Читать книгу Crisis in the Eurozone - Costas Lapavitsas - Страница 9
ОглавлениеPart 1 BEGGAR THYSELF AND THY NEIGHBOUR
C. Lapavitsas, A. Kaltenbrunner, D. Lindo, J. Michell, J.P. Painceira, E. Pires, J. Powell, A. Stenfors, N. Teles
March 2010
1. SEVERAL DIMENSIONS OF A PUBLIC DEBT CRISIS
A crisis with deep roots
The sovereign debt crisis that broke out in Greece at the end of 2009 is fundamentally due to the precarious integration of peripheral countries in the eurozone. Its immediate causes, however, lie with the crisis of 2007–9. Speculative mortgage lending by US financial institutions, and trading of resultant derivative securities by international banks created a vast bubble in 2001–7, leading to crisis and recession. State provision of liquidity and capital in 2008–9 rescued the banks, while state expenditure prevented a worsening of the recession. The result in the eurozone was a sovereign debt crisis, exacerbated by the structural weaknesses of monetary union.
The crisis of public debt, thus, represents Stage Two of an upheaval that started in 2007 and can be called a crisis of financialisation.1 Mature economies have become ‘financialised’ during the last three decades resulting in growing weight of finance relative to production. Large corporations have come to rely less on banks, while becoming more engaged in financial markets. Households have become heavily involved in the financial system through assets (pension and insurance) and liabilities (mortgage and unsecured debt). Banks have been transformed, seeking profits through fees, commissions and trading, rebalancing their activities toward households rather than corporations. Financial profit has emerged as a large part of total profit.2
But financialisation has unfolded in different ways across mature countries, including those within the European Union. Germany has avoided the explosion of household debt that recently took place in other mature countries and peripheral eurozone countries. The performance of the German economy has been mediocre for many years, while great pressure has been applied on German workers’ pay and conditions. The main source of growth for Germany has been its current account surplus inside the eurozone, resulting from pressure on pay and conditions rather than on superior productivity growth. This surplus has been recycled through foreign direct investment and German bank lending to peripheral countries and beyond.
The implications for the eurozone have been severe. Financialisation in the periphery has proceeded within the framework of the monetary union and under the dominant shadow of Germany. Peripheral economies have acquired entrenched current account deficits. Growth has come from expansion of consumption financed by expanding household debt, or from investment bubbles characterised by real estate speculation. There has been a general rise of indebtedness, whether of households or corporations. Meanwhile, pressure has been applied to workers’ pay and conditions across the periphery, but not as persistently as in Germany. The integration of peripheral countries in the eurozone, then, has been precarious, leaving them vulnerable to the crisis of 2007–9 and eventually leading to the sovereign debt crisis.
Institutional bias and malfunction in the eurozone
The institutional mechanisms surrounding the euro have been an integral part of the crisis. To be more specific, European Monetary Union is supported by a host of treaties and multilateral agreements, including the Maastricht Treaty, the Stability and Growth Pact and the Lisbon Strategy. It is also supported by the European Central Bank, in charge of monetary policy across the eurozone. The combination of these institutions has produced a mix of monetary, fiscal, and labour market policies with powerful social implications.
A single monetary policy has been applied across the eurozone. The ECB has targeted inflation and focused exclusively on the domestic value of money. To attain this target the ECB has taken cognisance of conditions primarily in core countries rather than assigning equal weight to all. In practice this has meant low interest rates across the eurozone. Further, the ECB has operated deficiently since it has not been allowed to acquire and manage state debt. And nor has it actively opposed financial speculation against member states. As a result, the ECB has emerged as protector of financial interests and guarantor of financialisation in the eurozone.
Fiscal policy has been placed under the tight constraints of the Stability and Growth Pact, though considerable residual sovereignty has remained with member states. Fiscal discipline has been vital to the acceptability of the euro as international reserve, allowing the euro to act as world money.3 Since it lacks a unitary state and polity, the eurozone has not had either an integrated tax system or fiscal transfers between areas. In practice, fiscal rules have been applied with some laxity in core countries and elsewhere. Peripheral countries have attempted to disguise budget deficits in a variety of ways. Nonetheless, fiscal stringency has prevailed during this period.
Given these constraints, national competitiveness within the eurozone has depended on the conditions of work and the performance of labour markets, and in this regard EU policy has been unambiguous. The European Employment Strategy has encouraged greater flexibility of employment as well as more part-time and temporary work. There has been considerable pressure on pay and conditions resulting in a race to the bottom across the eurozone. The actual application of this policy has, however, varied considerably, depending on welfare systems, trade union organisation, and social and political history.
It is apparent that the institutions of the eurozone are more than plain technical arrangements to support the euro as domestic common currency as well as world money. Rather, they have had profound social and political implications. They have protected the interests of financial capital by lowering inflation, fostering liberalisation, and ensuring rescue operations in times of crisis. They have also worsened the position of labour compared to capital. And not least, they have facilitated the domination of the eurozone by Germany at the expense of peripheral countries.
Peripheral countries in the shadow of Germany
Peripheral countries joined the euro at generally high rates of exchange – ostensibly to control inflation – thereby signing away some competitiveness at the outset. Since monetary policy has been set by the ECB and fiscal policy has been constrained by the Stability and Growth Pact, peripheral countries have been encouraged to improve competitiveness primarily by applying pressure on their workers. But they have faced two major problems in this regard. First, real wages and welfare states are generally worse in the periphery than in the core of the eurozone. The scope for gains in competitiveness through pressure on workers is correspondingly less. Second, Germany has been unrelenting in squeezing its own workers throughout this period. During the last two decades, the most powerful economy of the eurozone has produced the lowest increases in nominal labour costs, while its workers have systematically lost share of output. EMU has been an ordeal for German workers.
German competitiveness has thus risen further within the eurozone. The result has been a structural current account surplus for Germany, mirrored by current account deficits for peripheral countries. This surplus has been the only source of dynamism for the German economy throughout the 2000s. In terms of output, employment, productivity, investment, consumption, and so on, German performance has been mediocre. At the core of the eurozone lies an economy that delivers growth through current account surpluses deriving in large part from the arrangements of the euro. German surpluses, meanwhile, have been translated into capital exports – primarily bank lending and foreign direct investment – the main recipient of which has been the eurozone, including the periphery.
This is not to imply that workers in peripheral countries have avoided pressures on pay and conditions. Indeed, the share of labour in output has declined across the periphery. It is true that the remuneration of labour has increased in nominal and real terms in the periphery, but productivity has risen by more – and generally faster than in Germany. But conditions within the eurozone have not encouraged rapid and sustained productivity growth in peripheral countries – partly due to middling levels of technology – with the exception of Ireland. Peripheral countries have thus lost competitiveness as the nominal compensation of German workers has remained practically stagnant throughout the period.
Confronted with a sluggish but competitive Germany, peripheral countries have opted for growth strategies that have reflected their own history, politics and social structure. Greece and Portugal have sustained high levels of consumption, while Ireland and Spain have had investment booms that involved real estate speculation. Across the periphery, household debt has risen as interest rates fell. The financial system has expanded its weight and presence across the economy. But in 2009–10 it became apparent that these strategies were incapable of producing positive long-term growth results.
