Eurosceptics do it better

euroscepticism On December 28th, there was an article in the Opinion pages of The Daily Telegraph that must have filled the hearts of most British eurosceptics with hope. In it, Leo McKinstry argued that “the EU is in desperate trouble”, for its “edifice of federalism is crumbling, broken by its own ruinous contradictions and spectacular failures”: the single currency and the economic policies it implies have, McKinstry writes, created a “political fallout” in countries like Italy, Greece, Portugal and Spain, where extremist parties have earned an ever greater support from the electorate; and the migrant crisis, he warns, is “threatening to tear apart the social fabric of Europe”, as “fiercely anti-immigration, anti-EU movements like the Front National in France, the Dutch Party for Free and the Swedish Democrats” also attract more and more voters.

Optimists and Europhiles might read these words and take them to be nothing more than gloomy wishful thinking to be expected from the reactionary Telegraph. But the same could hardly be said of The New York Times and its Sunday Magazine, which – in its December 20th issue – wondered whether the EU has “reached its breaking point”: Jim Yardley, the publication’s Rome bureau chief, noted how Europe is facing the simultaneous threats of terrorism in its cities, of an aggressive autocratic Russia in its periphery, of the migrant crisis in its borders, while a stagnant economy and a rising political extremism in countries like France and Belgium are rotting their democracies from within. And to complicate things further, Yardley argued, the EU is particularly ill-suited to deal with such issues: “European Union institutions have vast regulatory powers over everything from data roaming to environmental standards to trade deals to antitrust rules”, but “often lack the structural power, political decisiveness and bureaucratic efficiency to act collectively when faced with big, unforeseen problems like the Greek crisis, the surge of migrants or the standoff with Putin over Ukraine. National leaders are often forced to decide these issues in marathon emergency meetings in Brussels at the European Council, and even then, only incremental progress is made”, producing “a perfect recipe for public cynicism: a system of intrusive regulators whose tentacles can spread into your personal life, even as leaders appear indecisive in the face of genuine crises”.

And yet, in Brussels, no one either is aware of these problems or seems to care. On the last December 11th, The Guardian reported that the EU Commission was devising plans to “to strip national governments of authority over their borders in an emergency and to create a border guards force to police the EU’s frontiers, supervise asylum claims, and detain and deport failed asylum seekers”, in response to the refugee crisis. As Ian Traynor, the report’s author, explained, while “in theory, the new regime and the powers ceded to Brussels over its operation apply to all 26 countries in Europe’s free-travel Schengen area”, it would, “in practice”, only “apply to the external borders of the Schengen area, so would not greatly affect countries such as Germany that are surrounded by other Schengen nations”.

In other words, some countries – Italy, Greece, Spain – would be subjected to policy decisions taken by other countries – Germany, Poland, Austria – that would not bear the brunt of their consequences. Perhaps these plans won’t ever be put into effect, once the lawmaking process in Brussels stalls and indecision takes over. But the mere fact that people with responsibilities within the EU came up with such an idea is a sign that “euroenthusiasts” have failed to grasp what the events of the last decade or so should have made clear to them: that the EU has gone too far in the political “integration” of its member states.

Since its conception, the “European project” was meant to bind the countries that joined it in such a manner that going to war with one another would never again be in their interest. It began by pooling together the energy resources of France, Germany, Italy, Luxembourg, the Netherlands and Belgium within the European Coal and Steel Community. And it grew, not only geographically (with the multiple enlargements taking in new members) but in scope, with consecutive advances in transferring powers and (in “Eurocrat” parlance) “competences” from national states to Brussels. After all, the “project” was always meant to achieve an “ever closer union”.

“Europe’s” founders, however, understood how that process should only be carried out by way of “small steps”, to ensure that none of those ever jeopardized the fundamental interests of the club’s membership. But from the 1980’s onwards, with the European Single Act and the road towards the 1992 Maastricht Treaty – and later culminating in the Lisbon-Treaty-Formerly-Known-as-The-European-Constitution, that prudent outlook was discarded.

And so it was that, for the last 30 years, the “steps” taken by “Europe” have been too great, both in quantity and in length. The increasing number of policies subject to qualified majority voting and of powers transferred from national parliaments to the “Community’s”’ sphere meant that in a growing number of issues the various countries of the EU have lost the power to defend what their electorates believe – rightly or wrongly – to be their own national interest. The result, aside from weakening the health of each nation’s democracies, was to change “Europe” into a conflict-generating machine between the various European countries, instead of the peace-building institution it was meant to be.

