The Eurozone Crisis:Unnecessary and Self-Inflicted

April 2013

Mark WeisbrotCenter for Economic and Policy Research

www.cepr.net

Debt crisis or policy crisis?

Conventional wisdom: Eurozone governments have borrowed too much, must reduce debt (and therefore annual deficits) in order to get back to a sustainable debt level and restore growth.

“Confidence fairies” (Krugman) – idea that reducing budget deficit will inspire so much confidence that growth improves

• Alternative: debt and deficits are the result of the world financial crisis and recession.

• Bubble growth – overborrowing was in the private sector.

• This shows up in the Eurozone countries’ current account balances:

Spain: Current Account BalancePercent of GDP

Source: Eurostat.1995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20102011

2012-15

-10

-5

0

5

10

-11.8

0.8

6.2

Spain

Germany

Perc

ent o

f GDP

• Recession cuts revenues and increases spending.

• Before the crisis Spain and Ireland were reducing their Debt/GDP ratio and Italy’s was stable.

• Spain and Ireland were running fiscal surpluses and had lower debt than Germany and France.

Spain: Main Fiscal VariablesPercent of GDP

Source: IMF WEO.

 200

3200

4200

5200

6200

7200

8200

9201

0201

1201

2

Fiscal Balance -0.2 -0.3 1.0 2.0 1.9 -4.2-

11.2 -9.4 -8.9 -7.0Primary Balance 1.9 1.5 2.5 3.3 3.0 -3.1 -9.9 -7.9 -7.0 -4.5Net Interest Payments 2.1 1.8 1.6 1.3 1.1 1.1 1.3 1.4 1.9 2.5Net Debt 41.4 38.6 34.9 30.7 26.7 30.8 42.5 49.8 57.5 78.6Gross Debt 48.8 46.3 43.2 39.7 36.3 40.2 53.9 61.3 69.1 90.7

Ireland: Main Fiscal VariablesPercent of GDP

Source: IMF WEO.

 200

3200

4200

5200

6200

7200

8200

9201

0201

1201

2

Fiscal Balance 0.3 1.3 1.7 2.9 0.1 -7.3-

13.9-

30.9-

12.8 -8.3

Primary Balance 1.6 2.4 2.7 3.9 1.0 -6.2-

12.1-

27.9 -9.6 -4.4Net Interest Payments 1.2 1.1 1.0 1.0 0.9 1.1 1.8 3.1 3.1 3.9

Net Debt 22.6 19.8 15.8 12.1 11.1 24.6 42.0 74.7 94.9103.

0

Gross Debt 30.8 29.2 27.1 24.8 25.0 44.5 64.9 92.2106.

5117.

7

Greece: Main Fiscal VariablesPercent of GDP

Source: IMF WEO.

 200

3200

4200

5200

6200

7200

8200

9201

0201

1201

2

Fiscal Balance -5.7 -7.4 -5.6 -6.0 -6.8 -9.9-

15.6-

10.5 -9.1 -7.5

Primary Balance -0.7 -2.6 -1.0 -1.3 -2.0 -4.8-

10.4 -4.7 -2.2 -1.7Net Interest Payments 5.0 4.9 4.7 4.7 4.8 5.1 5.1 5.8 6.9 5.9

Net Debt 97.3 98.8101.

2107.

3107.

4112.

6129.

0144.

6165.

4170.

7

Gross Debt 97.4 98.9101.

2107.

3107.

4112.

6129.

0144.

6165.

4170.

7

Italy: Main Fiscal VariablesPercent of GDP

Source: IMF WEO.

 200

3200

4200

5200

6200

7200

8200

9201

0201

1201

2Fiscal Balance -3.6 -3.6 -4.5 -3.4 -1.6 -2.7 -5.4 -4.5 -3.8 -2.7Primary Balance 1.3 1.1 0.1 1.0 3.1 2.2 -1.0 -0.3 0.8 2.6Net Interest Payments 4.9 4.6 4.6 4.4 4.7 4.9 4.4 4.2 4.6 5.4

Net Debt 88.4 88.0 88.9 89.3 86.9 88.8 97.2 99.1 99.6103.