The integration of peripheral countries in the eurozone has been precarious as well as rebounding in favour of Germany. The sovereign debt crisis has its roots in this underlying reality rather than in public profligacy in peripheral countries. When the crisis of 2007–9 hit the eurozone, the structural weaknesses of monetary union emerged violently, taking the form of a public debt crisis for Greece, and potentially for other peripheral countries.
The impact of the crisis of 2007–9 and the role of finance
The immediate causes of the crisis of 2007–9 lay in the US mortgage bubble which became global due to securitisation of subprime assets. European banks began to face liquidity problems after August 2007, and German banks in particular found that they were heavily exposed to problematic, subprime-related securities. During the first phase of the crisis, core eurozone banks continued to lend heavily to peripheral borrowers in the mistaken belief that peripheral countries were a safe outlet. Net exposure rose substantially in 2008.
But reality gradually changed for banks as liquidity became increasingly scarce in 2008, particularly after the ‘rescue’ of Bear Stearns in early 2008 and the collapse of Lehman Brothers six months later. To rescue banks, the ECB has engaged in extensive liquidity provision, accepting many and debatable types of paper as collateral for secure debt. ECB actions have allowed banks to begin to adjust their balance sheet, thus engaging in deleveraging. By late 2008 banks were already reducing their lending, including to the periphery. Banks also stopped buying long-term securities preferring to hold short-term instruments – backed by the ECB – with a view to improving liquidity. The result was credit shortage and accelerated recession across the eurozone, including the periphery.
These were the conditions under which states – both core and periphery of the eurozone but also the UK and other states – began to seek additional loanable funds in financial markets. A major cause of rising state borrowing was the decline of public revenue as recession lowered the tax intake. State expenditure also rose in several countries after 2007 as the rescuing of banks proved expensive, and to a lesser extent as states attempted to support aggregate demand. Accelerated public borrowing in 2009 was induced by the crisis, and hence by the earlier speculations of the financial system. In this respect, the Greek state was typical of several others, including the USA and the UK.
In the conditions of financial markets in 2009, with the banks reluctant to lend, the rising supply of state paper put upward pressure on yields. Speculators found this environment conducive to their activities. In the past, similar pressures in financial markets would have led to speculative attacks on currencies and collapsing exchange rates for the heavy borrowers. But this was obviously impossible within the eurozone, and hence speculative pressures appeared as falling prices of sovereign debt.
Speculators focused on Greek public debt on account of the country’s large and entrenched current account deficit as well as because of the small size of the market in Greek public bonds. Credibility was also lost by the Greek government because of systematic fiddling of national statistics to reduce the size of budget deficits. But the broader significance of the Greek crisis was not due to the inherent importance of the country. Rather, Greece represented potentially the start of speculative attacks on other peripheral countries – and even on countries beyond the eurozone, such as the UK – that faced expanding public debt.
The Greek crisis, therefore, is symptomatic of a wider malaise. It is notable that the institutions of the eurozone, above all the central bank, have performed badly in this context. For the ECB private banks were obviously ‘too big to fail’ in 2007–9, meriting extraordinary provision of liquidity. But there was no similar sensitivity toward peripheral countries that found themselves in dire straits. It made little difference that the problems of public debt were largely caused by the crisis as well as by the very actions of the ECB in providing banks with liquidity.
To be sure the ECB has been hamstrung by its statutes which prevent it from directly acquiring public debt. But this is yet more evidence of the ill-conceived and biased nature of European Monetary Union. A well-functioning central bank would not have simply sat and watched while speculators played destabilising games in financial markets. At the very least, it would have deployed some of its ingenuity to constrain speculation, and the ECB has demonstrated considerably ingenuity in generously supplying private banks with liquidity in 2007–9. Not least, a well-functioning central bank would not have decided what types of paper to accept as collateral on the basis of ratings provided by the discredited private organisations that were instrumental to the bubble of 2001–7.
Policy options for peripheral countries
The crisis is so severe that there are neither soft options, nor easy compromises for peripheral countries. The choices are stark, similar to those of developing countries confronted with repeated crises during the last three decades.
The first alternative is to adopt austerity by cutting wages, reducing public spending and raising taxes, in the hope of reducing public borrowing requirements. Austerity would probably have to be accompanied by bridging loans, or guarantees by core countries to bring down commercial borrowing rates. It is likely that there would also be ‘structural reform’, including further labour market flexibility, tougher pension conditions, privatisation of remaining public enterprises, privatisation of education, and so on. The aim of such liberalisation would presumably be to raise the productivity of labour, thus improving competitiveness.
This is the preferred alternative of ruling elites across peripheral and core countries, since it shifts the burden of adjustment onto working people. But there are several imponderables. The first is the opposition of workers to austerity, leading to political unrest. Further, the eurozone lacks established mechanisms both to provide bridging loans and to enforce austerity on peripheral members. There is also strong political opposition within core countries to rescuing others within the eurozone. On the other hand, the option of forcing a peripheral country to seek recourse to the IMF would be damaging for the eurozone as a whole.4
Yet, despite legal constraints, it is not beyond the EU to find ways of advancing bridging loans while at the same time enforcing austerity through political pressure. The real problem with this option is not the institutional machinery of the eurozone. It is, rather, that the policy is likely to lead to aggravated recession in peripheral countries making it even more difficult to meet public borrowing targets. Poverty, inequality and social division will increase substantially. Even worse, it is unlikely that there will be long-term increases in productivity through a strategy of liberalisation. Productivity increases require investment and new technologies, neither of which will be provided spontaneously by liberalised markets.
Peripheral countries would probably find themselves lodged in an unequal competitive struggle against Germany, whose workers would continue to be severely squeezed. Attempting to remain within the eurozone by adopting austerity and liberalisation would lead to sustained falls in real wages in the vain hope of reversing current account deficits against Germany. The eurozone as a whole, meanwhile, would continue to be faced with a weaker world economy due to the crisis of 2007–9. It is a grim prospect for working people in the periphery, and far from a bed of roses for German workers.
The second alternative is to reform the eurozone. There is almost universal agreement that unitary monetary policy and fragmented fiscal policy have been a dysfunctional mix. There is also widespread criticism of the ECB for the way it has provided abundant liquidity to banks, while keeping aloof of borrowing states, even to the extent of ignoring speculative attacks. A range of reforms that would not challenge the fundamentals of the Maastricht Treaty, the Stability and Growth Pact, and the Lisbon agenda might well be possible. The aim would be to produce smoother interaction of monetary and fiscal forces, while maintaining the underlying conservatism of the eurozone.
There is very little in such reforms that would be attractive to working people, or that could indeed deal with the structural imbalances within the eurozone. Hence there have been calls for more radical reforms, including abolition of the Stability and Growth Pact and altering the statutes of the ECB to allow it regularly to lend to member states. The aim of such reform would be to retain monetary union, while creating a ‘good euro’ that would be beneficial to working people. The ‘good euro’ strategy would involve significantly expanding the European budget to deliver fiscal transfers from rich to poor countries. There would be an active European investment strategy to support new areas of economic activity. There would also be a minimum wage policy, reducing differentials in competitiveness, and lowering inequality across the eurozone.
The ‘good euro’ strategy, appealing as it sounds, would face two major problems. The first is that the eurozone lacks either a unitary or a federal state, and there is no prospect of acquiring one in the near future, certainly not with the required progressive disposition. The current machinery of the eurozone is entirely unsuited to this task. The strategy would face a continuous conflict between, on the one hand, its ambitious pan-European aims and, on the other, the absence of state mechanisms that could begin to turn these aims into reality.
