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Eurozone Economic Governance

by nanne Sun Feb 4th, 2007 at 08:25:24 PM EST

The French are the only ones who bring up 'economic governance' in the Ecofin.

Quote by outgoing Dutch Minister of Finance Gerrit Zalm, who deems deeper cooperation to be unlikely and undesirable. (Dutch source)

Zalm is something of a neoliberal. Although I think that he has done good work in the Netherlands from the viewpoint of intergenerational equity in cutting the budget deficit, he also has some whacky ideas and an obvious bias in this case. On the other hand, I didn't attend any Ecofin meetings (or had the time to investigate and read any potentially existing transcripts) and he went to quite a lot of them.

So France, the only country to bring this up. According to Zalm, also the only country that didn't live up to some of the Ecofin agreements on collective action in the few cases where they were made. But that's a different problem (for the moment). Is it good that France is the only one calling for more  economic governance? Or should we have more of it?


According to Migeru in the diary on the Franco-German Trade Gap, the monetary union in Europe creates 'economic tensions' which can only be solved on the level of the entire economy, thus necessitating a political union (or at least a common economic policy).

There are a lot of European policies that cause spillover pressures in one way or another, and spillover pressures alone rarely spur further integration. Rather, they are solved through ugly ad-hoc adjustment mechanisms or ignored insofar as they can be. The mere existence of pressures to create a political union is no guarantee at all that anything of the sort will come into existence.

What are these economic tensions? And are they too big to be ignored, or solved through things other than a more political union?

There is problem that might be described as jurisdictional competition (Standortwettbewerb) between the different eurozone countries to be the most attractive location for business investment. This causes a number of difficulties, such as that corporate taxes are set at too low a level, or that countries try to keep their labour costs low. Internally, this is socially undesirable and externally it might cause economic problems for other states. Amongst French politicians a traditional concern exists that this will lead to a race to the bottom, but it should be noted that it is possible for a state to pursue alternative strategies (taking the high road).

The low road that the Germans took will cause them some difficulties in the future. As Afew has noted in the diary on the Franco-German Trade Gap, it depends upon offering cheap, disposable labour. The labour force of Germany, however, is set to shrink. At the same time, old age entitlements are set to rise. It should be a matter of state policy, therefore, to maximise the wealth generated by its labour (at least this seems like the logical conclusion to me but my economic knowledge is not unlimited). Instead Germany is or has been seeking high participation through wage moderation, which is not the right policy as it drives the more talented workers away and has a negative effect on domestic consumption.

The interest rate policy of the ECB is another issue. This was also talked about in the Franco-German Trade Gap thread. There, it was asked by naneva if higher interest rates which would be good for Germany would be bad elsewhere. I don't think that they will be bad anywhere right now as there are no parts of the eurozone that are in depression. However, according to Daniela Schwarzer and Sebastian Dullien the rates will be bad for Portugal and Italy plus economies with low domestic demand (read Germany?). The reason given for this is that Portugal and Italy are in more direct competition with Asian countries. I guess that this means it will be due to a stronger Euro with regard to the currencies of these countries, but I don't know if that will happen (the euro will grow against the dollar but not necessarily against the currencies of the Asian countries -- that all depends upon their monetary policy). In any case, the low interest rates of the ECB were not beneficial in the past to the faster growing economies.

A rather elaborate discussion on the ECB's policy is given on AFOE by Edward Hugh in a post where he quotes a piece by Claus Vistesen. In the discussion on the German economy they note the slumping domestic spending, which they both attribute to the demographic pattern in that country (whereas I think it's more logical to assume that it is due to wage moderation). One interesting thing to note is the chart on the 'real exchange rate' in the piece of Vistesen. Although he states that Germany has been having a kind of 'beggar thou neighbour' relationship with its fellow Eurozone countries due to its low real exchange rate, note that the same might actually be said of France.

The problem that there are differing levels of inflation in the eurozone exists in part due to the lower level of economic integration of the EU compared to the US (trade between US states is 2 to 3 times greater than between EU15 states Update [2007-2-5 17:22:18 by nanne]: see this briefing (pdf)). Theoretically, a higher level of trade and labour and capital mobility should have a dampening effect on inflation differences, and also on differing economic cycles.

Problems related to differing economic boom and bust cycles within one monetary area are described by Vistesen as 'asymmetric shocks'. Other than a newly developed globalisation adjustment fund (which is tiny) the EU doesn't have any real mechanisms to deal with this issue. As Migeru describes it in the Franco German Trade Gap diary, a single employment, redistribution and industrial policy is needed.

Right now all we have in that area is the stability and growth pact and the Lisbon agenda, but these have not brought about a strong enough degree of policy coordination to parse for a common economic policy.

