The most encouraging reports involve Greece, the economy that was most reviled. Over $175 million of new money entered the Greek stock market between June 2012 and February 2013, and according to The Wall Street Journal, “everything from Greek real estate to energy stocks are finding buyers.” In April 2013 the troika approved the disbursement of further bailout assistance to Greece based on its progress in cutting government spending and moving toward a balanced budget. On May 14, 2013, the Fitch service upgraded Greece’s credit rating, and in a review of the Greek economy, The New York Times reported, “The drive to improve competitiveness, mainly through much lower wage costs, is finally bearing fruit, too. This is most visible in tourism, which accounts for 17 percent of gross domestic product. Revenues are expected to jump 9 percent to 10 percent this year.” Greece is also benefiting from the privatization of government-owned assets. The fifteen-hundred-acre former Athens airport site is expected to attract €6 billion of investment to establish a mixed-use development that should create more than twenty thousand well-paying jobs.
Another recent story from Greece involves events tantamount to a controlled experiment, something economists seek but seldom find. Prior to 2010, port facilities in the major Greek port of Piraeus had been owned by the government. That year the government sold half the port for €500 million to Cosco, a Chinese shipping concern, while retaining the other half. A comparison of operations in the Chinese- and Greek-controlled halves of the facility in 2012 showed a striking contrast:
On Cosco’s portion of the port, cargo traffic has more than doubled over the last year, to 1.05 million containers. And while profit margins are still razor thin . . . that is mainly because the Chinese company is putting a lot of its money back into the port. . . . The Greek-run side of the port . . . endured a series of debilitating worker strikes in the three years before Cosco came to town. . . . On the Greek side of the port, union rules required that nine people work a gantry crane; Cosco uses a crew of four.
This comparison perfectly illustrates the fact that there is nothing intrinsically noncompetitive about Greek workers or Greek infrastructure. Greece needs only more flexible work rules, lower unit labor costs, and new capital. Chinese capital is a conspicuous part of the solution, and Chinese investors such as Cosco are willing to commit capital when a productive business climate can be assured.
Developments in Spain are equally encouraging. Spanish unit labor costs have already dropped over 7 percent relative to Germany, and economists expect further decreases. In February 2012 Spain’s prime minister, Mariano Rajoy, implemented laws that increased labor flexibility by allowing employers to terminate workers in a downturn, reduce severance pay, and renegotiate contracts entered into during the property boom prior to 2008. The result was a drastic increase in Spain’s competitiveness in manufacturing, especially the automotive industry.
The positive effect was immediate. Renault announced plans to increase production in the northern Spanish city of Palencia. Ford Motor Company and Peugeot also announced increased production at their plants in Spain. In October 2012 Volkswagen announced an €800 million investment in its plant near Barcelona. All these investment and expansion plans will have positive ripple effects because the large manufacturers are tied to a network of parts suppliers and subcontractors throughout Spain.
The expanded employment and output as the result of lower wages in Spain is a refutation of the sticky-wage theories of Keynes and Krugman, and it is happening on a widespread scale from Greece to Ireland. Although this is a difficult and painful adjustment, the shift is sustainable, and it leaves Europe well positioned to be a globally competitive manufacturing base and magnet for capital inflows.
The Economist, along with many others, has cited adverse demographics as a major hurdle in the way of more robust European growth. Europe does have a rapidly aging society (as do Russia, Japan, China, and other major economies). Over a twenty-year horizon, the demographics of working-age populations are rigid in a closed society, which can be a large determinant of economic outcomes, but this view ignores forms of flexibility even in a closed society.
A working-age population is not the same as a workforce. When unemployment is high, as it is in much of Europe, new entrants can come into the workforce at a much higher rate than population growth, assuming jobs are available. The pools of well-educated unemployed are so large in Europe today that demography places no short-term constraints on productive labor factor inputs. As noted, improved labor mobility can also facilitate growth in the productive workforce by enabling unemployed workers in the Eurozone’s depressed regions to move to more productive regions to supply the labor needed. Immigration from eastern Europe and Turkey can supply ample labor to western Europe, much as the Chinese interior has supplied labor to Chinese coastal factories for decades. In short, demographics are not a constraint on European growth as long as there is underutilized labor, labor mobility, and immigration.
* * *
Internal economic adjustment alone may not be enough to secure the future of the euro and the EU more broadly. Expansion of the institutions of the EU will also be required, as captured in Merkel’s phrase “More Europe.” The EU is like an aircraft with a single wing; it can choose to remain grounded, or it can build the other wing. Efforts to deal with the immediate crises in 2010 and 2011, including monetary ease and multilateral bailout packages, have been sufficient to avoid a collapse, but they are not sufficient to correct the fundamental contradictions in the design of the euro and the ECB. A single currency has been shown to be dysfunctional without uniformity of fiscal policy and bank regulation, along with improved mobility of labor and capital among currency union members.