At a deeper level, the ‘good euro’ strategy would clash with the putative role of the euro as world money. If fiscal discipline was relaxed among member states, there would be a risk that the value of the euro would collapse in international markets. Were that to happen, at the very least, the international operations of European banks would become extremely difficult. The international role of the euro, which has been vital to the project from the beginning, would come under heavy pressure. It is not clear, then, that the ‘good euro’ strategy would be compatible with monetary union. In this light, a ‘good euro’ might end up as ‘no euro’. Those who advocate this strategy ought to be aware of its likely implications, i.e., leading to the end of monetary union; their institutional, political and social demands have to be tailored accordingly.
The third alternative is to exit from the eurozone. Even here, however, there are choices. There is ‘conservative exit’, which is increasingly discussed in the Anglo-Saxon press, and would aim at devaluation. Some of the pressure of adjustment would be passed onto the international sphere, and exports would revive. But there would also be losses for those servicing debt abroad, including banks. Workers would face wage declines as the price of tradable goods would rise. Devaluation would probably be accompanied by austerity and liberalisation, compounding the pressure on workers.
Long-term improvements in productivity would, however, occur only if market forces began spontaneously to develop new capacity in the tradable goods sector. This is extremely difficult for peripheral eurozone countries, with middling technology and middling real wages. It is notable that the ruling elites of peripheral countries are aware of these difficulties, as well as of their own lack of capacity to deal with them. They have implicitly admitted that they possess neither the means nor the will to pursue an independent path. Consequently, conservative exit might lead to stagnation with repeated devaluations and decline in incomes.
There is, finally, ‘progressive exit’ from the eurozone, which would require a shift of economic and social power toward labour in peripheral countries. There would be devaluation accompanied by cessation of payments and restructuring of public debt. To prevent collapse of the financial system there would have to be widespread nationalisation of banking, creating a system of public banks. Controls would also have to be imposed on the capital account to prevent outflows of capital. To protect output and employment, finally, it would be necessary to expand public ownership over key areas of the economy, including public utilities, transport and energy.
On this basis, it would be possible to develop industrial policy that could combine public resources with public credit. There are broad areas of the national economy in peripheral countries that call for public investment, including infrastructure. Opportunities exist to develop new fields of activity in the ‘green’ economy. Investment growth would provide a basis on which to improve productivity, ever the Achilles heel of peripheral economies. Financialisation could then begin to be reversed by lessening the relative weight of finance.
A radical policy shift of this type would require transforming the state by establishing mechanisms of transparency and accountability. The tax and transfer payments of the state would then take a different shape. The tax base would be broadened by limiting tax evasion by the rich as well as by capital. Public provision for health and education would be gradually improved, as would redistribution policies to alleviate high inequality in peripheral countries.
A policy of progressive exit for peripheral countries would come with evident costs and risks. The broad political alliances necessary to support such a shift do not exist at present. This absence, incidentally, is not necessarily due to lack of popular support for radical change. More important is that no credible political force in Europe has had the boldness to oppose austerity hitherto. Beyond political difficulties, a major problem for progressive exit would be to avoid turning into national autarky. Peripheral countries are often small and need to maintain access to international trade and investment, particularly within Europe; they also need technology transfer.
International alliances and support would be necessary in order to sustain flows of trade, skills and investment. These would be far from easy to secure if the rest of the EU remained under the spell of monetary union. But note that progressive exit by the periphery would also offer fresh prospects to core eurozone countries, particularly to labour which has suffered throughout this period. If the eurozone unravelled generally, economic relations between core and periphery could be put on a more cooperative basis.
The order of analysis in Part 1
Part 1 focuses on the peripheral countries of the eurozone, above all, Greece, Portugal, Spain and Ireland. When appropriate, Italian data and performance have also been considered, though Italy cannot easily be considered a peripheral country to the EU. The core of the eurozone is taken to comprise Germany, France, Belgium and the Netherlands.5 Comparisons are usually made with Germany, the leading country of the core and the EU as a whole. The introduction of the euro in 1999 – and 2001 for Greece – provides a natural point of reference for all comparisons. Each country has had its own distinctive institutional, social and historical trajectory, and therefore some pretty brutal generalisations are deployed below. But there are also evident commonalities which derive in large part from worldwide patterns of economic development in recent years, as well as from the nature of the EU and the eurozone.
Thus, chapter 2 discusses macroeconomic performance of peripheral countries compared to Germany. Chapter 3 moves to labour markets, the remuneration of labour and the patterns of productivity growth. Chapter 4 then turns to international transactions particularly within the eurozone. On this basis, chapter 5 considers the evolution of public finance and the expansion of public indebtedness after 2007. Chapter 6 places the growth of public debt in the context of the operations and performance of the financial sector following the crisis of 2007–9. Chapter 7 concludes by considering the alternatives available to peripheral countries.
2. MACROECONOMIC PERFORMANCE: STAGNATION IN GERMANY, BUBBLES IN THE PERIPHERY
Growth, unemployment and inflation
Growth rates among the countries in the sample were generally lower in the 2000s than in the 1990s (fig. 1). This fits the pattern of steadily declining growth rates across developed countries since the late 1970s. But there is also significant variation. Ireland registered very high rates of growth in the 1990s, driven by investment by US multinational corporations that were given tax breaks. Profit repatriation has been substantial, creating a large disparity between Irish GDP and GNP. Much of Irish growth has been due to transfer pricing within multinationals, thus also inflating productivity growth. Greek growth also accelerated in the early 2000s, bolstered by expenditure for the Olympic Games. Spanish growth, finally, has been reasonably high throughout the period.
Fig. 1 GDP Growth Rates
Source: Eurostat
However German growth rates have remained anaemic throughout, with the exception of a minor burst in the second half of the 2000s. Exports have played a significant role in causing this uptick of growth, a development of the first importance for the evolution of the eurozone. Portuguese and Italian growth has barely diverged from German growth rates since the introduction of the euro.
Unemployment rates are consistent with growth rates (fig. 2), showing convergence toward lower levels in the 2000s compared to the 1990s. This is mostly because Spanish and Irish unemployment rates declined rapidly at the end of the 1990s. Spanish unemployment, however, remained at the high end of the spectrum throughout, and has risen faster than in other countries once the crisis of 2007–9 materialised. Unemployment seems to expand rapidly in Spain at the first sign of economic difficulty. The Greek labour market is probably not very different, bearing in mind that official statistics tend to underestimate unemployment. Greek unemployment rose rapidly in 2009, once the crisis had hit hard. Equally striking, however, have been the high rates of German unemployment throughout this period, if anything exhibiting an upward trend. The same holds for Portugal, which has followed Germany in this respect too.
Fig.2 Unemployment Rates
Source: Eurostat
Inflation rates, on the other hand, present a more complex pattern (fig. 3). Rates converged to a fairly narrow range of 2–4 percent in 2001, at the time of the introduction of the euro. However, in the following three years rates diverged, only to converge again in 2004, this time to a narrower range of 2–3 percent. Inflation targeting by the ECB and the application of a common monetary policy took some time to produce the desired effect. The picture is at most a qualified success for the ECB as inflation rates accelerated again in 2007–8. The most important element of figure 3, however, is that German inflation rates have remained consistently below the rest throughout the period, rarely exceeding 2 percent. This performance lies at the heart of the problems of the eurozone.