There is, however, a redistributive policy in the EU through its structural funds and general budget. It is unclear to me to what extent it can stabilise asymmetric shocks (seems like it can't do it for all countries because it only favours the poor areas which are largely concentrated in the poorer countries). But it fulfils the separate but equally valid aim of reducing long term inequalities. In a study made in 2000, it was found that the EU budget has a 'remarkably redistributive effect' (pdf file here).  I'll give you a quote:

Finally, when we consider the net financial balance, we find that the EU budget has a remarkably redistributive effect on the income of its members. This result is a necessary condition to speed up the convergence process among European countries. Our results show that the EU budget redistributes the 5 percent of any difference between richer and poorer countries. Although this number is well below the estimates for the United States (federal taxes and transfers redistribute approximately a 20 percent), it is important to notice that this redistributive effect is achieved with budget resources that represent less than 1.27 percent of the European GNP. (DOMÉNECH, R., MAUDES, A. AND J. VARELA (2000): Fiscal Flows in Europe: The Redistributive Effects of the EU Budget.)

This is impressive, but again we can note that the actual redistribution (which is all that counts) in the US is 4 times greater, its trade flows are 2-3 times greater and it does have substantial stabilising mechanisms which don't exist in Europe. Also note that this data is historic and that with the expansion, the redistributive effect of the budget has probably decreased.

So... what are the answers?

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..., according to Daniela Schwarzer and Sebastian Dullien the rates will be bad for Portugal and Italy plus economies with low domestic demand (read Germany?). The reason given for this is that Portugal and Italy are in more direct competition with Asian countries.

I was looking at the Spanish Institute for Foreign Trade (ICEX) webpages, which helps SPanish companies wishing to conduct business abroad, and looking at news items pertaining to the leatherworking sector, there was a lot of profiling of North African and Latin American countries. My interpretation of that (backed by some anecdotal evidence from press articles online) is that the Spanish leatherworking industry is dying off, except for high-end, high-quality manufacturing for major brands, and that the low-price range manufacturers are moving their operations abroad in an attempt to cut their labour costs to compete with China.

This is a point that is often made about Germany, but it seems to be true for al of the European productive economy, and it is that cheap labour abroad is forcing european producers to concentrate on high-quality, high-value-added, high-margin, low-volume products. Germany's capital goods are usually the prime example of this, but I think organic food and high-quality leatherworking can also follow the same pattern. There is still room for products made in europe, but they are in niche markets.

In the US, outsourcing seems to have hollowed out entire inductrial sectors to the point that not even the high-end manufacturing or even the design are carried out in the US any longer, just the branding. I am concern about Europe's ability to retain some manufacturing base in the sectors that are now being outsourced, because without contact with manufacturing one quickly loses the expertise necessary for doing the high-end stuff, or the design.

"It's the statue, man, The Statue."

by Migeru (migeru at eurotrib dot com) on Mon Feb 5th, 2007 at 04:42:37 AM EST
I did some quick research on this capital goods thing with the German industry (through the EU's market access database). With regard to extra-EU trade, the export balance in 2005 for...

Chapter 84      NUCLEAR REACTORS, BOILERS, MACHINERY AND MECHANICAL APPLIANCES; PARTS THEREOF

Is 35.8 billion (imports 33.2 billion, exports 69 billion)

Chapter 85      ELECTRICAL MACHINERY AND EQUIPMENT AND PARTS THEREOF; SOUND RECORDERS AND REPRODUCERS, TELEVISION IMAGE AND SOUND RECORDERS AND REPRODUCERS, AND PARTS AND ACCESSORIES OF SUCH ARTICLES

Is -0.7 billion (imports 36.5 billion, exports 35.8 billion; note that this includes only some capital goods and almost all consumer electronics)

Chapter 87      VEHICLES OTHER THAN RAILWAY OR TRAMWAY ROLLING STOCK, AND PARTS AND ACCESSORIES THEREOF

Is 44 billion (imports 9.5 billion, exports 53.5 billion)

So, the car & other land vehicles industry still accounts for a larger part of the surplus. Of course, relatively speaking these are also low-volume products and they definitely are high-value-added.

by nanne (zwaerdenmaecker@gmail.com) on Mon Feb 5th, 2007 at 06:24:34 AM EST
[ Parent ]
Market Access Database - YOUR GUIDE TO CRACKING WORLD MARKETS

Wow, I had no idea that existed...