The good news is that these deficiencies are well understood by political and financial leaders in Europe and are being remedied at a rapid pace. On January 1, 2013, the EU Fiscal Stability Treaty entered into force for the sixteen EU member nations that had ratified it as of that date, including all the periphery nations. The treaty contains binding procedures requiring signatories to have budget deficits of less than 3 percent of GDP when their debt-to-GDP ratio is under 60 percent. In cases where the debt-to-GDP ratio exceeds 60 percent, the deficit must be less than 0.5 percent of GDP. The treaty also contains the so-called debt brake that requires signatories with a debt-to-GDP ratio in excess of 60 percent to reduce the ratio by 5 percent of the excess each year until the ratio is less than 60 percent. Treaty provisions are implemented and enforced at the member level for the time being, but the treaty stipulates that the members will incorporate the treaty rules in the overall EU legal framework before January 1, 2018.
An EU-wide bank deposit insurance program to mitigate banking panics is currently under consideration, as are proposals to replace separate sovereign bonds issued by Eurozone members with true Eurobonds backed by the credit of the Eurozone as whole. Action on these fronts may follow, but first further progress must be made on fiscal restraint and other market reforms.
The threads of banking union and consolidated bailout funds have begun to intertwine. In June 2013 a Euro Working Group of senior finance ministry officials from the Eurozone announced a €60 billion bailout fund to provide direct support to banks in distress.
Beyond these fiscal and banking reforms, the EU’s future is further brightened by the accession of new members either to the EU, the Eurozone, or both. In July 2013 Latvia received approval from the European Commission and the ECB to adopt the euro as its currency. Croatia officially became an EU member on July 1, 2013, and its central bank governor, Boris Vujcic, announced that Croatia wanted to move as quickly as possible to full adoption of the euro as its currency. Candidate countries whose membership in the EU is under way but not yet completed are Montenegro, Serbia, Macedonia, and Turkey. Potential candidates who do not yet meet the requirements for EU membership but are working toward conformity are Albania, Bosnia and Herzegovina, and Kosovo. In the future, it is
not too much to expect that Scotland and Ukraine may apply for membership.
The EU is already the largest economic power in the world, with combined GDP greater than that of the United States and more than double that of China and Japan. Over the next ten years, the EU is destined to evolve into the world’s economic superpower, stretching from Asia Minor to Greenland and from the Arctic Ocean to the Sahara Desert.
Germany sits at the heart of this vast economic and demographic domain. While Germany cannot control the entire region politically, it will be the greatest economic power within the region. Through its indirect control of the ECB and the euro, it will dominate commerce, finance, and trade. Eurobonds will provide a deep, liquid pool of investable assets larger than the U.S. Treasury bond market. If needed, the euro can be supported by its members’ combined gold holdings, which exceed 10,000 tonnes, about 25 percent more than the U.S. Treasury’s official gold holdings. This combination of large, liquid bond markets, a sound currency, and huge gold reserves may enable the euro to displace the dollar as the world’s leading reserve currency by 2025. This prospect will hearten Russia and China, which have been seeking escape from U.S. dollar hegemony since 2009. Germany is also the key to this monetary evolution because of its insistence on sound money, and because of the example it has set of how to be an export giant without a weak currency.
Germany’s new Reich, intermediated through the EU, the euro, and the ECB, will be the greatest expression of German social, political, and economic influence since Charlemagne’s reign. Even though it will come at the expense of the dollar, the changes will be positive in most ways, because of Germany’s productivity and its adherence to democratic values. Europe’s diverse historical and cultural landscape will be preserved within an improved economic framework. With German leadership and foresight, the EU motto, “United in diversity,” will be realized in its truest form.
CHAPTER 6
BELLS, BRICS, AND BEYOND
We aim at progressively developing BRICS into a full-fledged mechanism of . . . coordination on a wide range of key issues. . . . As the global economy is being reshaped, we are committed to exploring new models.
Declaration of the BRICS
March 2013
Citizens of the Baltic countries can be grateful that their leaders never listened to Krugman.
Anders Åslund
September 2012
■ Supranational
The European Union, the United States, China, and Japan constitute a global Gang of Four that comprises 65 percent of the world’s economy. The remaining 157 nations tracked by the IMF make up the other 35 percent of global output. Among these 157 nations is a Gang of Ten consisting of Brazil, Russia, India, Canada, Australia, Mexico, Korea, Indonesia, Turkey, and Saudi Arabia, which each produce between 1 percent and 3 percent of global output. Each of the smallest 147 nations produces less than 1 percent of global output, and most produce far less. The wealth concentration among nations is as starkly skewed as it is within nations. Among the 80 percent of nations with the lowest output, any one could disappear tomorrow and the impact on global growth would scarcely be noticed.
This is important to recall when Wall Street analysts promote theses on investing in emerging markets, frontier markets, and more exotic locales. The fact is there are few significant capital markets, their capacity to absorb inflows is limited, and they have a tendency to overheat when they try to absorb more than a modest amount of capital. Yet as China heads for a hard landing, as the United States is stuck in low gear, as Japan endures its third decade in depression, and as Europe muddles through a structural adjustment, it is difficult to deny the Gang of Ten’s investment appeal, and the appeal of those not far behind, such as Poland, Taiwan, South Africa, Colombia, and Thailand.