1

Gross Debt103.

9103.

4105.

4106.

1103.

1105.

7116.

0118.

6120.

1126.

3

Portugal: Main Fiscal VariablesPercent of GDP

Source: IMF WEO. 2012 Article IV Consultation.

 200

3200

4200

5200

6200

7200

8200

9201

0201

1201

2

Fiscal Balance -3.7 -4.0 -6.5 -3.8 -3.2 -3.7-

10.2 -9.8 -4.4 -5.0Primary Balance -1.3 -1.7 -4.2 -1.3 -0.6 -1.0 -7.3 -7.0 -0.4 -0.8Net Interest Payments 2.4 2.4 2.3 2.5 2.6 2.7 2.8 2.9 4.0 4.2

Net Debt 51.1 53.1 57.8 58.6 63.7 67.4 79.0 88.9 97.3113.

2

Gross Debt 55.7 57.5 62.5 63.7 68.3 71.6 83.1 93.3108.

1120.

0

Eurozone Fiscal Deficits (avg. 2005-2007)Percent of GDP (Deficit Shown as Positive)

Source: IMF WEO.

-6

-4

-2

0

2

4

6

8

Gree

ce

Portu

gal

Italy

Fran

ce

Malta

Slov

ak R

epub

lic

Germ

any

Aust

ria

Belg

ium

Slov

enia

Cypr

us

Neth

erla

nds

Irela

nd

Spai

n

Luxe

mbo

urg

Esto

nia

Finla

nd

Perc

ent o

f GDP

Eurozone Net Debt (avg. 2005-2007)Percent of GDP

Source: IMF WEO.

-80

-60

-40

-20

0

20

40

60

80

100

120

Gree

ce

Italy

Belg

ium

Portu

gal

Fran

ce

Germ

any

Aust

ria

Spai

n

Neth

erla

nds

Irela

nd

Esto

nia

Finla

nd

Perc

ent o

f GDP

Eurozone back in recession

• Last 5 quarters of real growth were negative.

• Why?• Pro-cyclical policy:

Growth and Austerity in the Eurozone2008-2012

Source: IMF WEO and Martin Wolf.

-4 -2 0 2 4 6 8 10-20

-15

-10

-5

0

5

10

f(x) = − 1.09687513068836 x − 1.56398351582925R² = 0.413404931620476

2008-2012 Change in Structural Fiscal Balance (% Potential GDP)

Fore

cast

% C

hang

e in

GDP

(200

8-20

12)

AUT

DEU

FRA

SVK

BEL

FIN NLDCYP

MLT

GRC

IRL

SVN

ESPPRT

ITA

Unemployment in Eurozone2005-current

Source: Eurostat.

2005 2006 2007 2008 2009 2010 2011 2012 20135.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

7.3

12.0

Perc

ent o

f Tot

al W

orkf

orce

Compare to Europe and ECB

• Note the political irony: Europe has bigger left, socialist parties, but much more right-wing fiscal and monetary policy.

• (More on this topic later.)• Result: U.S. still down about 10

million jobs; but economy is growing.

• 2.1% annual average GDP growth since June 2009 – not enough to get close to full employment, but a much better story than eurozone

The Case of Greece

Most important Problem:Fiscal policy is pro-cyclical

• 2009-2013: Greece attempts to reduce debt, cutting its structural balance by 18.7 percent.

• (For comparison: $2.9 trillion in the U.S.)

• As the economy shrinks, it becomes harder to make the revenue targets

• IMF has been way off in its projections and getting worse.

Greece:Real GDP Projection

Source: IMF various. Latest review is from January 2013, First and Second Reviews Under the Extended Arrangement.2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

140

150

160

170

180

190

200

210

220

163.96488056

198.869510912828

209.5

1st Review2nd Review3rd Review4th Review5th ReviewLatest ReviewActual

billi

ons o

f 200

5 co

nsta

nt e

uros

Greece:Unemployment Rate Projections

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 20200

5

10

15

20

25

30

2013; 26.6

2020; 11.3

2012; 24.4

1st Review

2nd Review

3rd Review

4th Review

5th Review

Latest Review

Actual

perc

ent o

f tot

al w

orkf

orce

Source: IMF various. Latest review is from January 2013, First and Second Reviews Under the Extended Arrangement.