In short, the German economy has produced a characteristic macroeconomic performance throughout the period, marked by mediocre growth, high unemployment and low inflation. German performance has set the tone for the eurozone and placed its stamp on the operation of the euro. The sovereign debt crisis has its roots as much in the performance of Germany, as it does in the actions of peripheral countries.
Fig. 3 Inflation Rates (Harmonised Index of Consumer Prices)
Source: Eurostat
Investment and consumption
A closer look at the components of aggregate demand gives further insight into macroeconomic performance. Before looking at investment and consumption, however, note that the economies in the sample are generally service-based. The secondary sector contributes slightly less than 30 percent of GDP in Germany, Italy, Spain and Portugal. It amounts to roughly 45 percent of GDP in Ireland, but that is largely due to the presence of multinationals. Greece is also an exception, the secondary sector standing at about 20 percent of GDP – an aspect of persistent de-industrialisation since the 1980s. Agriculture makes a minor contribution to output in all eurozone countries.
Investment performance has been poor, with the exception of Spain and Ireland (fig. 4), both of which even underwent investment booms in the late 2000s. But Irish investment in the 1990s was in large part due to US multinational activities. Generally, there has not been a strong wave of investment in the eurozone.
Fig. 4 Gross Fixed Capital Formation (percent of GDP)
Source: Eurostat
Fig. 5 Gross Fixed Capital Formation Net of Housing (percent of GDP)
Source: Eurostat
A better picture of underlying trends is given by investment net of housing (fig. 5). It then becomes clear that the investment boom in Ireland in the 2000s was primarily due to a real estate bubble. The Spanish investment boom was also heavily based on real estate. Investment in the productive sector has been generally weak in all the countries considered.
Consumption, on the other hand, has remained pretty flat relative to GDP, with the exception of Portugal where it rose significantly after the introduction of the euro (fig. 6). The striking aspect of consumption, however, is the exceptionally high level of Greece, rapidly approached by Portugal in the second half of the 2000s. High household consumption has been the mode of integration for both countries in the eurozone. This is a significant difference with Spain and Italy, and has important implications for indebtedness, as is shown below. The other exception is Ireland, where private consumption has been a very low proportion of GDP.
The patterns of consumption are broadly reflected in saving (fig. 7). For both Greece and Portugal saving as a percentage of GDP became negative in the second half of the 2000s. Thus, high and rising consumption has been supported by rising household debt. However, saving has also declined in Spain, Italy, and even in Ireland in the 2000s. Households across the periphery have found it difficult to sustain consumption on current income. The exception is Germany, where saving rose in the second half of the 2000s, in line with weak consumption. German growth, such it has been in the 2000s, has come neither from investment nor from consumption, but from exports. Persistent pressures of stagnation, and even contraction, in the domestic German economy have been fundamental to the evolution of the euro, directly contributing to the sovereign debt crisis.
Fig. 6 Household Consumption (percent of GDP)
Source: Eurostat
Fig. 7 Saving (percent of GDP)
Source: Eurostat
Debt
Household debt has risen consistently across peripheral countries in the sample. Financialisation of individual worker incomes has proceeded apace among peripheral countries of the eurozone throughout the last two decades. Growth of debt has been driven by consumption but also by rising prices of real estate. Low interest rates in the 2000s, as the ECB applied the same monetary policy across the eurozone, allowed workers to increase indebtedness. In particular, Portugal, Spain and Ireland have approached ratios of household debt to GDP of around 100 percent (fig. 8). These are very high levels of debt that will be difficult to support if unemployment and interest rates rise in the near future.
Fig. 8 Household Liabilities (percent of GDP)
Source: Eurostat, CB and FSA of Ireland
The vital exception is again Germany, where household indebtedness has declined, in line with weak consumption and the absence of a housing bubble. While households in peripheral countries have been accumulating debt as part of the integration of these countries in the eurozone, German households have been reducing the relative burden of their debt. This contrast is an integral part of the differential response of eurozone countries to the shock of the crisis of 2007–9, contributing to the sovereign debt crisis.
Corporate debt, meanwhile, has not shown a tendency to rise significantly across the sample in the years following the introduction of the euro, with the exception of Spain and Ireland, the only countries in which investment also rose significantly during the period (fig. 9).
Fig. 9 Non-financial Corporation Liabilities (percent of GDP)
Source: Eurostat, CB and FSA of Ireland
Recapping, macroeconomic performance of peripheral countries relative to Germany has demonstrated considerable variation but also common patterns. At the core of the eurozone, Germany has been marked by low growth, flat investment, stagnant consumption, rising saving, and falling household debt. Germany has not been a dynamic capitalist economy on any score. The only source of dynamism has been exports, for reasons that will become clear below.
Confronted with the stagnant and export-oriented performance of the dominant country of the eurozone, peripheral countries have adopted a variety of approaches. Thus, Spain and Ireland have had investment booms that were based heavily on real estate speculation and bubbles. Greece and Portugal, meanwhile, have relied on high consumption, driven by household debt. Indeed, household debt has risen substantially across peripheral countries. Italy, finally, has been lodged in what could only be described as stagnation throughout this period.
Integration of peripheral countries into the eurozone, in other words, has been precarious. This is apparent in their export performance, which is the mirror image of German performance, as is shown below. It is also apparent in the patterns of household financialisation, which have moved in the opposite direction to Germany. These structural contrasts lie at the root of the current crisis. The evidence also shows that it is fallacious to interpret the crisis as the result of inefficient peripheral economies being unable to deal with the efficient German economy. It is the size of the German economy and its export performance – which has very specific causes attached to the euro – that have allowed it to dominate the eurozone. Efficiency has had little to do with it. Consider now the labour market in order fully to establish this point.
3. LABOUR REMUNERATION AND PRODUCTIVITY: A GENERAL SQUEEZE, BUT MORE EFFECTIVE IN GERMANY
A race to the bottom
The EU has systematically promoted labour market reform aimed at reinforcing the process of monetary integration. Starting with the Maastricht Treaty (1992), social provisions began to be included in European treaties apparently to reinforce economic coordination. Labour market policies have been considered national initiatives; however, the Luxembourg European Council (1997) launched the first European Employment Strategy, followed by the Lisbon Strategy in 2000. The Lisbon Strategy stated the need for more flexibility in labour markets. The apparent aims were to achieve full employment, to create a knowledge intensive labour market, and to raise employment rates.
During the 2000s the Lisbon agenda was repeatedly reinforced, including by “Guidelines for Growth and Jobs”, “National Reform Programmes” and “Recommendations” from the European Council. Particularly after the de Kok report (2004), policy toward labour markets has stressed the need for flexibility, contract standardisation, promotion of temporary and part-time work, and creation of (tax) incentives to encourage labour force participation.6 It is also true that improving the quality of employment was emphasised by the Council meetings of Nice (2000) and Barcelona (2002). In practice, however, the pressure of reform has led to a race to the bottom for workers’ pay and conditions. Several European legislative initiatives have met with strong resistance in recent years, for instance, reform of the internal market in services (Bolkenstein directive), or the new Working Time directive that would potentially increase the working week to sixty-five hours. Partly as a response, the European Commission has recently promoted a general agenda of reform focused on the Danish model of “flexicurity” – weak legal protection of labour relations compensated by strong state support for the unemployed.