"It's the statue, man, The Statue."

by Migeru (migeru at eurotrib dot com) on Mon Feb 5th, 2007 at 06:29:07 AM EST
[ Parent ]
They also have something like that for developing country exporters (called the Export Helpdesk). The data ultimately comes from eurostat, but I haven't been able to find comprehensive data there (including intra-EU/intra-Eurozone trade).
by nanne (zwaerdenmaecker@gmail.com) on Mon Feb 5th, 2007 at 06:36:19 AM EST
[ Parent ]
Nanne, you have a typo in the title.

"It's the statue, man, The Statue."
by Migeru (migeru at eurotrib dot com) on Mon Feb 5th, 2007 at 05:12:23 AM EST
Thanks, updated
by nanne (zwaerdenmaecker@gmail.com) on Mon Feb 5th, 2007 at 06:05:02 AM EST
[ Parent ]
I sort of liked it the other way: nice and evocation - "eco-moanic", "eco-manic", "eco-monic".
by Colman (colman at eurotrib.com) on Mon Feb 5th, 2007 at 06:08:26 AM EST
[ Parent ]
Eco-moronic, eco-monadic, eco-gnomic...

"It's the statue, man, The Statue."
by Migeru (migeru at eurotrib dot com) on Mon Feb 5th, 2007 at 06:09:02 AM EST
[ Parent ]
Heh. But economic governance is largely a desirable thing, IMO. So, as to the current state, etc.
by nanne (zwaerdenmaecker@gmail.com) on Mon Feb 5th, 2007 at 06:27:20 AM EST
[ Parent ]
I'd personally take a little issue with how you characterise German actions. I don't say that they did the right thing, but we should understand some of the pressures on them.

France has a certain level of unemployment. We've discussed the unreliability of the figures, so let me just say that like all economies they feel like they could use a bit less unemployment, but my overall perception is that unemployment is not seen as a major emergency for policy over the last few years.

Now, in "West Germany" I think you could make a similar case, but (even if we concede that the Eastern regions have less overall political clout) the unemployment situation in the East must be affecting policy.

Wage moderation may not be sustainable, but the alternative shifting from a medium-skilled (on average) high volume German economy to a higher-skilled, lower volume (on average) German economy doesn't look like it's politically sustainable in the short term. (After all, the Grand coalition isn't all that stable, IMO.)

I'll note in addition to Migeru's notes about high-end vs low-end etc. that I'll ring my usual alarm bell:

High end employs less people. This is a problem that someone needs to actually address. Maybe there is no alternative but for us, as a whole to get poorer, but we should be managing this decline, else the resulting inequalities between a "skilled elite" and an "unskilled (and largely unemployed) mass" are going to be problematic.

by Metatone (metatone [a|t] gmail (dot) com) on Mon Feb 5th, 2007 at 06:19:58 AM EST
High end employs less people. This is a problem that someone needs to actually address. Maybe there is no alternative but for us, as a whole to get poorer, but we should be managing this decline, else the resulting inequalities between a "skilled elite" and an "unskilled (and largely unemployed) mass" are going to be problematic.
Yes, yes, yes. Can a front-pager make a debate out of this?

"It's the statue, man, The Statue."
by Migeru (migeru at eurotrib dot com) on Mon Feb 5th, 2007 at 06:21:58 AM EST
[ Parent ]
Out of... this diary?  That particular paragraph?
by the stormy present (stormypresent aaaaaaat gmail etc) on Mon Feb 5th, 2007 at 08:07:25 AM EST
[ Parent ]
That particular paragraph, I suppose.

THX!

"It's the statue, man, The Statue."

by Migeru (migeru at eurotrib dot com) on Mon Feb 5th, 2007 at 08:12:08 AM EST
[ Parent ]
I did it as a FP story incorporating a few other things I've been thinking about and a comment of yours from upthread.  If a debate takes off, we'll put it over in the debates section... OK?
by the stormy present (stormypresent aaaaaaat gmail etc) on Mon Feb 5th, 2007 at 09:44:29 AM EST
[ Parent ]
High end manufacturing does employ less people. But the same doesn't necessarily hold for some other sectors. Niche markets like renewable energies and organic agriculture employ more people than centralised energy or industrial agriculture.

The point that the reunification of Germany added a large labour force that had a skill-set ill-adapted to a high road strategy is valid, I must admit that I forgot that. Re-education and continuous education of the workforce is a crucial part of any high road strategy, but the problems with the East Germans may have been to large for such a strategy to work in the past.

Nonetheless, Germany will face a longer crisis due to its ageing population and if it doesn't adjust its strategy to maximise per capita income on the long term, it's going to have to cut old age entitlements rather drastically. That will be at least as politically unsustainable.

by nanne (zwaerdenmaecker@gmail.com) on Mon Feb 5th, 2007 at 12:47:35 PM EST
[ Parent ]


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