Back in 2003, just as the “Union” became far from united on whether to side with the Americans on their intervention in Iraq or not, Valery Giscard d’Estaing and the other proponents of the “Constitution” kept pushing for a Common Foreign Policy and a Common European Army. At the time, the Portuguese columnist José Pacheco Pereira wrote an op-ed piece warning that if such plans were brought into effect and a situation like the dispute over the Iraq war would arise, what in 2003 was a simple difference of opinion between sovereign countries with diverging interests, would by that point turn into an institutional conflict within the EU, leading to its disintegration and possibly worse.

Looking back, it’s easier to see that Pereira didn’t need to imagine such a scenario. There already was – and still is – one not-merely-hypothetical-but-very-much-real factor bringing discord into the “Union” and threatening to pull it apart: the Euro.

What happened with the EU’s single currency was exemplary (albeit in the worst sense the word can have) of the problem. It was born, as most things in “Europe” are, out of a bargain between France and Germany, in which the former supported the latter’s unification, and Germany gave up its old currency and at least some control over its traditionally tight monetary policy. It allowed for a gigantic leap, symbolically and practically, towards a true “European Union”, a political entity with powers previously intrinsically linked with national sovereignty. What it created, however, was far from the harmonious and free-from-nationalist-and-self-interested-feelings space from Monchique to Cape Greco and Limassol to Nuorgam in which everyone would join in singing the “Ode to Joy” in multiple languages but in tune and in unison.

By joining within the same monetary area economic realities so distinct as to make them have incompatible economic policy needs, the Euro meant, on the one hand, a currency undervaluation in Germany with the corresponding loss in value of its citizens’ income, and on the other hand, a currency overvaluation on countries with less competitive and attractive economies (like Greece or my native Portugal), posing significant obstacles to those who, unfortunate enough to live in them, wished to export goods or services that could otherwise have benefited from a weaker currency that would make them more appealing to holders of stronger currencies.

At the same time, and to make matters worse, the euro created a bubble in those countries’ sovereign debt bonds: comfortably seated under the same monetary umbrella that sheltered Germany; theoretically obliged to meet certain budgetary criteria aiming to protect the euro’s stability; and with the implied promise that, should things unravel, the simple fact that they shared a currency would make countries like Germany pay for the solvency of countries like Portugal, Greece or Italy; these countries were able to borrow money for German-level interest rates, while following Greek-style budgetary policies. Once the subprime crisis in American crossed the Atlantic, it didn’t take long for the monetary umbrella to become powerless to shelter them from the fears of their creditors.

Once Greece or Portugal were on the brink of bankruptcy and had to be bailed out, the need to do so without jeopardizing the euro’s credibility as a stable currency created the terrible combination that has brought us to our current predicament: paying for the “bailout packages” by the richest countries angered their voters due to their perception that they are paying for the “sloth” and “profligacy” of the other countries; in Greece or Portugal, the “harsh” measures and the loss of budgetary autonomy inherent to those packages and the EU’s Budget Treaty made their electorates despise the “lack of solidarity” of the “austeritarian” rich; and the solutions that might help overcome the worst economic and financial consequences of this arrangement – a deeper economic and political integration, with Eurobonds, euro-wide welfare benefits, and new and wider “competences” over national budgets given to the (undemocratic) EU institutions – would end up worsening not just the problem of the lack of democratic control of political decision-making, but also – especially – that increasingly serious “war of electorates” created by the way the euro and the EU were designed.

One thing “euroenthusiasts” are not able to say is that they hadn’t been warned. For exemple, in 1997, the Nobel laureate in Economics Milton Friedman famously wrote an article in which he argued that the Euro would be a huge mistake: The EU, Friedman argued, lacked the prerequisite attributes that would allow for a sensible adoption of a common currency between its member states:

“Europe’s common market is composed of separate nations, whose residents speak different languages, have different customs, and have far greater loyalty and attachment to their own country than to the common market or to the idea of “Europe.” Despite being a free trade area, goods move less freely than in the United States, and so does capital. The European Commission based in Brussels, indeed, spends a small fraction of the total spent by governments in the member countries. They, not the European Union’s bureaucracies, are the important political entities. Moreover, regulation of industrial and employment practices is more extensive than in the United States, and differs far more from country to country than from American state to American state. As a result, wages and prices in Europe are more rigid, and labor less mobile. In those circumstances, flexible exchange rates provide an extremely useful adjustment mechanism.”