Given that a single monetary policy has applied across the eurozone, and given also the tough constraints on fiscal policy (through the Stability and Growth Pact) labour market policy has been one of the few levers available to different countries to improve external competitiveness. Therefore, the effects of labour market policies have varied profoundly among different eurozone countries. Core countries have been historically characterised by high real wages and strong social policies, while peripheral countries have typically had low real wages and weak welfare states. Political and trade union organisation has also differed substantially among eurozone countries. All eurozone countries have joined the race to impose labour market flexibility and compress labour costs, but from very different starting points and with different mechanisms.
Of fundamental importance in this connection has been labour market policy in Germany. Put in a nutshell, Germany has been more successful than peripheral countries at squeezing workers’ pay and conditions. The German economy might have performed poorly, but Germany has led the way in imposing flexibility and restraining real wages. Characteristic of the trend have been the labour market reforms of 2003 introduced by the Social Democratic Party and known as Agenda 2010. New labour contracts have reduced social contributions and unemployment benefits. Since the early 1990s, furthermore, it has been possible for German capital to take full advantage of cheaper labour in Eastern Europe. The combined effect of these factors has been to put downward pressure on German wages, thus improving the competitiveness of the German economy.7
Peripheral countries with weak welfare states, lower real wages, and well-organised labour movements, such as Greece, Portugal, Italy and Spain, have been unable to squeeze workers equally hard. Ireland, on the other hand, has been at the forefront of imposing more liberal conditions on its workers. Unfortunately for the Irish elite, this did not spare the country from the severe impact of the crisis of 2007–9.
The determinants of German competitive success
The difference in outlook between Germany and the peripheral countries can be demonstrated by considering the behaviour of nominal labour unit costs, that is, nominal labour remuneration divided by real output. Nominal unit costs can be disaggregated into nominal cost per hour of labour divided by labour productivity. This is a standard measure used to compare competitiveness internationally.8 The trajectory of nominal unit costs, therefore, gives insight into the variation of nominal cost of labour relative to labour productivity. This trajectory is shown in figure 10 for all the countries in the sample with 1995 as base year. Note that data on productivity is notoriously unreliable, thus the evidence should be used with considerable caution.
Fig. 10 Nominal Unit Labour Costs (1995 = 100)
Source: AMECO
Fig. 11 Real Compensation of Labour (1995 = 100)
Source: AMECO
The most striking aspect of this data is the flatness of nominal unit labour costs in Germany. It appears that the opening of Eastern Europe to German capital together with sustained pressure on pay and conditions has forced nominal labour costs to move at an almost identical pace to productivity. However, in peripheral countries things have been different. Unit labour costs have increased significantly as nominal labour costs have risen faster than productivity, with Greece in the lead. In short, peripheral countries have been losing competitiveness relative to Germany in the internal eurozone market.
The more rapid rise in nominal labour costs was accompanied by generally higher inflation in the periphery compared to Germany, as was previously shown in relation to figure 3. Nevertheless, nominal labour costs rose generally faster than inflation, thus leading to increasing real compensation of labour in the periphery, as is shown in figure 11 (definition in footnote 8). Extra care is required here as real compensation is not the same thing as real wages, and moreover it hides a broad range of payments to managers and others in the form of wages and bonuses. Furthermore, the aggregate conceals considerable inequality in real wages among different groups of workers. Still, figure 11 shows that the real compensation of labour has risen faster in peripheral countries compared to Germany, with the exception of Spain.
Real compensation and the share of labour in output
It is no wonder, therefore, that conservative commentators in the press have remarked that the sovereign debt crisis ultimately derives from peripheral country workers receiving higher increases in compensation than German workers, leading to a loss of competitiveness.9 This is true, but also misleading. The real problem has not been excessive compensation for peripheral workers but negligible increases for German workers, particularly after the introduction of the euro. Even in Greece, in which nominal and real compensation have increased the most, the rise in real compensation has been only of the order of 20 percent during the period of 2000–8, and that from a low base compared to Germany.
The modesty of labour remuneration in the periphery becomes clear when put in the context of productivity growth (fig. 12).
There has been weaker productivity growth in Germany compared to the rest during this period, with the exception of Spain which has been extremely weak. This is more evidence of the lack of dynamism of the German economy: Irish, Greek and Portuguese productivity rose faster, even if from a lower base (Irish productivity is probably exaggerated for reasons to do with multinational transfer pricing). Peripheral countries have generally improved productivity, and certainly done better than Germany, which has been a laggard. But the Lisbon Strategy has not succeeded in putting peripheral countries on a strongly rising path of productivity. There has been no true catching up with the more advanced economies of the eurozone, with the partial exception of Ireland. Productivity increases have been respectable compared to Germany, but that is because Germany has performed badly.
Fig. 12 Labour Productivity (1995 = 100)
Source: OECD
Nonetheless, productivity growth has still been faster than the rise in real remuneration of labour. Consequently, labour has lost share in output more or less across the sample, as is shown in figure 13 (definition in footnote 6). The only sustained increase after the introduction of the euro has been in Ireland, but even there workers barely made good the losses sustained in the 1990s. Workers have generally lost relative to capital across the sample, German workers faring poorly compared to the others.
To sum up, labour market policies at national and EU level have applied sustained pressure on workers across the eurozone. This pressure has played an important role in determining competitiveness, given the rigidity of monetary and fiscal policies. The result has been loss of output share by workers across the eurozone. In peripheral countries real compensation has increased in some countries, though productivity has increased even faster. Nonetheless, productivity did not rise fast enough to ensure catching up with the more advanced economies of the core.
Fig. 13 Labour share in GDP (1995 = 100)
Source: AMECO
In Germany, on the other hand, productivity, real compensation, and nominal unit labour costs have increased very slowly. It cannot be overstressed that gains in German competitiveness have nothing to do with investment, technology, and efficiency. The competitive advantage of German exporters has derived from the high exchange rates at which peripheral countries entered the eurozone and, more significantly, from the harsh squeeze on German workers. Hence Germany has been able to dominate trade and capital flows within the eurozone. This has contributed directly to the current crisis.
4. INTERNATIONAL TRANSACTIONS: TRADE AND CAPITAL FLOWS IN THE SHADOW OF GERMANY
Current account: Surplus for Germany, deficits for periphery
The international transactions of eurozone countries have been shaped in large measure by the policies adopted to support the euro. The euro has been devised as a common measure of value and means of payment within the eurozone; the intention was that it should also become means of payment and reserve outside the eurozone, thus competing directly with the US dollar as a form of world money in the world market. Monetary and fiscal policies of eurozone countries have had to be consistent with this aim, thus imposing a common monetary policy and tight constraints on fiscal policy for each state. The institutional and policy framework of the eurozone have not arisen merely due to ideological dominance of neo-liberal thinking within the EU. They have also been dictated by the need to sustain the euro in its role as world money within and outside the eurozone.