Economic costs so far:

• Loss of 20.1 percent of GDP (among worst of past century’s financial crises), 2008 to 2012

• 27 percent unemployment for 2013; still more than 16 percent by 2018 (April 2013 WEO)

• Minimum wage cut 32 percent for youth (under the age of 25) and 22 percent for older workers

• Mass layoffs (150,000 public workers by 2015)

• Cuts to health and education• Mass privatization totaling $30.77

billion projected ($2.09 billion realized to date).

Social costs:

“Suicides rose by 17% in 2009 from 2007 and unofficial 2010 data quoted in parliament mention a 25% rise compared with 2009. The Minister of Health reported a 40% rise in the first half of 2011 compared with the same period in 2010 […] Violence has also risen, and homicide and theft rates nearly doubled between 2007 and 2009.”

Kentikelenis et al. 2011. The Lancet:

• 52 percent increase in HIV 2010-2011.

GreeceEmployment as a Percent of Working Age Population

Source: Eurostat1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

39

41

43

45

47

49

EPOP Yearly

Strategy

• “Internal Devaluation”: how it is supposed to work

• Not Working• Real effective exchange rate hasn’t

fallen enough to pull the economy out of recession

Greece:Real Effective Exchange Rate

Source: Eurostat

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 22004 2005 2006 2007 2008 2009 2010 2011 2012

90

92

94

96

98

100

102

104

106

108

110 REER Deflated by CPI REER Deflated by ULC

Greece:Debt as a Percent of GDP

Source: IMF (various) and Weisbrot and Montecino (2012)

10

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

171%

1.575

1.785

1.24

Hai

rcut

on

Priv

ate

Deb

t

EU Net Interest Burden in 2011(Percent of GDP)

Source: IMF and Eurostat

Gree

ceIta

lyPo

rtuga

lIre

land

Hung

ary

Belg

ium

Malta

Unite

d Ki

ngdo

mPo

land

Fran

ceCy

prus

Aust

riaGe

rman

yLit

huan

iaRo

man

iaNe

ther

land

sLa

tvia

Spai

nSl

oven

iaCz

ech

Repu

blic

Slov

akia

Denm

ark

Bulg

aria

Esto

nia

Euro

are

a

-4

-2

0

2

4

6

8

perc

ent

of G

DP

Luxe

mbo

urg

Finla

ndSw

eden

Norw

ay

The Troika and the World

• Troika is slowing the world economy for second time since last year.• 2010 growth 5.2 percent• 2011 growth 4.0 percent• 2012 growth 3.2 percent

• IMF projections for world GDP growth in 2013 have been revised downward:• April 2012 projection 4.1 percent• October 2012 projection 3.6 percent• April 2013 projection 3.3 percent

• The ILO estimates a record 202 million people could be unemployed in 2013.

The Troika and the World

• How to explain the Troika’s behavior?

• They see the crisis as an opportunity to remake European social democracy.

• Neoliberal “reforms.”• When crisis ends, they lose their

leverage over weaker Eurozone economies.

• A delicate balance: they don’t want to end crisis without achieving their political goals; but don’t want a meltdown either.

The Troika and the World

• ECB executive board member Jörg Asmussen, the most senior German at the bank “said it was crucial to ensure that ECB decisions did not reduce pressure on governments to reform. That is one reason why the central bank is unlikely to reveal all details of the plan on Thursday.”

-- Reuters, Sep 4, 2012

The Troika and the World

• The policy advice given by the IMF to European Union countries in 67 Article IV agreements for the four years 2008-2011 shows a consistent pattern of policy recommendations:

• (1) a macroeconomic policy that focuses on reducing spending and shrinking the size of government, in many cases regardless of whether this is appropriate or necessary, or may even exacerbate an economic downturn;

[cont.]

The Troika and the World

• (2) a focus on other policy issues that would tend to reduce social protections for broad sectors of the population (including public pensions, health care, and employment protections), reduce labor’s share of national income, and possibly increase poverty, social exclusion, and economic and social inequality as a result.

