As I have ben predicting here for months, the problems in individual large European economies have become too large to bear for the prevailing European policy mix. Therefore, today, in releasing the next year’s country specific recommendations, the EC has moved away from front-loaded austerity, pushed back deficit reduction targets, and instead stepped up calls for structural reform. The pace of austerity is now considered to have been too swift – socially and politically unsustainable – and so timetables are getting pushed. But the paradigm remains the same – austerity and structural reform. The slant is now away from austerity simply in order to accommodate the facts on the ground.
The catalyst for this change is manifold. But it starts with the recession in three of the euro zone’s largest economies, the Netherlands, France and Italy. I see the economic downdraft in those economies, particularly the missed deficit hurdles, as instrumental in the change of tack.
In February, I wrote that France’s poor economic outlook is Europe’s next problem. “Now it has come to light that the French are going to have to cut their growth forecast for 2013. They will not hit their targets and so either they will need to re-double efforts or get the targets relaxed. I believe it will be the latter as opposed to the former because I suspect at least the Netherlands, Spain and Portugal will all need their targets relaxed as well. But the problem here is clearly that France’s economic outlook is poor and nothing on the horizon says it is going to get any better. This will mean higher debt and deficits and an unraveling of France’s housing market, inviting systemic fragility in French banking.”
All correct so far except the all important market view i.e. yields. French yields are lower despite the economic problems, not higher as I have been anticipating. This has been the consistent pattern all across Euroland. It’s hard to say why at this point. But the macro picture has been clear – France is in deep trouble.
On the Netherlands, let’s look to March. I wrote that the Dutch will miss targets in 2013 but refuse to institute more austerity. I put it this way: “Well, well, well, it seems we have a problem in Euroland. The Dutch have now confirmed what I have been saying all along: they have run into so many fiscal problems that they will need to relax their targets instead of doubling down on austerity. This is going to have far-reaching consequences.
“There is no way that the Dutch can openly flout targets this way without Spain and France (and Italy and Portugal) being allowed to do so as their economies and job markets are much worse than the Dutch. And Rajoy and Hollande have publicly requested their targets be relaxed while Rutte goes ahead and just does it unilaterally… Olli Rehn has said Spain’s targets were likely to be relaxed. Now that the Dutch have unilaterally decided to relax their targets, this is almost sure to happen…”
Finally, there is Italy where at the beginning of the month I wrote about Italy’s decoupling from the periphery. My point was that EC watchers thought Italy was going to get off the naughty list and that this would be a boost to their economy. “The first topic is Italy and its leaving the EC’s excessive deficit list. I brought this possibility up in my post on Italy earlier in the week. And I think this is pretty much a done deal now. All of the policy statements line up this way. Of note, Olli Rehn, who will be the chief EC minister presiding over this decision, has already said he is in favor of relaxing deficit targets. It is clear to me then that he favors the “medium-term fiscal consolidation” path that Mario Draghi was talking about at today’s ECB press conference. And it also occurs to me that Draghi may have had Italy uppermost in mind when he made these comments.
“Notice that Italy automatically receives stimulus once they get off the excessive deficit list. This is important as Italy is the third largest economy in the eurozone and banks there are getting chewed up by the increase in non-performing loans that is a direct result of austerity. If you listened to Draghi during the ECB presser, you would have noticed that he spoke a lot about the negative impact of recession on the quality of loan books for banks within the euro zone. He was quick to say that he wasn’t speaking about specific banks but he did note that more capital will need to be raised and that this negative impact needed to be mitigated. This, again, leads me to believe he was thinking about Italy and its huge importance within the euro zone.
“I believe policy makers in Europe now believe stopping debt deflation in Italy is the most important policy agenda item at present. And they are prepared to give Italy a boost to break the negative cycle. I anticipate this will mean de-coupling from the periphery, a process that I felt was beginning early in the year before the electoral crisis interrupted it.”
All of this was confirmed by the EC today.The EC released the following on excessive deficits in its general press release today:
Decisions under the Excessive Deficit Procedure (see MEMO/13/463)
The Commission has today recommended that the Council abrogate the Excessive Deficit Procedure (EDP) for five countries: Hungary, Italy, Latvia, Lithuania and Romania.