The pattern of international transactions that has emerged for eurozone countries is consistent with the putative role of the euro. In the first instance, peripheral countries were obliged to join the euro at generally high exchange rates. Core countries, above all Germany, insisted upon this policy with the ostensible purpose of ensuring low inflation. High inflation in individual countries would have undermined the ability of the euro to compete internationally against the dollar. The implication was to reduce at a stroke the competitiveness of peripheral countries in the internal market. To this poor start was added sustained loss of competitiveness, discussed in the previous section. The result, shown in figure 14, was inevitable: emergence of entrenched current account deficits for peripheral countries, matched by an equally entrenched current account surplus for Germany.
Care is obviously necessary in interpreting this picture. Greece, Portugal and Spain have run substantial balance of trade deficits, but they have also had significant surpluses on services. Ireland has followed the opposite path, again reflecting its own mode of integration into the eurozone based on higher investment, much of it directed to housing, and intensified labour flexibility. For all, inability to restrain nominal labour unit costs at German levels and, more fundamentally, inability to set productivity growth on a strongly rising path, resulted in current account deficits mirrored by surpluses for Germany. Note that two thirds of German trade is with the eurozone. Note also that the trade of the eurozone with the rest of the world is roughly in balance.
Fig. 14 Current account balance (percent GDP)
Source: IMF BOP
The euro and its attendant policy framework have become mechanisms ensuring German current account surpluses that derive mostly from the eurozone. Peripheral countries joined a monetary system that purported to create a new form of world money, thus signing away some of their competitiveness, while adopting policies that exacerbated the competitiveness gap. The beneficiary of this process has been Germany, because it has a larger economy with higher levels of productivity, and because it has been able to squeeze its own workers harder than others. Structural current account surpluses have been the only source of growth for the German economy during the last two decades. The euro is a ‘beggar-thy-neighbour’ policy for Germany, on condition that it beggars its own workers first.
Fig. 15 Capital and financial account (Net, $ bn)
Source: IMF BOP
Financial account: German FDI and bank lending to the periphery
Inevitably, the picture appears in reverse on the capital and financial account (fig. 15). Germany has exported capital on a large scale, while peripheral countries have been importing capital.
The financial account comprises fundamentally foreign direct investment (FDI), portfolio flows, and ‘other’ flows that are heavily driven by banks. The direction of aggregate flows between Germany and the periphery of the eurozone can be gauged from the composition of the German financial account (fig. 16).
The driving forces behind sustained capital exports by Germany since the introduction of the euro have been ‘other’ and FDI flows. Portfolio flows have been weaker, even turning inward for much of the 2000s. Put summarily, Germany has been recycling its current account surpluses as FDI and bank lending abroad. Bank lending peaked in 2007–8 and, as is shown below, this has been a vital element of the current sovereign debt crisis.
Fig. 16 Composition of German financial account (euro, bn)
Source: Bundesbank
The geographical direction of the recycling of surpluses is clear, once again, from the composition of German capital exports. The eurozone has been the main recipient of German FDI (fig. 17), while also competing with the non-euro part of the EU for German bank lending in the 2000s (fig. 18). Once the crisis of 2007–9 broke out, German banks restricted their lending to non-euro EU countries but continued to lend significantly to eurozone countries.
Fig. 17 German outward FDI by region (euro, bn)
Source: Bundesbank
To recap, international transactions of eurozone countries have been driven by the requirements and implications of monetary union. Peripheral countries have lost competitiveness relative to Germany because of initially high exchange rates as well as because of the ability of German employers to squeeze workers harder. The result has been a structural current account surplus for Germany, mirrored by structural current account deficits for peripheral countries. Consequently, German FDI and bank lending to the eurozone have increased significantly. ‘Other’ flows to peripheral countries rose rapidly in 2007–8 as the crisis unfolded, but then declined equally rapidly. That was the time when peripheral states were forced to appear in credit markets seeking funds.
Fig. 18 German ‘other’ outward flows by region (euro, bn)
Source: Bundesbank
5. RISING PUBLIC SECTOR BORROWING: DEALING WITH FAILED BANKS AND WORSENING RECESSION
The straitjacket on fiscal policy
The public sector of peripheral countries, and above all Greece, has been at the epicentre of the current turmoil. The reasons for this, however, are only partially related to the intrinsic weaknesses of the public sector in peripheral countries. The current crisis is due to the nature of monetary union, to the mode of integration of peripheral countries in the eurozone, and to the impact of the crisis of 2007–9. Public sector debt has become a focus for the tensions that have emanated from these sources for reasons discussed below.
It is apparent that the sovereign debt crisis has not been chiefly caused by state incompetence, inefficiency and the like. Eurozone states have been operating within the framework of the Stability and Growth Pact, the main components of which emerged already in the early 1990s with the Maastricht Treaty. The underlying logic has been that, if the euro was going to become a world reserve currency and means of payment, there had to be coherence of fiscal policy to match the single monetary policy. Rising public deficits and accumulating state debt would have reduced the international value of the euro. The Stability and Growth Pact is important to making the euro a competitor to the dollar.
In this respect, the EU has faced an inherent contradiction because it is an alliance of sovereign states. Sovereignty means little without power and ability to tax, always reflecting the social composition of particular countries. Therefore, a compromise was reached, in large measure imposed by the core countries. The Growth and Stability Pact has imposed the arbitrary limit of 60 percent national debt relative to GDP and an almost equally arbitrary limit of 3 percent for budget deficits that would hopefully prevent the level of public debt from rising. Fiscal policy was placed in a straitjacket that has tormented eurozone states for nearly two decades.
The Stability and Growth Pact represents a loss of sovereignty for eurozone states. However, not all states within the eurozone were created equal. The loss of sovereignty has been more severe for peripheral states, as has been repeatedly demonstrated when France or Italy have exceeded the presumed limits on deficits and debt. It is no surprise, therefore, that peripheral states have resorted to the weapons of the weak, that is, subterfuge and guile. Some of the techniques used to hide public debt have been ruinous to public accounts in the long run. Greece has led the way with persistent manipulation of national statistics throughout the 2000s as well as by striking barely legal deals with Goldman Sachs that presented public borrowing as a derivative transaction. Public–private transactions have also been widely deployed in the periphery to postpone expenditure into the future, typically at a loss to the public.
But fiscal policy has continued to be the province of each individual state, and has remained fragmented compared to unified monetary policy. Furthermore, the Stability and Growth Pact has made no provision for fiscal transfers across the eurozone, as would have happened within a unitary or federal state. There are no centralised fiscal means of relieving the pressures of differential competitiveness and variable integration into the eurozone. The European budget is currently very small, at just over 1 percent of the aggregate GDP of all EU states, which is a small fraction of the German, French, and UK budgets. Moreover, it is not allowed to go into deficit.
This structural weakness of the eurozone has been much discussed in recent years, including during the course of the current crisis.10 What is less discussed, however, is that it also has implications for the ECB. A key function of a central bank is to manage the debt of its state, handling the state’s access to financial markets and ensuring the smooth absorption of fresh issues. A central bank is also able to acquire state debt directly, facilitating the financing of fiscal deficits for longer or shorter periods of time. But the ECB has no obligation to manage the debt of eurozone member states, and is expressly forbidden to buy state debt. On both scores, the ECB does not behave as a normal central bank. The inherent weakness of the ECB is part of the dysfunctional co-ordination of monetary and fiscal policy within the eurozone, which has been made apparent in the course of the sovereign debt crisis.