Adopting the Euro, then, Friedman warned, “would have the opposite effect” of what its advocates intended:

“It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.”

And Friedman was far from a lonely voice. Today, as the EU and its various member states face the refugee crisis and its political consequences, it would be wise of them to mind the lesson of the euro cautionary tale: sometimes, Eurosceptics do it better; sometimes, a healthy dose of Euroscepticism is exactly what “Europe” needs if it wants to be healthy. The EU was a stabilizing element in the European continent for decades because it served the interests of those who’d joined it. By taking too many steps too far towards “an ever closer union”, those countries lost their ability to protect those interests. And by making itself unable to serve its members’ interests, the EU is making it ever more likely that one day, those countries will no longer be interested in being a part of it.

 

Bruno 2014Bruno Alves lives in Caxias, Portugal, but sometimes wishes he didn’t. He writes about politics, film and TV for O Insurgente, is an op-ed contributor to the Lisbon daily Diário Económico and a weekly commentator for its cable TV channel ETV, and has written for the American online film magazine Bright Wall/Dark Room and for the British website CapX. Bruno welcomes both writing job offers and insults at alves.bm@netcabo.pt, and you can also find him on Twitter @ba_lifeofbruno.

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The Red Threat strikes again?

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After losing the general elections that took place last week, the Socialist party seems determined to get the hold of power through unnatural coalitions with other left-wing parties. If you’re from the North of Europe this won’t sound that obnoxious. After all, countries such as Denmark or Finland have been governed by grand coalitions including parties from the left to the right. Except for one relevant detail. The coalition the Socialist party is proposing involves a trotskyist and a marxist-leninist party that have been very blunt regarding the role of Portugal in the Euro and in the European Union: out.

Now, even if they drop these radical proposals, thereby reducing the ideological distance to the Socialist party (which, after all, endorsed joining the EU and Euro), there will still be consequences. As part of the bargaining that is taking place, they may well demand disastrous conditions for giving the green light, possibly generating turmoil in the markets or in any reasonable person for that matter, at least one who remembers the outcome of radical left-wing experiments.

There is plenty of reason to worry. It takes a lot of time to push important reforms, and it took significant effort from the Portuguese people to put their public finances back in shape again. And all it takes, as Greece has witnessed, is a couple of months to throw it all away. This could well do it.

“The coming political crisis in Portugal”

Our co-author, Bruno Alves, for the British site CapX:

The country’s democracy has entered a vicious circle of which it will be immensely difficult to get out: as more and more regular voters mistrust politicians of any party, the more those politicians depend on the support of those groups that are opposed to the very measures that could help out the rest of the population, thereby provoking higher levels of dissatisfaction with the work of politicians, making them increasingly dependent on the support of those who vote for them no matter what or are a part of their particular clienteles, further marginalizing everyone else, and so on and so on, forever and ever.

The coming election won’t just likely end up in a hung parliament. It will also signal how Portugal is facing a severe – if slow-burning – political crisis, in which the country itself, not just its Parliament, will be left hanging out to dry.

Read the rest here.

The only way out is out

After so many hardships, battles and fighting that Ulysses [Odisseu to our greek friends] had to endure while returning from the War of Troia, the most challenging one was resisting the enchantments of the Sirens. The Sirens were charming women that allured the crews, attracting their boats to the cliffs and rocks so as to wreck the ships — the calls of the Sirens were nothing but fantasies, albeit their consequences were real. The tragedy now taking place in Greece is an obnoxious remake, in an Italian neorealistic style, of Homero’s epic poems.

Drained of all energy and exhausted, as were the sailors returning home from the battle, the Greeks gave in to the Sirens. They surrendered to demagogy and populism. They conceded to the false promises of an end to austerity. They succumbed to an utopian future requiring no effort and no sacrifice, no stoicism their ancestors once so proudly embraced. Only the Europeans taxpayers money, with no conditions or obligations whatsoever — or so go the chants of Syriza’s Sirens.

And the boat has sunk. In less than 6 months, Greece has shifted from a steady situation, although modest, of a growing GDP and primary surpluses to economic and social chaos. Hundreds of pensioners lining up in front of closed banks. Capital controls, if not fleeing. Wages and pensions in risk of not being paid. An economy stalled by uncertainty. Tsipras & Co. have shown the bad can still get ugly.

