Thursday 25 September 2014

The social case for burden sharing - the case for a Marshall Plan not a Versaille Treaty


This is an extract of the Essay HOW TO SAVE tHE EURO  published in JANUARY 2012 ( the full essay is available on the blog) 

Chapter 4: The social case for burden sharing

The obvious objection that would arise in surplus countries is the usual ‘why should we carry any burden to make good for the laxity or nonchalance of the weak countries?
Political leaders of surplus countries are particularly exposed to such demagoguery pressures. Political leaders get the democratic credentials from their home base but at the same time leaders like Chancellor Merkel of Germany and President Sarkozy of France are today responsible for the economic health of the entire Euro area.
This often presents them with difficult situations of split loyalties, at least in the short term. Whose interest are they going to defend?; the interest of their domestic audience on whom they depend for democratic legitimacy or the interest of the wider Euro area which in certain situations requires solidarity and burden sharing arrangements to restore it to health, which solidarity and burden sharing is perceived by their domestic audience as a form of taxation without representation.
I make emphasis that such conflicts or split loyalties are more apparent than real. They are certainly present if a short term narrow view of things is taken but these conflicts fade away if the long term objectives are brought into focus overcoming the short term pain with the promise of long term gain.
It is a situation analogous to the situation of the United States after the Second World War.  With Europe in tatters needing substantial reconstruction with many countries suffering outright poverty, the United States learned from the misguidedness of the Versailles Treaty after the 1st World War .
Treaty of Versailles

Of the many provisions in the treaty, one of the most important and controversial required Germany to accept responsibility for causing the war (along with Austria and Hungary), to disarm, make substantial territorial concessions and pay heavy reparations to certain countries that had formed the Entente powers. The total cost of these reparations was assessed at 132 billion Marks (then $31.4 billion, £6.6 billion) in 1921 which is roughly equivalent to US $442 billion and UK £217 billion in 2011, a sum that many economists at the time, notably Lord J M Keynes deemed to be excessive and counterproductive and would have taken Germany until 1988 to pay. The Treaty was undermined by subsequent events starting as early as 1932 and was widely flouted by the mid-1930s.
The result of these competing and sometimes conflicting goals among the victors was compromise that left none contented: Germany was not pacified or conciliated, nor permanently weakened. This would prove to be a factor leading to later conflicts, notably and directly World War II.
Instead of forcing reparation obligations on Germany and Italy, the US included them as major beneficiaries of the Marshall Plan 
The Marshall Plan
Europe was devastated by years of conflict during World War II. Millions of people had been killed or wounded. Industrial and residential centres in England, France, Germany, Italy, Poland, Belgium and elsewhere lay in ruins. Much of Europe was on the brink of famine as agricultural production had been disrupted by war. Transportation infrastructure was in shambles. The only major power in the world that was not significantly damaged was the United States.
From 1945 through 1947, the United States was already assisting European economic recovery with direct financial aid. Military assistance to Greece and Turkey was being given. The newly formed United Nations was providing humanitarian assistance. In January 1947, U. S. President Harry Truman appointed George Marshall, the architect of victory during WWII, to be Secretary of State.
In just a few months, State Department leadership under Marshall with expertise provided by George Kennan, William Clayton and others crafted the Marshall Plan concept, which George Marshall shared with the world in a speech on June 5, 1947 at Harvard. Officially known as the European Recovery Program (ERP), the Marshall Plan was intended to rebuild the economies and spirits of Western Europe, primarily. Marshall was convinced the key to restoration of political stability lay in the revitalization of national economies. Further he saw political stability in Western Europe as a key to blunting the advances of communism in that region.
Sixteen nations, including Germany, became part of the program and shaped the assistance they required, state by state, with administrative and technical assistance provided through the Economic Cooperation Administration (ECA) of the United States. European nations received nearly $13 billion in aid, which initially resulted in shipments of food, staples, fuel and machinery from the United States and later resulted in investment in industrial capacity in Europe. Marshall Plan funding ended in 1951.
Results
Marshall Plan nations were assisted greatly in their economic recovery. From 1948 through 1952 European economies grew at an unprecedented rate. Trade relations led to the formation of the North Atlantic alliance. Economic prosperity led by coal and steel industries helped to shape what we know now as the European Union.
Source: George C. Marshall Foundation
The problem in politics is that the short term is much more visible than the long term.  The short term is here and now whereas the long term is a pie in the sky.   It takes a high dose of political leadership that can do a Truman and persuade the US electorate that it is in their self- interest to use their tax money to help the “enemy” which has been defeated to reconstruct and enter the western area of political influence.
Unfortunately today such political leadership is lacking. The main European leaders are focused on the short term as they face their domestic audience for re-election in 2012 in case of President Sarkozy and in 2013 in case of Chancellor Merkel.  They have not and are not doing enough to prepare their domestic electorates to understand the long term benefit of saving the Euro and what short term burden sharing is needed to achieve such long term benefits.
  