Rising public deficits and debt due to the crisis
Turning to the actual path of public finances, it is important to note that public finance reflects the historical, institutional, and social development of each country. There can be no generalisation in this regard as welfare systems are variable, tax regimes reflect past compromises, the ability to collect tax depends on the efficiency of the state machine, and so on. Nonetheless, the Stability and Growth Pact has imposed certain common trends upon eurozone states.
Public expenditure declined steadily in the 1990s, with the exception of Greece, where it remained fairly flat (fig. 19). In the 2000s, expenditure stayed more or less flat, except for Germany, where it continued to fall steadily, and Portugal, where it rose gently. Once again, Germany has had considerable success in imposing fiscal austerity on itself, but also on other countries in the sample. Public expenditure turned upward after 2007 as the crisis hit and states attempted to rescue financial systems while also supporting aggregate demand. Once again, Germany is the exception as expenditure did not pick up.
Fig. 19 Government expenditure (percent GDP)
Source: Eurostat
Fig. 20 Government revenue (percent GDP)
Source: Eurostat
Public revenue showed equal complexity, reflecting the particular conditions of each country (fig. 20). Greek public revenue slumped in the middle of the 2000s as taxation was lowered on the rich, while the operations of the tax-collecting mechanism were disrupted. It rose toward the end of the decade, but not enough to make good the earlier decline. The path of Irish public revenue has been the weakest, though an attempt was made to shore things up in the second half of the 2000s. Spain and Portugal maintained reasonable revenue intake throughout. Public revenue declined across the sample once the crisis of 2007–9 began to bite. Recession and falling aggregate demand were at the heart of the fall.
Declining revenue and rising expenditure, both caused by the crisis, inevitably led to rapid increase in public deficits. With deficits rising, several peripheral and other even out eurozone states arrived in the financial markets in 2009 seeking to borrow large volumes of funds. The pressure to borrow appears to have been particularly strong in Greece, Spain and Ireland, less so in Portugal.
Fig. 21 Government primary balance (percent GDP)
Source: Eurostat
Consequently, and inevitably, national debt also began to rise relative to GDP after 2007 (fig. 22). Note that there are significant differences in the volume of public debt among eurozone countries, again reflecting each country’s respective economic and social trajectory.11 But Greek debt, which has attracted enormous attention since the start of the crisis, was not the highest in the group, and nor has it been rising in the 2000s. On the contrary, Greek national debt declined gently as a proportion of GDP in the second half of the 2000s. Only in Germany and Portugal did national debt rise throughout this period, though gently and from a fairly low base. The sudden rise of public debt across the eurozone in the last couple of years has been purely the result of the crisis of 2007–9.
Fig. 22 General government gross debt (percent of GDP)
Source: Eurostat
Public sector performance in the eurozone can thus be easily summed up. The Stability and Growth Pact has imposed a straitjacket on member states, but its effect has been conditioned by residual sovereignty in each state. The fragmentation of fiscal policy has contrasted sharply with the unification of monetary policy. Nevertheless, eurozone states have generally restrained public expenditure, while maintaining a variable outlook on revenue collection. The decisive moment arrived with the crisis of 2007–9, which pushed peripheral states toward deficits. At that point the underlying weaknesses of integration in the eurozone emerged for each peripheral state, including current account deficits and rising capital imports from the core.
There are no structural reasons why the tensions of debt should have concentrated so heavily on Greece. No doubt the country has a relatively large public debt and therefore faces a heavy need for refinancing, particularly as the budget swung violently into deficit in 2009. But Italian public debt is also high. It is also true that Greek governments have been persistently manipulating data, and that the country faces a large current account deficit. But these pressures could have been handled reasonably smoothly if it was not for speculation in the financial markets. Even speculation could have been confronted decisively, if the eurozone authorities had shown any inclination to bring it to heel. To analyse the interplay of these factors it is now necessary to consider the financial sector, the part of the economy that is most heavily responsible for the crisis of 2007–9.
6. THE FINANCIAL SECTOR: HOW TO CREATE A GLOBAL CRISIS AND THEN BENEFIT FROM IT
An institutional framework that favours financial but also productive capital
The European Central Bank (ECB) and the national central banks constitute the European System of Central Banks (ESCB), which has price stability as its primary objective.12 The ECB has normative power over the national central banks since decision-making on monetary (and financial) policy emanates from the ECB and then reaches national central banks. It can also make recommendations to national authorities relating to prudential supervision of credit institutions and the stability of the financial system.
The ECB is an unusual central bank. It has the exclusive right to authorise the issuing of banknotes in the EU, though notes are issued by individual central banks. It is also responsible for holding and managing official foreign reserves of member states. However, the ECB (and the national central banks) is prohibited from offering overdrafts or other credit facilities to member states, including the purchase of public debt instruments. The ECB is considered independent in the sense that no public institution or individual member state is authorised to influence its operations and decisions. But its substantial independence comes from the absence of a unitary European state with which it would have been obliged to interact.
The peculiar character of the ECB is also apparent in its own statutes. Subscription to ECB capital and the transfer of foreign reserve assets to the ECB, for instance, are proportionate to each member state’s population and GDP. Furthermore, when the number of member states exceeds fifteen, participation in the decision-making process of the ECB is supposed to take place on the basis of GDP as well as on the aggregate balance sheet of the monetary financial institutions of each member state, again reflecting a hierarchy of state power.13
The ECB has supported financialisation in Europe mostly by protecting the interests of financial capital. European financial markets have been unified as financial liberalisation has spread and become deeper. Restrictions on financial operations have been abolished among the member states. Monetary union and the establishment of the euro as world money have benefited European financial capital in competition with US and other global banks. The euro has also been marked by an appreciation bias, rising from around 0.95 to the dollar at its launch to reach a peak of 1.58 in July 2008. The euro has retreated since then, particularly following the sovereign debt crisis, and currently stands at around 1.35 to the dollar (March 2010). Without necessarily being deliberate, the appreciation bias has served the interests of financial capital since it has helped to induce global wealth holders to change the currency composition of their portfolios in favour of the euro.
It appears that the appreciation bias of the euro has not damaged the interests of the European productive sector, because it has forced productive capital to lower costs in order to be able to compete globally. This has meant steady pressure on workers’ pay and conditions. German structural adjustment in the 2000s, in particular, has been based on squeezing workers, as was shown above. Productive capital has further benefited from reductions in uncertainty surrounding exchange rates as well as from differences in financial environment. Finally, a strong and rising euro has also supported European capital in undertaking mergers and acquisitions (M&A) in other parts of the world. In short, the euro as world money has served the international interests of both financial and productive capital in Europe.
For European banks in particular, the euro has provided liquidity facilities regulated by the ECB that have been able to support banking expansion across the world. The European banking system (above all, German and Dutch banks) steadily increased its net long US-dollar positions until the middle of 2007 (roughly $400 bn), with the ECB effectively acting as one of the main funding counterparties.14 Note also that, in contrast to other central banks of mature countries, the ECB has always accepted private securities as collateral in its operations. Normal procedure for central banks is to accept only government securities. The Federal Reserve, for instance, started to accept private securities in 2008 only as an extraordinary response to the crisis.
