This is the final section of my biggest blog to date, I hope you have enjoyed the blog thus far and if you are new to this site then you can find part I here and part II here.
We left part II asking what Ireland and it's fellow EU members could do to rest power back from the ever dominant Germans, and their Champion of Austerity, Chancellor Angela Merkel.
The Eurozone crisis has uncovered deep rifts between the various member states, something that the creation of the European project was meant to prevent. At the onset of the crisis, the French and the Germans were considered to be in the strongest negotiating position, however since then the French have been dragged into the mess - were recently downgraded again by S&P - and no longer have the perceived power that they once had. This means Germany stands alone as the power broker in Europe. The other nations are looking after their own vested interests, and are not clubbing together to act as a voice of opposition to Germany's austere policies.
I can't say that I completely disagree with German policy. When the crisis hit, many countries realised that they had been living far beyond their means, mainly because they were able to borrow at very low interest rates thanks to the Euro. Whereas before, banks in Italy would have had to buy pesos to invest in Spanish banks/debt, they now shared a common currency and money flowed freely to where the returns were highest - the booming economies of Ireland and Spain etc. Germany actually began the Euro project in a protracted slump, and as a result of this the ECB set the interest rate at contemporarily low rates. In order to get back to growth in the early noughties, the Germans reformed their economy, they liberalised labour markets - more on this later, broke the unions iron grip and encouraged prudent spending and high savings. These German savings flowed into the rest of the Eurozone, as German banks looked to make a higher return, than was available in Germany. For countries like Ireland and Spain this was equivalent to pouring oil, on a raging bonfire of already cheap money. Money that we now know was largely invested in construction.
When the bubble burst and the collateral damage was being surveyed, it seemed that sensible Germany had escaped most of the pain, while the peripherals were left counting the cost of an almighty party. Suddenly the main source of a countries revenue - construction - had dried up, yet the government spending, that had also risen in the boom years, was as big as ever. Worse yet, the spending was an integral part of the economy and slashing it would lead to even further falls in GDP.
Banks were crippled and had to be bailed out - according to the ECB and by extension Germany - as, lets not forget, a lot of the money that those banks had been lending was actually German cash. Brian Lenihan recounted how the erstwhile president of the ECB, Jean-Claude Trichet, called him up the night that Anglo was saved, and told him that Ireland could not allow the banks to fail, as it could result in the collapse of the European banking system.
So in effect Ireland bailed out Germany.
Apart from the very obvious flaw with this plan - that we %@&&*%$ bailed out Germany - there were some bones of contention.
During the boom, banks made outrageous amounts of profit, and paid their clueless CEOs fantastic sums of money, however when the bust came everyone shared the pain, and the banks became state owned - socialism by any other name. Did the very stupid people running these banks give back some of the money, nope not a single penny, they were put out to pasture and paid more taxpayer money. One could argue that they should all have been jailed, but thats another matter.
All of this inevitably lent to the bailout 2 years later - how ironic - with the Germans leading from the front, in terms of the structure of said bailout, and the terms and conditions that would apply.
In the 2 years between the re-capitalisation of the banks and the Irish bailout, the Germans developed memory loss and forgot, why we were where we were in the first place. They did however remember, that when their economy was in trouble that austerity won out in the end. This therefore was to be the plan for every other struggling European country.
As I mentioned, I don't fault Germany entirely for this course of action. Ireland was spending far too much vis a vis the tax it was taking in. Drastic cuts had to be made to steady the ship. Other reforms were also needed. Ireland's labour laws were already very flexible - employees can be fired and by extension hired quite cheaply, but other areas did need drastic reform. Areas such as protected professions e.g. lawyers needed to be liberalised and more competition fostered in general. The banks also needed to be cleaned up, and people in negative equity needed to be dealt with. As it turns out very little was done about this in the end.
The troika - as our new paymasters were known - were not satisfied with that however, and they insisted that tax levels were increased across the board. This is an area where I do find fault with German policy. During the bailout the Irish budget was being released to the German parliament, before most Irish politicians got to see it. Germany was a big factor behind the ridiculous rise to 23% of the top rate of VAT, and the 53% top rate of income tax that are still in force today. This has done Ireland no favours and has depressed demand, and led people to emigrate to countries with lower rates of tax. It has oft been said that you can not tax your way out of a recession, this is not strictly true in my opinion, but the amount you can raise from tax without causing further pain is limited. The concept of 23% VAT is a joke considering we have a land border with Northern Ireland - where a weak pound and lower rate of VAT come into play.
Ireland was not alone in facing these demands, Greece has been forced to cut even more savagely. Portugal, Spain, Cyprus and Italy too have had to make growth destroying cuts.
The German's had the advantage of pursuing austerity during a time when their trade partners were booming, and there is no doubt that the pain they went through has paid off in the long run. Prescribing austerity to every other country during a global downturn, has proven to be somewhat effective, it can not and will not end the Euro crisis however.
