Yves here. One of the major focuses of the INET conference in Paris was the Eurozone crisis. The live broadcast of Nobel prize winner Joe Stiglitz’s interview of Yanis Varoufakis attracted over 50 million viewers.
Another event widely anticipated among conference attendees was a panel on the last day of the conference, Saturday, featuring Hans Werner Sinn, a well-known and particularly vocal defender of the orthodox German view of the Greek crisis, that Greece had been a profligate borrower that needed to take a big dose of austerity medicine. The other panelists contested various aspects of Sinn’s thesis, but the most striking and effective contrast came from Servass Storm of Delft University, who summarized a devastating paper that shredded conventional wisdom on the roots of the Eurozone crisis. I’ll present a post on the paper proper later this week.
Lee Sheppard was gracious enough to recap the panel, which was notable also by virtue of Sinn toning down his normally forceful views, although in the Q&A section, he became more heated. It is worth noting that Sinn advocated the idea of a temporary exit from the Eurozone for Greece (how does that work, exactly?) with Greece getting relief (aka subsidies) for essential imports like pharmaceuticals.
By Lee Sheppard, contributing editor of Tax Notes International
The purpose of the euro was to push down labor costs in Europe by making prices transparent using a single currency. Germans were especially keen about this “benefit” of the single currency. Hans Werner Sinn of Munich University is arguably correct that the Club Med countries did not do what they were supposed to do in getting their acts together by reducing costs to become competitive.
However, an unexpected thing happened when the euro was created. Yields on sovereign and private debt went lower, enabling more borrowing by Club Med countries. Some countries had too much private borrowing and some countries had too much public borrowing.
To Sinn, who appeared before a skeptical audience at INET, it doesn’t matter how the capital flowed into the country. Excessive foreign borrowing pushed up wages and had a detrimental effect on competitiveness. He argued that the Club Med countries should act like Ireland and take the pain in exchange for bailouts. Wrong relative prices explain the euro crisis, in Sinn’s view.
Veal Milanese is really Wiener schnitzel. Yes, northern Italy is very productive. Italy’s tradable sector is roughly the same size as its non-tradable sector. But Italy on the whole has low productivity, low education attainment, a bad business environment and high labor costs. Italy has low R&D spending and low levels of tertiary educational attainment. Italy is not good at enforcement of contracts or tax collection. Things are getting better, but they are still not good, according to Dominic Lombardi of CIGI.
Lombardi defended Italy’s reputation for profligacy and not getting it together. He argued that Italy did not spend or borrow too much. There were capital account surpluses every year except 2009 and 2010. Italian sovereign debt only increased when Italian GDP collapsed. If growth in the European Union had been average, Italian sovereign debt would be only a hundred and fifteen percent of GDP rather than a hundred and thirty percent. Roughly 30 percent of Italian sovereign debt is held by foreign holders. So he argued that it was contagion and risk aversion that pushed up sovereign yields in Club Med.
Will Greece ever become competitive? Sinn insisted that every country can become competitive. But it is hard to see what areas Greece can become competitive in or indeed what tradable sectors it has. “Greece will never make it in the eurozone,” Sinn said. It would be best for them to temporarily exit, according to Sinn.
Servaas Storm of Delft University saw no statistical proof that capital flows inflated wages in Club Med. Wages don’t explain current account numbers because they are too small to affect them and are not transmitted in prices. Rather, what he called the “banking glut” of debt buildup produced artificial growth at the time. And that borrowing was not used productively. It went into Spanish houses.
Even if Greek labor costs were to be reduced to rock bottom, non- cost competitiveness would still be more important, according to Storm. Direct labor costs are just not that large a component of final goods costs. The truth is that Club Med is not technologically intensive. Storm argued that non-price competitiveness, like technological innovation, is more important than cost competitiveness.
Storm called the eurozone crisis “a huge tragedy and a disgrace.” He argued that structural reform is a euphemism, and cause poverty and dislocation. Internal devaluation will not help. It is causing unemployment, in his view. Mission-oriented public investment would be more helpful. “Europe need to wake up from a deep slumber of a decided opinion,” said Storm, quoting John Stuart Mill.
Should Germans be required to take their holidays in Greece? Sinn argued that quantitative easing would produce price realignment in the form of inflation in Germany, provided Club Med countries don’t borrow more and do become competitive. Andrea Terzi argued that there should be monetary stimulus to enable people to buy their own output.
Weren’t the eurozone capital flows just vendor financing to enable Greeks to buy Porsches? Storm noted that much of the borrowing was not used productively. Sinn claimed that a third of the funds borrowed by Greece flowed back out into private bank accounts (note this figure is contested; nearly 90% of the bailout funds went to banks, and not to Greeks, but Sinn may be looking at a longer time frame). Andrea Terzi of Franklin University (Switzerland) pointed out that neglect of infrastructure does not show up in budget numbers, so you need to drill deeper into the actual uses of funds, and not just the gross level.
Keynes said that real outcomes are shaped by monetary decisions, Terzi noted. (Greece and Portugal had violent revolutions in the 1970s.)
Is the lingering stress all really a monetary problem and attributable to the failure of the European Central Bank to monetize? “Behind every penny of savings is a penny of debt,” according to Terzi. “Savings need to be funded.” Savings equal government debt plus private that plus foreign debt. “Debt is high when EU rules say so,” Terzi argued. Thus the crisis was caused by lack of credit. Because government has to create money for people to spend, savings are not the way to correct capital flows in a monetary economy.