There is no doubt that the institutional arrangements of the euro have been beneficial to European finance. However, after the outbreak of the global crisis and as global banks faced trouble, the significance of the absence of coordination between the monetary and the fiscal spheres became apparent. In contrast to the USA and the UK, monetary union has revealed an underlying weakness, namely the absence of a unitary or federal state in Europe.
Given the absence of political union, the Stability and Growth Pact has acted as anchor for the euro in the world market. Contrary to the USA, which has been able to relax fiscal policy, the euro has required fiscal tightening as the crisis has unfolded. The implication has been to push member states toward policies that further squeeze workers in peripheral countries, while defending the interests of the European financial system. Thus, monetary union has meant an asymmetric adjustment between banks and states in the financial sphere after the crisis: banks have been protected, while the onus of adjustment has fallen on weaker peripheral states.
Banking in the eurozone: The core becomes exposed to the periphery
Financialisation has developed in both core and peripheral countries of the eurozone, as is clear from the rising volume of financial institution assets relative to GDP (See table 1).
There are no apparent differences between core and peripheral countries with respect to the underlying trend of financialisation; there is, however, considerable variety among them. Furthermore, there has been no dramatic increase in foreign bank ownership, unlike the trend toward growing foreign bank entry in several developing economies during the same period. Assets of foreign banks (both subsidiaries and branches) in the eurozone stand around 20–25 percent of total assets of credit institutions, the only exception being Ireland, with around 50 percent.15
Table 1 Credit institutions, Total Assets/GDP
Source: ECB (2010): Structural indicators for the European Union banking sector, and ECB (2005): European Union banking structures
The international investment position of European banks, however, presents several noteworthy features. Figure 23 shows that the aggregate cross-border claims of banks have been rising globally since the mid-1980s, and quite rapidly in the 2000s.16 But the aggregate of cross-border claims of European banks rose much faster in the 2000s. The data is presented in US dollars, and the appreciating euro to US dollar exchange rate is shown on the right hand scale. To a certain extent, the appreciating euro has probably inflated balance sheets denominated in euro compared to those denominated in dollars. Nevertheless the growth in the international claims of European banks appears also to reflect greater integration within the European Union, drawing on the beneficial effect of the single currency and single market for finance.
Fig. 23 International positions by nationality of ownership of reporting banks (USD, bn)
Source: BIS Locational Banking Statistics
Turning to cross-border lending within the eurozone, it is useful to consider trends by splitting countries into core (Germany, France, Belgium and the Netherlands) and periphery, broadly understood (Greece, Ireland, Italy, Portugal, Spain). Lending has increased in both directions. As is shown in figure 24, gross exposure by banks grew from March 2005 until early 2008, after which it declined across the board as banks reined in their lending. It is important to stress, however, that even though there has been growth across the sample, flows from core to periphery have become more important in size than flows from core to core.
Furthermore, as figure 25 shows, net banking flows from core to periphery have been positive and increasing in the second half of the 2000s (starting March 2005, notwithstanding a statistical adjustment in March 2007)17 peaking in September 2008. As gross flows in figure 24 indicate, this change has been driven mainly by lending from core to periphery, which rose throughout this period. It is also notable that claims by periphery to core began to fall earlier than those from core to periphery.
Fig. 24 Gross cross-border bank claims (euro, bn)
Source: BIS Consolidated Bank Statistics
Fig. 25 Net cross-border claims, core to periphery (euro, bn)
Source: BIS Consolidated Bank Statistics
The evidence presented here shows that exposure of core banks to peripheral countries increased considerably after the first signs of the international financial crisis in 2007. There are several probable reasons for this phenomenon. Core banks had no concerns about the creditworthiness of peripheral states until 2009, indeed lending to governments seemed a reasonable course of action. ECB policy, furthermore, was to support all banks, thus increasing the creditworthiness of peripheral banks. Above all, money markets became very volatile after August 2007 and there were significant differences between individual inter-bank rates (LIBOR). Core banks found themselves holding surplus euro in 2007–8 and, given overall credit concerns, perceived peripheral banks to be safer than banks in other countries (especially the US and the UK). While the Anglo-Saxon financial systems had already been hit by the crisis, European countries appeared to be safer locations. This lack of concern about the state of the European periphery can also be inferred from the Credit Default Swap (CDS) spreads shown in figure 32, which were low and stable until mid September 2008 (when Lehman Brothers failed). Rising spreads in Greece and Portugal and a buoyant housing market in Spain appeared to offer high and reasonably secure returns to core banks.
Fig. 26 Core bank gross claims on periphery vs. capital & reserves (euro, bn)
Source: BIS Consolidated Banking Statistics; ECB Eurosystem Statistical Data Warehouse
Figure 26 above shows the gross exposure of the core countries compared to their Capital and Reserves. Additionally it shows the equity of the banking system at the end of 2008, which is the only date for which this type of data is available from the ECB or Eurosystem Central Banks. The graph shows that exposure of core banks to the periphery grew faster than their capital and reserves until early 2008. At that time banks began to rein in lending while continuing to strengthen their capital base. The main contributors to core lending to the periphery are France and Germany, whose trajectories are shown in figure 27.
The single point in figure 26 marks the equity of core banks in December 2008, allowing for visual assessment of exposure. At the end of 2008 the gross exposure of core banks to the periphery stood at around 1.4 trillion euros. Meanwhile, total equity of the core banking system was 0.6 trillion euros, making the exposure to peripheral countries approximately 2.6 times equity. The two single points in figure 27 indicate the equity of French and German banks, respectively, in March 2009. On this basis, the exposure of German banks appears perhaps somewhat heavier than that of French banks.
Fig. 27 French and German bank gross claims on periphery vs. capital & reserves
(euro, bn)
Source: BIS Consolidated Banking Statistics; ECB Eurosystem Statistical Data Warehouse
Be that as it may, there is no doubt that core banks have become heavily exposed to peripheral countries. Yet, the assets are loans and therefore it is probable that they have not been entered on the balance sheet on a mark-to-market basis, reflecting current market prices. Consequently, provision against losses would presumably take place only when the possibility of default by borrowers became very high and the loans began to look impaired. Judging by Credit Default Swap (CDS) spreads (fig. 32), which capture risk premia, the risk to core banks did not look forbidding in March 2010.
However, things could change very rapidly, if peripheral countries took a turn for the worse.18 A 10 percent drop in the value of banking assets would be serious for the core banking systems, but it may not necessarily be terminal. If, on the other hand, 50 percent of loans to the periphery defaulted with a 50 percent recovery ratio, resulting in a loss of 25 percent of total exposure; or equally, if an exit from the euro resulted in a 25 percent devaluation of domestic currencies, the outcome would be disastrous for the banking system of the core nations, given current levels of equity. German and French banks would be particularly vulnerable.
This was the hard reality behind the negotiations between core and periphery regarding a rescue plan for the weakest, in the first instance, Greece. If the periphery was not rescued and generalised default occurred, the banking system of the core would find itself in a very difficult position. Needless to say, banks were rescued by states once in 2007–9, and they would probably be rescued again, should this eventuality arise.
ECB operations allow banks to restrict their lending
When the financial crisis hit in 2007, many European banks found that their assets were worth less than estimated. In the preceding period European banks had attempted to keep in step with large US banks by borrowing to acquire speculative mortgage-backed and other asset-backed securities, thus raising their returns. When the interbank market froze in 2007–8, European banks struggled to find liquidity, thus coming under heavy pressure.