As the Greek crise unfolds, its the resolution that will leave a mark in the European project, but in a way opposite to what has been suggested so far. It’s Greece staying in the Eurozone, and not the other way around, that would open a dangerous precedent, creating a moral hazard. In particular, it would prove that a populist approach, false promises and breaking the rules of a common project are effective negotiation tools. Having opened the Pandora box, what would prevent the other Eurozone countries from adopting a similar stance whenever a given rule is not in their particular interest? If you can question the keystones of the European project, what would prevent Podemos or the National Front from raising them? It is by staying in the Eurozone, and not by leaving, that the European project is ought to be severely damaged.

Although I’m not particularly fond of a Grexit, I reckon its imperative. Greece should exit the Eurozone in order for the European project, in all its dimensions, to stay afloat. An exit may be convenient to all parties. It suits the remaining Euro members, in this way closing the door to a terrible precedent that would give legitimacy to positions of clash. But it befits Greece in particular, as more importantly than money and a debt relief, they are in need of an extensive economic reform plan that could help them regain competitiveness, in this way putting an end to debt-addiction. Unfortunately, it is politically easier to get some of that competitiveness back by cutting wages and pensions through inflation and currency devaluation other than through tough political reforms. It is easier to maintain budget deficits by printing money, monetizing them. It is easier to lower prices (relative to other countries) through currency devaluation instead of promoting structural reforms that help companies become more efficient. It is easier to keep the vices, the clientelism, the chaos and the false promises than to get rid of them.

Such proposals are nothing but a concealed form of austerity on steroids, making it harder to protect the most vulnerable. However, they are easier to accept, especially when the Greeks have fallen to the tunes of the protonationalist tale of «it is us against them». Another Siren song that has never ceased to play the trick on the populations. History repeats itself. Not by misfortune but rather by oversight.

Greece: reminder – how did it all start

Greece joined the Eurozone in 2001. From that moment, it had an amazing growth. While other countries, like Portugal, went through a “lost decade”, Greece saw its GDP grow by 32% in 7 years. In the same perio, Portugal’s GDP grew by 9% and Germany’s a little more than 11%.

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With this GDP growth came a tremendous growth in wages. Between 2000 and 2007, wages and salaries grew by an astonishing 75%, almost triple the growth in Portugal and 10 times more than Germany.

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With the salary growth, greeks increased their standards of living. In these 7 years, consumption grew by 33%, while in Germany it stagnated and in Portugal it grew by a third.

consumption

How was this increase in standards of living possible? There was no technological revolution in Greece, there was no influx of international investment like in Ireland and no natural resources were found in the Mediterranean. This was achieved thanks only to an extraordinary increase in public debt, a big portion of it masked in the official accounts. It was like Portugal, but on steroids.

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So, we are in 2008, the Greeks had increased their standards of living like never before. But that increase in standard of living had only been achieved thank to a significant economic distortion. That high standard of living was only possible as long as there was someone available to loan the money required to keep it. A big part of the economy only existed thanks to the high level of public spending fueled by external debt. When the state would stop being able to fund itself, that share of the economy would simply disappear.
That is what happened in 2008-09.

(source of data in charts: Eurostat)

On Debt and Taxes

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The cover piece of last week’s The Economist concerned what it called “subsidies” that encourage borrowing, stating that these are a dangerous flaw at the heart of the world economy. The article is misguided in its objective, its reasoning is flawed – in some cases outright fallacious – and some of its underlying principles are simply outrageous.

The Objective

The stated objective of The Economist’s piece is to make the case for eliminating incentives to excessive leverage that undermine the financial system. This ignores the simple fact that the system’s instability stems from its design rather than from the amount of credit it grants. Over the last hundred years, the total leverage of the financial system – particularly banking – has increased constantly as required reserves progressively decreased; to the point where at the beginning of the ongoing crisis many of the world’s largest banks, especially in America, had reserve ratios close to 2%. This contrasts with ratios of 25% at the end of the 19th century and 10-15% throughout most of the 20th century. Other developed economies had ratios as high as 20% as recently as the 1960’s. Modern regulatory requirements changed the focus from required reserves to risk adjusted capital requirements. As the article itself mentions, these requirements have been reinforced during the crisis, although still only a fraction of what reserve requirements were before agreements such as Basel came along. Like with tango, it takes two parties to make a loan agreement. If banks are providing too much credit to the point of becoming unstable when payment defaults rise, this is a consequence of their ability – by design – to do so. As Viral Acharya and Julian Franks noted in their 2008 article on the role of government guarantees, the banking system became complacent with its internal perception of its own risks and failed to adequately budget its required return on capital. It did so at its own peril, that of its shareholders and also of taxpayers asked to bail out failing banks. Failing to recognise this reality will not help bring stability back to the sector.