 On the contrary they are jockeying for positions to appear as strong leaders in the eyes of their electorates by forcing deficit countries to take all the adjustment pain on their fragile shoulders in order to become more like Germany and to abandon the Mediterranean ‘joie de vivre’ which is depicted as having brought them into trouble. They are clearly adopting a narrow viewpoint giving priority to their political status in the eyes of their domestic audience at the expense of the quality leadership which is required at European level. They seem not to have what it takes to lead their domestic audience the way America did vs. Europe after the Second World War.  They are adopting the Versailles approach when the situation requires a Marshall Plan approach. This will backfire!
It is highly debatable whether the Mediterranean ‘joie de vivre’ could be blamed for the difficulties that peripheral countries are facing inside the monetary union.   France itself is a Mediterranean country and should not agree too quickly with the German argument that the periphery has to become miniature economic replicas of Germany. Malta, a small and resource-less island is right at the heart of the Mediterranean Sea enjoying a high dose of ‘joie de vivre’.  Yet Malta has not had any perceivable problems inside the monetary union it joined in 2008.  
Furthermore if everyone were to become a German type surplus manufacturing base who is going to run deficits to mirror the surpluses? Is it not more realistic and economically expedient if the Mediterranean countries while running balance of trade deficits run comparable services surpluses by offering quality tourism and other services (financial services, back office operations, ICT services etc) just as Malta does for which the ‘joie de vivre’ would be an essential ingredient rather than a perceived liability?
The core countries have to realise that it is in their interest to save the Euro system as the cost of its blowing up is much, much more than that of reforming it on sustainable level as I propose in this Essay. But I would go beyond that. Surplus countries have an obligation to burden share the adjustment process of the weak countries, for some or all of the following reasons:
·         The weakness of some members of the Euro, in particular Greece, Italy, Spain and Portugal, was known in advance to all as argued in Chapter 2 of this Essay. Accordingly strong members share some of the responsibility for admitting into the Euro Club members who were clearly not ready for the commitment.
·         Also as argued in Chapter 2, Germany and France were the first countries to openly breach the Euro rules in 2003 and they demanded impunity, indeed demanded and obtained weakening of the rules, setting a bad example for the weak countries and weakening the ability of the European Commission to impose discipline on offenders. If you cannot throw the book at Germany why should you be able to throw the book at Greece?
·         When Greece was clearly floundering on prudent fiscal housekeeping and anyone with eyes to see should have suspected that Greece statistical submissions were, politely put, inaccurate, most countries simply looked the other way and pretended not to notice.
·         All Euro members allowed the markets to imply that whatever is stated in black and white in the agreements ultimately there is a sense of inbuilt solidarity among Euro members and no Euro country would be allowed to default. In particular Mr Jean Claude Trichet when President of the ECB gave many verbal assurances that no Euro country will default on its debts.
  
 ECB Press Conference in Franfurt – 9th June 2011
Question: The euro area finance ministers last night agreed to set up a working group to study how a bond exchange roll over could be structured to avoid Greece being declared at default. First, do you think it is possible that we can get a commitment from the private sector to buy new Greek bonds without triggering a credit event?
Second, if the ECB, the private sector and the European finance ministers were to agree to such a voluntarily roll over, and then the rating agencies declared this to be a credit event, would that make any difference as to whether the ECB would accept these new bonds as collateral?
Trichet: Let me re-state our position, which I trust is very well known. First, we are not in favour of restructuring and haircuts. We exclude all concepts that are not purely voluntary or that have any element of compulsion. We call for the avoidance of any credit events and selective defaults or default. This is our position, which we have made clear for a long period of time: it is the position of the Governing Council and all governments know that position. We are not in dialogue with one particular government. Do not forget that we are the central bank for 17 countries: we issue the currency in 17 countries and have a dialogue within the Eurogroup, which is the grouping of the 17 countries. We are fiercely independent. Let me make two additional remarks: Whatever happens and it is not our decision, as this is the responsibility of the governments, we will apply our rules and our framework as regards both the soundness of our counterparties, I mean the banks, and the quality of the collateral that we take in our refinancing operations. This is crystal clear and has been communicated to governments.


