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ASSA/AEA Annual Meetings 2012:
The experience, however, taught me a great deal, and it is a set of lessons on which I am still reflecting, because it made me realize that the narrative in which we are currently locked, not only in describing the situation in Greece, but in Europe, is doubly misleading and dangerously so. What I want to talk about today are those questions of whether or not, 1) the Greek crisis really is a Greek crisis; 2) whether the Euro crisis really is a Euro crisis; and then 3) try to project into the future, at least a sense of whether the Euro will survive, and how Europe will grow, and under what conditions.
You all know the stories about the Greeks. They’re lazy, they overspend, they over-borrowed, they paid no taxes, they didn’t work, they maintained a consummate socialist hostility to business in all forms. All you have to do is read Michael Lewis, oe The Wall Street Journal, or The Financial Times, or The Economist, not to mention Bilde or any of the other European tabloids that said far worse things than I’ve just listed.
Greeks got what they deserved because they ignored a Greek fable, that of Aesop, and the distinction between the Germanic and the Anglo-Saxon ant and the Mediterranean grasshopper.
Now here’s some very interesting data collected from the OECD, EuroStat, the ECB, and IMF: 1) Greeks pay more in taxes than Americans as a percentage of GDP, 5 percentage points more, in fact, than Americans pay. How could that be? you say. Because the Greeks collect their taxes in a distinctively different way, mainly through heavy Social Security taxation of wages on payroll, through a high VAT and excise tax system; but none of this is very progressive. The possibility of progressive income taxation on both individual and corporate incomes is in fact fraught with corruption and underpayment, so much so that we know that in Greece income taxes amount to about 4% of GDP; whereas in Europe as a whole it’s about 9%. So there’s a significant gap in terms of collection of income tax, but that’s not to say that the Greeks are not paying taxes. Quite to the contrary.
Secondly: We all know that the Greeks’ public sector is absolutely bloated, filled with hundreds of thousands of Greek workers, possibly the largest civil service in Greece. Wrong. The Greek civil service is about one-fifth of the total workforce, which puts it right dead spot on in the European average. It’s about a percentage point or two higher than Germany; it’s about 4 percentage points higher than the United States; but in numerical terms, as a share of the total workforce, it is not in fact bloated. There are efficiency questions, there are organization questions, there are a number of questions about the civil service that I could address, and believe me, I spent a lot of time in this area; but it is not a question of it being a bloated civil service numerically.
Greek government debt, we all know, was growing out of control. False. From the mid-1990s up until 2007, the Greek ratio of debt to GDP was about 100%—high to be sure, but quite stable over that more than decade-long period. Its climb up to 160% of GDP has come since the crisis that emerged in late 2008 and 2009, principally as a consequence of all the public funding that has been tossed to it by the IMF, the ECB, and the European commission.
Now I mention this—and, oh, let me mention a couple of other things: Greeks are lazy. Well, according to the OECD, Greeks work the longest hours of any population in Western Europe. Greeks are anti-business. Well, they have more entrepreneurs per capital than any other country in Western Europe, and in fact in some odd way they’re the Brandeisian ideal that Justice Brandeis wanted us to head back to: a nation of small shopkeepers, of small taverna owners, of micro firms. Fully a quarter of total GDP is accounted for by micro firms in the Greek economy. That’s employees of firms with employees of five or fewer. So you get a sense that what you have is almost a perfect Marshallian world, at least in terms of price takers versus price makers. This is a world built on small business. So not anti-business.
Greeks in aggregate, if you measure government, corporate, and household debt, didn’t over-borrow. In fact, household debt is below that of the European average, and corporate debt is substantially below that. Now that’s of course a function of the enormous number of micro firms who aren’t in a position to do extensive borrowing; but it makes the point that the aggregate of public household and corporate debt in total places it in the bottom quarter of European countries in terms of total debt to GDP.
So you say to yourself, well what then is the Greek crisis if it’s not about the ant versus the grasshopper, and the Greeks being lazy and overspending and over-borrowing. What I want to suggest is that the Greek crisis is more accurately described as the collateral damage, the road kill if you will, of the US’s deregulation of finance over the last 20 years, and its consequent blowup in 2008.