The Reasoning

The main flaw in The Economist’s reasoning is in considering interest deduction in taxes for corporations as a “subsidy”. The favouring of interest in capital structure is a result of the corporate tax. As interest is an expense of doing business, the higher the corporate tax rate, the higher the tax shield. But this is not a “subsidy”. If corporate profits were wholly taxed at the time of dividend distribution, the incentive from tax shields would be zero. Also, this view that tax shields incentivise excessive leverage are a rather naive and narrow take on the Miller-Modigliani theorem. The reality is that too much debt increases the risk to shareholders therefore raising the required return on equity. This acts as a break on the incentive for leverage. As already noted, if a firm going under from too much debt puts pressure on the financial system, this is a result of too little capital or reserves of banks. The system should withstand the normal failures of over indebted corporations. If we’re going to be so radical as to try to orchestrate a fundamental change in corporation tax all over the world, then it would be much better to tackle it from the perspective of eliminating double taxation and simplifying the tax system by taxing shareholders rather than firms.

The second flaw is conflating this issue of corporate taxes with tax incentives for mortgages. While a case can be made against interest deductions in mortgages, the truth is – as The Economist itself recognises – that home ownership statistics are relatively indifferent to the ability to deduct mortgage interest in the personal income tax; that is, countries with no tax breaks have similar home ownership rates to countries that have them. Again, in view of the article’s objective of bettering the financial system’s stability, it’s safe to say that episodes such as the sub-prime crisis were little or not at all created by the existence of these tax breaks. So many other factors, widely discussed and dissected during the last few years, contributed heavily to the crisis, that focusing on mortgage tax breaks seems pointless.

There are other, smaller, flaws. For example, the piece states that most of the tax breaks accrue to the wealthy, therefore increasing inequality. But at the same time it says that house prices are higher because of the distortion. Now, while wealth inequality will be nominally higher with the breaks, due to higher prices, the net effect should actually be reduced disposable income inequality from the same cause. You can’t have your cake and eat it. If the wealthy are overpaying for their property, they will be worse off in terms of their disposable income. Also, their increased wealth will be illiquid and prone to crashes. We should be careful about measuring wealth inequality in both paper and housing bubbles.

The Principles

This is where the article becomes jarring. The whole piece focuses on forgone government tax receipts due to the tax shields and breaks. It goes as far as comparing the forgone taxes to government spending items, basically assuming in its argument that those potential revenues were the government’s to begin with, to spend where it saw fit. From a supposedly economically liberal newspaper, this tax and spend attitude is surprising, to say the least. Government “need” doesn’t give a blanket moral license for iniquitous taxation. Changing the way interest – as a business expense – was always deducted when calculating taxable profits is so dramatic a shift that a through moral justification is required. The Economist fails to provide one. The financial arguments are flawed, the behaviour incentive arguments are patronising and the government “need” argument ridiculous. On the other hand, while reasonable, the issue of eliminating mortgage interest deductions in personal income taxes is not obvious. The rationale for these breaks is not weak. In the presence of property and capital gains taxes, differentiating between home buyers according to how they finance their purchase is a compelling argument. To reverse the present system requires also a compelling argument.

Another banking scandal coming up

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After the noisy fall-out of Banco Espírito Santo, the largest private bank at the time, another bank is near insolvency in Portugal. This time is Banco Montepio, the banking holding of a mutual savings organization. The claim is made by an expert in banking insolvencies: João Rendeiro, the founder and ex-chairman of BPP, a small bank that has also been liquidated back in 2010.

According to João Rendeiro, the bank needs more than a billion euros capital injection that the mutual savings organization’s member are incapable, or unwilling, to provide. The Portuguese Central Bank has already requested a change in the top management of the bank. The proposed new leader of the bank is no one less but the finance minister that led the country in the years before 2011 bankruptcy and requested Troika’s support.