·         Strong countries made a feast out of the problems of weak countries[i].   Greece’s balance of payments deficits are the surpluses of Germany. A UBS research paper[ii] shows that the benefit being enjoyed by the surplus countries is so large that it is much cheaper for the surplus countries to help the deficit countries to overcome their difficulties through responsible burden sharing than it would be if the Euro blows up. 

 ·        The crisis itself has been as much an economic bonus for surplus countries as much as it has been an economic distress of the deficit countries. The crisis has weakened the Euro against other major currencies making core surplus countries, whose economy is export oriented beyond the borders of the EU, even more competitive than it would have been if there were no crisis.


·         The crisis has also been a bonus for surplus countries in that their borrowing cost have reduced just as the borrowing costs of deficit countries have shot up.  The crisis has triggered investors to take risks off their portfolios and seek capital security in preference to yield.







There is a strong case for surplus countries to rise above the egoistic narrow view of the situation and explain to their electorates that not only it is in their interest to save the Euro but that they also have a moral duty to support the deficit countries to overcome their problems. This has to involve a fair burden sharing arrangement which is in the long term interest of the surplus countries as an indispensable step to save the Euro. Collapse of the Euro will be highly detrimental to the economies of surplus countries, apart from other political, social and possibly even security considerations.






[i] See this Report in Der Spiegel International to understand how Germans are unperturbed by the Euro crisis: http://www.spiegel.de/international/germany/0,1518,801388,00.html.

[ii] UBS Investment Research dated 6th September 2011 “Euro break-up – the consequences” authored by Deo/Donavan/Hathaway.

Sunday 21 September 2014

Celebrating Independence



This articles was published in The Malta Independent on Sunday - 21 09.2014

In preparing to celebrate 50 years of independence, I looked back to the views I had expressed 25 years ago.

In a speech I had made at a public conference held on the subject of “Malta’s political freedom – economic implications”, I had ended my address as follows:

“When in 1964 Malta became politically independent that was the first step stone for the modern political and constitutional history leading to the post-independence economic progress. Should we celebrate that first step stone or should we continue to protest that with more care and greater respect to national interest, by greater awareness of our true values and competences, with less regard to superficialities and more stress on the substance, we could have acquired through independence not just the first step stone but a whole building structure…

“In my opinion, just as a young man celebrates his birthday whatever the circumstances in which he was born, Malta should celebrate with deserving dignity every anniversary of its political birth. This should not exclude criticism for whoever got too impressed with superficialities and gave us political birth on a bed of thorns when we could have achieved birth on straw manger if not on a cottoned bed.”

That was 1989, coming quite soon after a period when, under a Labour administration from 1971 to 1987, Independence Day was not even celebrated and 21st September was considered a non-event, or worse, an event of betrayal. It was probably the first voice from Labour’s stables arguing that independence should be celebrated irrespective of the conditions under which it was obtained.

While there must be a point in time when independence was obtained, in celebrating and commemorating that point in time we would in fact be commemorating the journey leading to it, and the achievements after it that would not have been possible without independence.

Thankfully, in the second quarter century after independence we have come a long way and today we are celebrating the 50th anniversary as a truly national event without partisan divisions. Homage is due to ex Labour leader Alfred Sant who started this process, and present Prime Minister Joseph Muscat who sealed the issue in spite of objections from those preferring to stick to yesterday’s illusions.

My wish is that in the third quarter century after independence, the political maturity process will continue to evolve, permitting celebration of a unique national day which would include symbolically not just the point in time event but the whole process represented by all current five national days as well as the current status of the EU and euro area members.

As we celebrate the 50th anniversary of independence, it is perhaps opportune to scan the horizon for threats that may challenge our sovereignty. Will the rise and spread of Islamic fundamentalism become a challenge to our sovereignty, especially if it reaches North African nations? Will these new realities offer challenges which cannot be properly served by Malta’s constitutional neutrality? Will our cosmopolitan mentality cause irreversible dilution to our national character, especially to the use of our language?

I don’t know the answers to the questions which certainly deserve further thought and inputs from our best thinkers and strategists in diplomacy, in government, in business and in politics. But I can certainly add something to the economic threat which the instability of the euro area could cause to our economic sovereignty and economic fortunes.