In part II I looked at other ways that Europe could lessen it's debt pile, and described how a good dose of inflation was required; to devalue the debt; and speed up the recovery. Germany as the most powerful country in Europe has the final say - although technically the ECB controls this - and will not change its ways on a whim. Someone needs to stand up to the Germans, and I feel that Ireland needs to be a part of this.
Ireland is in a strong negotiating position - believe it or not. It has swallowed it's austerity pill, taken the bailout and is now on the verge of an exit, and return to the bond markets. Our small island can be a beacon of hope for other nations, proving that there is a light at the end of the tunnel. This should be our negotiating stance.. the Germans need to be told in no uncertain terms, that they need to loosen their iron grip on the ECB and allow more inflation - quantitive easing, direct buying of government bonds etc. This will allow the likes of Spain and Greece to become competitive once more, and should help to devalue the Euro, giving them an export boost and a well needed shot in the arm. Germany may well complain that the competitiveness issue is not their fault and that reform is the key. There is no more room for reform though, as voters get more and more fed up of austerity.
You might well think at this point - well the ECB have just cut the rate to 0.25%, so surely Germany does not have that much control. You would be right in this regard. The rate of interest is set solely by the ECB, however with this rate already very low the incremental affect of each new cut is minimal. What the ECB really need to do is tear up the rule book and start printing money to really stoke inflation. This is where the German's hold the power, money printing is not allowed under EU law, and as long as Germany opposes this there will be no change here.
Let me explain why inflation will help. In Italy if you want to fire a worker you need to pay them 2 years salary, this means that Italian businesses, will try and hire as few new people as possible and are also unable to cut the people who are now earning too much money, for the work that they do. If inflation were to come in and rise at 2-3%, then the real cost of wages in Italy would conversely, fall by 2-3% per year, until such a point where they were once again in line with productivity. As productivity and wages become aligned, more workers could be hired easing pressure on the government and allowing them to then reform the labour market - they would make firing people a lot easier and cheaper - without having to deal with an already angry - and highly unemployed - electorate. People often talk about how Ireland regained its competitiveness, and we can say that this is thanks to the liberal labour laws in Ireland. People who cost too much were fired and either replaced with cheaper labour or not replaced at all. Archaic as this may sound, it is very important for businesses to be able to cut costs when times are tough.
Germany too has liberal labour laws, but controls its inflation and wage increases very carefully. This has meant that they have been able to continue to export successfully, even within the crisis hit Eurozone, where others have failed. German wages are comparatively very competitive vis a vis Spain and Italy and therefore they can export goods at a lower cost. They also have a very high end manufacturing sector where costs are a less important factor than skills or efficiency.
What needs to be done?
The peripheral nations should band together with the likes of France, and take the fight to Germany. They can reasonably argue that they have done all that they can to fix their economies and now need a boost in competitiveness. To achieve this they need a devalued Euro, inflation and for Germany to boost its domestic consumption i.e. buy more imports and sell less exports. Without these changes there will be no meaningful growth - not in the long term anyway. Growth is key as it reduces unemployment, reduces state spending and brings deficits back under control. Growth will also make the electorate more placid, and allow the less popular reforms to be pushed through, with less opposition from the people.
Should Germany stand defiant, then the peripherals should use the only negotiating chip they have left and threaten to leave the Euro. This if nothing else will make Germany stand up and take note. As we have already discussed a Euro with only the wealthier nations in it, would sky rocket in value. The countries that left however would enjoy greatly devalued currencies and would be able to export at incredibly competitive rates. A holiday in Spain would cost a fraction of today's price and Irish agricultural goods would be able to undercut any other big agri exporting nation. This decision would not be without its costs however, and therefore it would need to be used as a bargaining chip, rather than a giant game of chicken.
One thing is for sure, Germany thinks that this crisis will solve itself and they are wrong. The peripheral's have done as much as can be reasonably expected - while keeping voters onside - and it is now Germany's turn to acknowledge this and give some leeway. The fact that Germany is still in coalition talks makes it unlikely that there will be any announcement in the immediate future, but once the government is formed Merkel needs to reassess her view on Europe.
Conclusion
This blog has covered a lot of different areas, I looked at the last 5/6 years and tried to look at what needs to be done in the future also. A lot of this was done at 10,000 feet and I am aware that I skipped over some of the bigger topics i.e. inflation, costs of defaulting, labour laws and so on. I will try and come back to these individual topics in more detail in future blogs. There is no doubt that I have taken some liberties with my explanations in order to try and limit the length of the articles. Please do feel free to let me know your thoughts on this blog (all three parts). Thanks for sticking with me so far, and I hope you continue to enjoy going forward.
Cheers,
Andrew
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