Greek banks didn’t themselves buy CDO’s directly. They were not caught in the downdraft when that collateralized debt obligation market; but they had followed their traditional pattern of lending heavily to Greek ship owners, to tourist complexes, and more recently, as the Greek economy has grown, to things like shopping centers. Greece is the third fastest-growing country in terms of shopping centers per capita in Western Europe. We can talk about that. But all of them are all deeply, cyclically sensitive sectors in the Greek economy. As you all know, global trade collapsed at a much steeper rate than actual declines in GDP as a consequence of the global meltdown, which you would naturally expect; but that idled huge amounts of tonnage of Greek ships, and it meant that the Baltic dry rate, which is the measure of shipping prices, prices that ship owners can expect, fell by almost 80 percent in the two years after the beginning of the crisis. So in other words, one of the two largest sectors in the Greek economy saw its ability to earn income absolutely collapse, and having nothing to do directly with the intrinsic qualities, or performance, or capacities of the Greek domestic economy; directly, instead, as a consequence of the global economy and the global economic downturn.
The same goes for tourism, which is roughly a fifth of Greek GDP. And what you get with tourism is a collapse of demand by German and British and Scandinavian households, which again is not a function of a change internal to the Greek economy, or mismanagement by the Greek economy, or anything intrinsic about the Greek economy itself; but rather a change in the situation of the European economy which is itself was functionally related to the collapse of Wall Street and the US deregulation of finance.
Now what we discovered very quickly after Papandreou took office was that the attention of finance turned to Greece in early 2010 with the realization in 2009 that for many hedge funds and bank trading floors, particularly the Big Four or Big Five banks, with the most massive investments in highly leveraged trading and derivatives, that there was no future, at least for the foreseeable future, in playing the US housing market in any way, shape or form. Securitization and resale of US mortgages was not going to be a growth industry for the foreseeable future.
What did seem very attractive at the beginning of 2010, however, were two areas: One was commodities in the Third World. And so you saw in 2010 rapid run-up in many commodity prices that seemed somehow oddly unrelated to the lack of global demand. There was some asymmetrical demand located in Asia; but it was being offset by fall-offs in demand in the developed West, both in Europe and in the United States. And the shift in total global demand was nowhere proportionate to the rise of commodity prices over that 2010 period.
The other was the emerging realization for some of these investors and traders that sovereign debt represented an opportunity. It had represented opportunities in the 1980s and 1990s at different points in Latin America and Asia; but for the first time in many many years, European sovereign debt became an opportunity to play markets by sorting government bonds and, as the traders began to realize as they looked more closely at these economies, and at the case of Greece in particular, realized how much of Greece’s government bonds were being held by the largest Greek banks. But Greek banks were another opportunity to short in the market.
Now I mention this not to try to pretend that there wasn’t something fundamentally, structurally challenging about the Greek economy. With these collapses in key sectors of the Greek economy, a lot of the loans that had been made by Greek banks to Greek ship owners, and to Greek hotel complex owners, and to Greek shopping center owners, were in fact effectively non-performing loans. And the Greek banks were highly reluctant to actually realize those non-performing loans, in part because in the shipping industry they had the history of cyclicality, and in tourism of cyclicality, and they thought, as banks often do, as creditors often do in these situations, that if they could only wait it out, things would get better. And in truth, looking over the medium- and long-term, that’s often what happens.
But what you have nibbling at the edges—traders in New York and London in particular, who are armed with a set of beliefs about the Greek economy and the Greek people; and you realize that what you’ve got is a situation of panic emerging among the Greek people themselves about what their future is, then the opportunity to play essentially on a panic option, to play a panic option based on a scarcity of information—because the Greek economy is not the most transparent in terms of ownership or a number of other features—became highly attractive. And the rate at which the Greek economy’s ability, the Greek government’s ability to borrow deteriorated, could be measured in a matter of weeks, beginning around Christmas time of 2009 going into the spring of 2008, and notably precipitated the first big rescue package by the Europeans and the IMF through a $110-billion Euro rescue package in May.