While the euro monetary union rules make stringent conditions about fiscal deficits and debt levels, it makes no provisions about Balance of Payments imbalances. This is wrong! Outside a monetary union balance of payment, imbalances are self-correcting through the rate of exchange mechanism. But in a monetary union, the rate of exchange mechanism does not work for one particular country but for the union as a whole. Within a monetary union, countries having a balance of payments surplus are having a free ride on the back of countries with payments deficits.

If Germany still had its Deutsche Mark, its exchange value would have shot up as part of the self-adjusting mechanism to restore equilibrium. But because of the euro, Germany can continue to enjoy its export competitiveness at the expense of deficit countries like France, Spain and Italy as the euro exchange rate, supported as it is by Germany’ surplus, does not fall enough to offer self-adjusting mechanisms to address their deficits.

In the absence of such balance of payments conditionality to restore equilibrium as rigidly as applicable for fiscal deficits, the euro monetary union remains at risk. So far, countries have accepted adjustment through austerity and high unemployment by choosing the lesser of two evils. Germany imposed government changes in Italy and Greece when their leaders were unwilling to go along with the prescribed austerity recipes.

Just imagine what would happen when, sooner or later, in a big country like France, Italy or Spain, the electorate, weary of never ending recession cum austerity poison chalice, democratically elect demagogues from the extreme right or left who make euro abandonment or re-design as their main policy platform.

What would be the consequences if Marie Le Pen is the next President of France with a mandate for France to either exit the euro or to stay in the euro only if it is developed into a fiscal union harmonising taxes and providing for fiscal transfers from surplus to deficit countries?

Would the euro survive the exit of a big member like France? Would the euro survive Le Pen’s Presidency? Can Germany treat Le Pen as it treated Berlusconi and Papandreou? Or if for survival the euro rules evolve to acknowledge that it must be underpinned by a formal fiscal union, which would remove the tax flexibility we currently enjoy, would that be a mortal blow to our sovereignty?

This is the time to celebrate the past and reflect on the future.

Monday 15 September 2014

Shifts and shocks


At last the book I always dreamed of writing but lacked the skills to do so has been written.

What a joy to read Martin Wolf's ( Financial Times Chief Economics Commentator at The Financial Times) new publication :

'THE SHIFTS AND THE SHOCKS: What we've learned - and still have to learn- from the financial crisis'

This has many of ideas that I have been sharing in my writings.  It has a clear warning that those who think that the sustainability of the Euro Monetary Union is now safe, because the crisis has abated from the intensity of 2012, are unrealistic optimists.

In spite of the valiant efforts of the ECB the Euro is still a slow motion train wreck.   I had written this on 23rd May 2012 in a piece entitled:

"Can this slow motion train wreck be avoided?"


Martin Wolf makes an important point that is worth emphasizing and reflecting upon. Whilst the Euro rules makes a lot on stringent conditions about budget deficit and debt levels it makes no provisions about Balance of Payments imbalances.   This is wrong!  Outside a monetary union balance of payment imbalances are self-correcting through the rate of exchange mechanism.   But in a monetary union the rate of exchange mechanism does not work for one particular country but for the union as a whole.    So within a monetary union countries having a balance of payments surplus are having a free ride on the back of countries with payments deficits.    

If Germany still had their Deutsche Mark its exchange value would have shot up as part of self-adjusting mechanism to restore equilibrium.   But because of the Euro, Germany can continue to enjoy their export competitiveness at the the expense of deficit countries like France, Spain and Italy as the Euro exchange rate does not fall enough to reflect their deficits.

In the absence of such balance of payments conditionality to restore equilibrium as rigidly as applicable for fiscal deficits, the Euro monetary union remains at risk.   So far countries have accepted adjustment through austerity and high unemployment as a choice of a lesser evil.   Germany imposed government changes in Italy and Greece when its leaders were unwilling to go along with their austerity recipes.

Just imagine what would happen when sooner or latter in a big country like France, Italy or Spain, the electorate, weary of never ending recession cum austerity poison chalice, democratically elect demagogues from the extreme right or left which make Euro abandonment or re-design as their main policy platform.

More controversial food for thought!!!   Should Malta make contingency plans for either of these two alternatives, of which, one will have to prevail in the longer term:

  • Break up of the Euro monetary system
  • Fiscal union ( jeopardizing our tax competitiveness) and shared debt responsibility as the ultimate required medicine to avoid Euro break up.

Worth bearing in mind.