Consider the BRICS. For convenience, as well as for marketing purposes, analysts bundle smaller nations into groups tagged with acronyms made of members’ names. BRICS is the granddaddy of such groups, consisting of Brazil, Russia, India, China, and a late entry to the club, South Africa. Each BRICS member has its own attractions and problems; what the BRICS do not have is much in common. The Russian economy is best understood as a natural-resource-extraction racket run by oligarchs and politicians who skim enormous amounts off the top and reinvest just enough to keep the game going. China has produced real growth but has also produced waste, pollution, and corruption to the point that China has an unsustainable model hostile to any foreign investor from whom it cannot steal technology. India has growth and great promise but has not come close to realizing its potential because its world-class red-tape raj stifles innovation. Among the BRICS, Brazil and South Africa come closest to being “real” economies in the sense that growth is sustainable, corruption is not completely rampant, and entrepreneurship has room to breathe.
Yet there is no denying the success of the BRICS moniker. The original term BRIC was created by Jim O’Neill and his colleagues at Goldman Sachs in 2001 to highlight the group’s share of global GDP and higher growth rates compared to established large economy groups such as the G7. But O’Neill’s analysis was not primarily economic; it was political. Beyond the basic facts about size and growth, O’Neill called for rethinking the G7’s international governance model to reduce Europe’s role and increase the role of emerging economies in a new G5 + BRICs = G9 formula.
In his proposed G9, O’Neill glossed over differences in social development, including bedrock principles such as civil rights and the rule of law, with the comment “The other members would need to recognise that not all member countries need to be the ‘same.’” He recognized that the BRICs were not at all homogeneous as economic models: “The four countries under consideration are very different economically, socially and politically.”
How O’Neill’s original work morphed from a political manifesto to an investment theme is best explained by Wall Street’s penchant for salespeople engaging their customers with a good story. But it is difficult to fault O’Neill for this; he had a political agenda, and it worked. By 2008, the G7 was practically a museum piece, and the G20, including the BRICS and others, was the de facto board of directors of the international monetary system. O’Neill correctly foresaw that in the post–Cold War, globalized world, the economic had become the political. Economic output trumped civil society and other traditional metrics of inclusion in global leadership groups. The BRICS concept was never an investment thesis so much as a political injunction, and the world took heed.
The BRICS success bred a host of acronymic imitators. Among the recent entrants in this naming derby are the BELLs, consisting of Bulgaria, Estonia, Latvia, and Lithuania; and the GIIPS of the EU periphery, consisting of Greece, Ireland, Italy, Portugal, and Spain. As a group, the GIIPS are best understood as a Eurozone subset that share the euro and are undergoing arduous internal economic adjustments. Within the GIIPS, one should distinguish between Spain and Italy on the one hand, which are true economic giants making up almost 5 percent of the global economy, and Portugal, Ireland, and Greece on the other, whose combined output is less than 1 percent of global total. On the whole, the BELLs and GIIPS have more economic factors in common than do the BRICS, and their proponents have explicit economic themes in mind versus the overtly political perspectives of O’Neill and Goldman Sachs.
■ BELLs
The BELLs are small, almost inconsequential, as their economies add up to just 0.2 percent of global GDP combined. But their geopolitical significance is enormous, since they form the EU’s eastern frontier and are the frontline states buffering Europe and the traditional eastern powers, Russia and Turkey. Unlike the BRICS, the BELLs do have much in common. In addition to being EU members, they had all fixed the value of their local currencies to the euro. Pegging to the euro has led the BELLs into the same internal adjustment and devaluation as the Eurozone periphery, since they cannot use currency devaluation as a quick fix for dealing with econo
mic adjustment issues.
Economists lament that they cannot conduct scientific experiments on national economies because many variables cannot be controlled and processes cannot be replicated. But certain cases have enough controlled variables to produce telling results when divergent polices are pursued under similar conditions. Two such quasi-experiments involving the BELLs have played out recently. The first contrasts the BELLs and the GIIPS; the second contrasts each BELLs member to the others.
Experiments are typically conducted by controlling certain variables among all participants and measuring differences in the factors that are not controlled. The first control variable in this real-world experiment is that neither the BELLs nor the GIIPS devalued their currencies. The BELLs have maintained a local currency peg to the euro and have not devalued. Indeed, Estonia actually joined the euro on January 1, 2011, at the height of anti-euro hysteria, and Latvia joined on January 1, 2014.
The second control variable is the depth of the economic collapse in both the BELLs and the GIIPS beginning in 2008 and continuing into 2009. Each BELL suffered approximately a 20 percent decline in output in those two years, and unemployment reached 20 percent. The decline in output in the GIIPS in the same period was only slightly less. The third control variable is that both the BELLs and the GIIPS suffered an evaporation of direct foreign investment and lost access to capital markets, a shortfall that had to be made up with various forms of official assistance. In short, the BELLs and the GIIPS both experienced collapsing output, rising unemployment, and a sudden stop in foreign investment in 2008 and 2009. At the same time, the governments never seriously considered devaluation, despite wails from the pundits.
The Death of Money Page 16