Now, there were a number of things that were positive about that rescue package, because in a sense it was part of pressure applied by outside sources on the Greek government and on the Greek population to undertake reforms that the Papandreou had wanted to undertake in the first place, and in which he had been elected. So they were broadly popular reforms to reduce the cost of Greek government, to lower exiguous wages and pensions in the public sector, and a number of other things. The pressure from the outside allowed him to go ahead with those reforms. And what was striking was that by the end of 2010, they had been able to reduce the government’s deficit as a share of GDP by 5 entire percentage point of GDP—more than any other country was able to reduce its government deficit as a share of GDP over that same time period. The United States and the United Kingdom that were running deficits the same order of magnitude have come nowhere close in the last two years to this level of reduction. And in fact, the IMF is estimating that going forward in 2012, the residual deficit is going to be composed almost entirely—in fact entirely—of debt servicing costs, of interest and repayment, because the Greek government has been able to maneuver itself into a position where it will run a primary balance that will either be even or start to go positive if some other conditions obtain.
Now what that tells me is several things, one of which is the idea that there are intrinsic structural problems to an economy, one that’s integrated as deeply as Greece had become in the European economy and the European economy had become in the global economy, means that it’s inappropriate for us as economists to continue trying to concentrate on national macro economies as the relevant frame of reference. Why is that important? Because what it leads us to in terms of understanding the fallout from this last great collapse of Wall Street is the attention that we need to give to global finance, and the lack of overall regulation of global finance, and the lack of even coordinative regulation among major actors in Europe and the United States, which would be the logical place from which to begin not only improved national standards of regulation, but a new era that essentially constitutes an era that might be shorthanded by the notion of the creation of a WFO, a World Finance Organization, that would begin to exercise national standards on a whole host of issues related to global finance.
Now the interesting thing about the Greek crisis was though that by the summer of 2010, even with this $110 billion Euro rescue package, the financial markets again heavily concentrated in London and New York, were probing, Portugal, were probing Spain, were probing Italy as much as they could, trying to test the idea that a nervous market could be stampeded against other sovereign countries as well too. And there were clear differences among the countries. For example, Italy had a fairly high level of total debt-to-GDP ratio; but it had a very high proportion of that debt owed to Italian nationals, which made it an entirely different situation from the one Greece was facing, where it had 80% of its outstanding debt owed to non-nationals. Okay?
But lost in the rising panic of 2010 was this idea that one could differentiate among these economies, or recognize that under what one might think of as normal conditions--that is, borrowing costs at something like the historical averages of the previous decade--that all of these problems that the Mediterranean countries were facing were by and large manageable over a five-to-ten-year horizon absent the role of panic in the financial markets that was being used as an opportunity to gain profit in the field of sovereign debt alongside the field of commodities in the absence of this hugely profitable but now vaporized market in US real estate securities.
Now, I turn from this to say that this is why I disagree with Rogoff and Rabini and even Paul Krugman, because I think that while we would never mistake them for the Three Musketeers—they have quite different views of the world—they have been unitary in this idea that the Euro crisis is the consequence of a fiscal mis-design, a structural from the very beginning that showed itself in the lack of any kind of coordinated fiscal integration to go along with the monetary integration represented by the Euro itself.
In fact, if you look at it, you see that the Euro did quite well for a decade, and that what we might want to posit is that the scale of the meltdown that followed, the crisis on Wall Street, was of such a magnitude that one can think of it as a century event even though the deregulation of finance suggests that it might be a decadal event if we don’t change the path that we’ve been on for the lat 15 years.
Why do I point to this? Because the idea is that there was nothing that was intrinsically wrong with the structure of the Euro even absent a common fiscal policy, and even with what amounted to fiscal guidelines, even though they were treaty obligations but were treated as guidelines, but again was not manageable within a context in which there was an absence of the recklessness of US financial markets over the previous 15 years. Because what you have to remember is that European financial markets have grown increasingly integrated with the US financial markets over these last 20 years to a degree that’s really quite extraordinary. We have enormous European banks, like Deutsche Bank and the big Swiss banks, operating in New York alongside Goldman Sachs, alongside Citi, alongside the B of A trading floors; so they themselves have been great initiators in this whole phenomenon of CDO’s and the real estate market; and they also turned, as any of you remember from reading Michael Lewis, in the case of German pension funds, into the suckers on whom were unloaded these terrible CDO’s. So you had them both in the terms of large financial institutions of Europe in a player’s role in this new Wall Street deregulated environment, and you had German pension funds and German individuals purchasing these CDO’s on the assumption that US markets were much better regulated than they in fact turned out to be. What were the Germans to know when three of the top American credit rating agencies were rating these bonds as triple-A in most cases. Coming from a land of law and regulation, they thought somehow, well, this must carefully vetted and tested.
