions consecutive Italian governments have been afraid to remove from the Labour Code the infamous Clause 18, making it difficult for employers to fire redundant or inefficient employees. Thereby they are discouraged from hiring new ones.
The average cost of electricity for households in 2012 amounted to 12 cents per 1 kWh in the US, while in the European Union it was 26 cents. For industrial users it was respectively 7 cents and 15 cents per kWh. The differences in gas prices are even bigger—American companies pay four times less than European ones. In the European Union in the period 2005–2013, average electricity prices for households increased by 55 % and for industrial users by 26 %. In the US they declined in the same period.
High energy prices are one of the causes of declining competitiveness of European industry. One of the factors driving them up are regulations concerning climate policy.
In 2005 the European Commission launched the globally first program of controlling emissions in the form of emission permits that can be traded, called ETS (Emissions Trading Scheme). A system like that had never existed in any country. The European Commission decided that increases of energy prices alone would not be enough as an incentive to save energy and hence to reduce emissions. It introduced emission limits for 11,000 industrial companies in the European Union. The ETS has proven to encourage corruption. The Europol (European Police Office) has detected crimes related to emissions trading, which caused billions in losses for government budgets. Many large corporations decided that the allocation was unfair to them. Dow Chemical, Shell and ExxonMobil have requested compensation of 5.5 billion dollars. The European zeal in the fight against global warming is not the only reason for the high cost of electricity and gas in the European Union. The European Union, which is rightly accused of excessive red tape, is unable to impose uniform regulations on all countries, creating single European gas and electricity markets. Each country is trying to achieve energy security on its own and as a result the capacities of electricity plants are used to a much lower extent than in the United States, which means higher costs.
Reforms, Yes, but First the Stimulus
Almost all European politicians declare that major structural reforms are needed, which would make it easier for companies to function, to hire and fire employees, to enter the market and to declare bankruptcy for the weakest, all in all strengthening the competition. It would mean decreasing the government involvement in the economy and reinforcing market mechanisms. “But first you need to stimulate economic growth,” the politicians are adding.
For seven years European economies have been egged on by fiscal stimuli, by larger budget spending and the monetary policy of central banks, which have been bringing down the already low interest rates.
In 2009, when Europe was plunged into a recession, all governments sought to compensate for a shortage of investment in the private sector by pursuing public investment. Even the International Monetary Fund insisted on them not to worry about budget deficits and to increase spending. We did not have to wait long for the results. Although the economy slowly started to move forward, some of the most indebted countries faced insolvency.
The European Commission then started to call for fiscal discipline, and because it is much easier to reduce investment spending than welfare spending, the European austerity plan took place mainly at the expense of cuts in public investment and in 2012 Europe fell into another recession. In the last year, the new head of the European Commission, Jean-Claude Juncker, presented the European economic recovery plan, which provides for an increase in public investment expenditure financed from the common EU coffers. It is supposed to be a way of avoiding further indebtedness of governments (spending on these investments would not be a burden on national budgets), yet it is only a bookkeeping trick. Juncker also called for deregulation of the economy—removal of barriers to entrepreneurship, deepening the integration of the European market including the energy market—but there were many such calls in recent years. It is much easier for governments to increase spending than to lift bureaucratic barriers.
The European Central Bank announced that from March 2015 until the end of 2016, it will buy debt securities on the secondary market, primarily government bonds, to the tune of 60 billion EUR a month. This is to be another idea for stimulating economic growth, although at the same time the ECB forecasts predict that even after the quantitative easing program is terminated, economic growth will not be strong enough to bring unemployment down below the 10% level.
Deep central bank intervention in the economy is a phenomenon unknown in the world before 2008 (with the exception of the Bank of Japan). The traditional role of central banks consisted of stabilizing prices and currency exchange rates, and hence ensuring predictability of economic conditions. For several years major central banks, including the EBC and the Bank of England, have conducted a policy which distorts asset pricing and financial parameters. The banks do it in order to stimulate the economy fast, but in the longer term the effects of such policy could be disastrous. While the mechanism of government intervention in the economy is familiar and businesses learned to adapt to it, central banks’ intervention may create bubbles on certain markets and lead to another financial disaster on a global scale.
Politicians would do best if they believed in the strength of self-regulating mechanisms in the economy. But they are not sufficiently patient to wait for the effects of these mechanisms. They want a rapid economic and therefore political success. What they get instead are fading economic dynamics and the risk of future crises.
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