The Commission has also recommended that the Council open an EDP for Malta.
Moreover, the Commission has adopted Recommendations to the Council with a view to extend the deadlines for correcting the excessive deficit in six countries: Spain, France, the Netherlands, Poland, Portugal and Slovenia.
In addition, the Commission has recommended that the Council decides that no effective action has been taken by Belgium to put an end to the excessive deficit and that the Council gives notice to Belgium to take measures to correct the excessive deficit.
In the press conference on these matters, EC President Barroso stressed that the timetables were merely slipping and that the need for fiscal considation was still urgent. However, in remarks reminiscent of his response to Matina Stevis that caused a furore, he conceded that austerity had to occur in a manner that was socially and politically tolerable. And it seems that is the only reason why the targets are getting moved.
In Portugal, Barroso was a far left leader of the underground Maoist movement as a student before the Carnation Revolution ended military dictatorship in 1974. But by the time he became Prime Minister in 2002 as a social democrat, he had moved much closer to the center and was responsible for the post-euro deficit reduction and austerity that Portugal needed to undergo to make the 3% Maastricht hurdle. This was pretty unpopular on the left. That’s a significant piece of history to understand Barroso’s split personality on social democracy, jobs, growth and austerity.
Here are a few highlights from the presser as communicated via twitter by Barroso:
- Europe needs a consensus on the policies that are both right for us as Union, and right for each MS #europe2020 #eucsr (Barroso)
- Deficit countries need to boost competitiveness; surplus countries need to remove structural obstacles #europe2020 #eucsr (Barroso)
- We urge Member States to continue and step up their efforts. There is no room for complacency, and there are no excuses #europe2020 #eucsr (Barroso)
- Many of our recommendations directly seek to boost competitiveness and make our economies more dynamic #europe2020 #eucsr (Barroso)
- We call on all countries to be more ambitious when it comes to growth-boosting economic reforms #europe2020 #eucsr (Barroso)
- We also need to spend smartly on research and innovation to create the jobs of the future. #europe2020 #eucsr (Barroso)
- To tackle jobs crisis we need: 1.labour market reforms; 2.monitor relation wages–productivity; 3. improve the skills +qualifications (Barroso)
- Investing in people also means taking care of the most vulnerable #europe2020 #eucsr (Barroso)
- Structural reforms and sound public finances are the foundation of a healthy economy #europe2020 #eucsr (Barroso)
- Specific focused action is needed to deliver short term results for the unemployed, especially the youth #europe2020 #eucsr (Barroso)
- I’m calling everyone to rally around this European Consensus now. #europe2020 #eucsr (Barroso)
So that is Barroso’s 2020 vision in a nutshell. Barroso strongly believes in social democracy. But he believes the way to get beyond crisis is via structural reform that leads to growth and deficit reduction that, coupled with actual fiscal consolidation, leads to an improvement in confidence, lower bond yields, economic growth and more jobs. This is the neoliberal paradigm that is predominant in Europe. The stress may be different in Germany or on the right, but the essential parts are the same whether we are talking about social democrats Denmark’s Helle Thorning-Schmidt and Portugal’s José Manuel Barroso or center-rght politicians like Spain’s Mariano Rajoy and Germany’s Angela Merkel.
Some other tidbits that Barroso confirmed on Germany were that country specific recommendations for Germany had wages increasing along with productivity. Barroso said this was to keep Germany competitive but to also help in the rebalancing effort now ongoing by boosting German domestic demand. I pointed out last week that these points are already being implemented in Germany. And this shift toward higher pay has continued into the private sector with VW now as well.
Obviously, the German wage and domestic demand growth story is also an election year story as well. Merkel cannot count on the FDP to help her move to a clear majority in parliament. SHe is pulling out all the stops including successfully wooing female voters. But that doesn’t diminish the significance of the change in tack away from wage restraint and supporting domestic demand. I don’t think the scale of rebalancing that Germany is willing to do will be enough, however. And so the euro zone will remain mired in slow growth or recession for a while.
I am going to leave it there for now. To be continued