So again, what I want to draw attention to is the problem with global financial market structures and away from the idea that there’s an intrinsic fiscal structural flaw—not to overshoot the case and say there is no reason for further federalization of Europe, or further integration of some kind of common fiscal policy that would better regulate the gap between countries in many cases; but to refocus economists’ attention on this great fact in the middle of the room of which we have stopped speaking by and large over the last couple of years; which is that Dodd Franke has not done the job yet, and may never do the job that one might have hoped would have been done in light of earlier eras of regulation by American government in earlier market collapses.
So what do I want to say from all of this? A few simple things: First, I think that there is a way out that we can already begin to see for Europe. The idea that Europe is on the verge of collapse, or the Euro system is on the verge of collapse I think is premature. You can see, for example, that just in the last few weeks the ECB’s willingness to step up and provide $500 billion-worth of long-term refinancing has already begun to bring down long-term notes of European rates in a meaningful way and short-term notes in what I’d call a dramatic way. So you have the ECB now finally beginning to discover that perhaps the Fed and the B of E know something about what a central bank is supposed to do, and perhaps they could learn from it.
You also can see that the EFSF and the EMF that’s going to follow very shortly [are] on a fast track in Europe to being both implemented and bulked up, if not to the steroidal levels of a billion-plus Euros that was being [?] in the summer, certainly being bulked up in ways that are meant to address specific problems from specific member economies that cannot go back into markets for sometime to find financing. Germany certainly economically has the capacity to increase imports from its fellow European member countries. And if there is a policy that one could encourage in Germany, it would be precisely that, and it’s one that can in fact be encouraged by the United States, the United Kingdom, and France as all part of this attempt to work Europe out of this crisis, but has not to date been a focus of much public attention, but should be.
I think there have also been meaningful progress on fiscal limits, even if coordinated around and not through [Masterick?]; and I could talk about those at some other time. But what hasn’t happened, again, is a confrontation with the terms of regulation of global capital markets. And it’s ultimately this unspoken issue and the unanswered questions that we need to face if we are to reconceive both the Greek and the Euro crisis in a way that’s useful to us analytically as economists, but more importantly, useful to citizens in Europe and the United States going forward.
So just briefly—and this will be less than a minute—what Europe needs: Better financial market regulatory institutions. In particular it needs to back away from following the US and the UK down this path of weak regulation or strong deregulation.
It needs to reemphasize the role of banks versus securitization as a source of financing on which there are a number of ways to do this; but in the last 25 years, banks have declined from 75% to 40% of total financing in Europe. Again, regulators have the power to shift those numbers back toward those older directions.
There’s a fatal reliance on US credit rating agencies, and the Europeans have talked now too long about moving toward a public European credit rating agency; but it is certainly something that could be done.
There’s still no significant limit on offshore hedge fund operations on the purchase of European securities, but the Europeans do have the power to implement that and to force the Americans to come to terms with the need for American oversight over the hedge funds, which are predominantly American and, to a lesser degree, British.
Finally, there’s a very incomplete effort going on around tax fraud and money laundering in general. As I’m sure you all know, the Germans, the French, and others, even conservative governments, have increased the pressure in Europe on Switzerland and Lichtenstein for the simple reason that these governments need revenue, and it isn’t a question of conservative versus liberal or socialist government; it’s that governments need revenue, and they’re losing too much of it to these tax havens and tax fraud opportunities. And there is plenty of opportunity for greater coordination among the countries of Europe to apply pressure, not just to European centers of tax evasion, but to offshore centers that remain outside the grip of the Europeans as long as the Americans and the Brits refuse to cooperate with them. But this is a politically potentially powerful subject of multilateral negotiation.
And then finally, we need to do something about the monitoring of derivatives, particularly because we live in a world in which the global GDP is somewhere around $60 trillion, and the notional value of global derivatives is around $600 trillion—ten times the sum of all the GDP of the world. And most of this is concentrated in currency and interest rates, and has in different forms very damaging effects on the ability of the ECB or of national governments to maintain their own fiscal and monetary policies, for no apparent reason, given that the initial argument, that derivatives in general were meant to make markets more efficient, have to answer in part to what happened over the last three years.
So thank you, very much.
Economists for Peace and Security