Recent History

• First crisis around Greek debt because ECB refused to buy sovereign bonds (May 2010)

• Continuing crises, partly because Troika insisted no haircut for creditors.

• But each time they compromised to avoid worse crisis.

• 8 aid packages, increasing in size, between May 2010 and December 2011.

• A small problem in early 2010 was made very big.

Recent History

• Mario Draghi takes office as ECB President last November

• Draghi is different from Trichet.• Long Term Refinancing Operation

(LTRO): €1 trillion for banks since December 2011.

• Despite compromises, Troika still pushed Europe into recession: this is a huge policy failure.

• Troika willing to take great risks to further their neoliberal political agenda.

The Troika and the World

• Financial markets are a problem too, but the ECB can overpower them

• ECB is therefore the main problem, as well as the potential solution.

• In 2011, it became clear that governments were tightening budgets – pro-cyclical policy – to satisfy the ECB, not to satisfy financial markets, which were increasingly ambivalent about fiscal tightening (e.g S &P’s latest downgrade of Spanish debt )

Alternatives

Alternatives

• ECB, European authorities could reverse course and allow for expansionary fiscal policy in Greece and Eurozone – but won’t.

Default and Exit:Argentina

• Banking system collapsed, but only one quarter of continued recession.

• Then growth: 63 percent in six years.

• Recovers pre-crisis GDP within 3 years.

• Allow 2/3 reduction in poverty and extreme poverty.

• Large increases in social spending, reduced inequality.

• Huge Success.

Argentina vs. GreeceComparative GDP Recovery Paths: Argentina (1996-2007) vs. Greece (2005-2016)

Source: Weisbrot and Montecino (2012)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

70

80

90

100

110

120

130In

dex:

pea

k G

DP

= 1

00

Argen

tina

Greece

Greece Historical Trend

Argentina Historical Trend

Argentine Recovery Misunderstood

• Not a commodities boom.• Not even export led.• Led by domestic consumption and

investment.• Change in macroeconomic policy

was key: change from pro-cyclical to pro-growth.

Greek advantages over Argentina

• Export sector twice as big.• More potential sources of

borrowing, if needed.• More developed economy, banking

system.

Argentina vs. GreeceExports as a Percent of GDP, Pre and Post-Devaluation

Source: Eurostat and INDEC.

2001 2003 2011Argentina Greece

0

5

10

15

20

25

30

11.6

25.924

Perc

ent o

f GDP

Spain

Spain

• Debt burden is manageable at reasonable interest rates.

Spain: Quarterly Real GDP GrowthSeasonally Adjusted Annualized Rates

Source: Eurostat

2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.1

0.2

-0.1

0.1

0.3

0.2

0.0

-0.5

-0.4 -0.4

-0.3

-0.8

Perc

ent C

hang

e

Spain: UnemploymentSeasonally Adjusted Annualized Rates

Source: Eurostat

2005 2006 2007 2008 2009 2010 2011 2012 20130.0

5.0

10.0

15.0

20.0

25.0

30.0

26.3

Perc

ent o

f Tot

al W

orkf

orce

Spain

• The IMF's latest (July 2012) Article IV consultation has Spain with 20.5 percent unemployment in 2017, despite the fact that it is, by the IMF estimation, operating at just about potential GDP.

Spain: Projected Interest PaymentsPercent of GDP

Source: IMF WEO.

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 20170.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2.11.8

1.61.3

1.1 1.11.3

1.4

1.9

2.5

3.5

3.84.0

4.24.5

Projections

Conclusion

Conclusion

• Last fall: Draghi makes statement interpreted as commitment to stabilize Italian and Spanish bonds

• This put an end to the acute crisis – a significant step

• But recession continues because of fiscal tightening

• Note difference from U.S. : Because eurozone citizens have lost any democratic input into economic policy-making

Conclusion

• Lack of democracy is key• Without credible threat to leave

euro, weaker countries are subject to Troika’s decisions

• High unemployment, needless suffering will continue for many years or until Troika is forced to retreat