Kash Mansori provides his take on competitiveness and the problems of Italy and Spain in a post on his blog „The Street Light“. He raises some valid points, but I still disagree on four aspects: data of the past, Germany’s central bank, Germany’s gain from being in the Euro and German policy during the devaluation.
1. Past data
You shouldn’t reason from past data on something that is almost entirely a forward-looking issue. Past budget deficits or current debt to GDP ratios tell you very little about the sustainability of debt. The future debt burden and the future capacity to pay are what matters.
Italy’s growth prospect is bleak, it hasn’t even started to devalue internally, it is ageing at a tremendous speed and it will have a huge debt burden; Spain has a lower debt burden, but had a construction sector equal to almost 1/6 of the whole economy, a banking problem of unknown size and a mind-boggling unemployment rate of 21%. The internal devaluation that lies ahead of Spain is gigantic.
This is not to say that Italy and Spain are necessarily insolvent, but doubts about their solvency are more reasonable than proponents of illiquid-but-solvent arguments usually admit, and Kash is not exception.
2. Germany’s central bank
Kash argues that Germany is not under bond market pressure because it has its own central bank. What he means is that everyone expects the ECB to backstop a fall in German bond prices and therefore they don’t fall. I am not convinced, at least for the current situation.
A sovereign default by Germany would be against very deeply rooted convictions of the German public. It is no surprise that Gemany introduced a constitutional debt brake based on a party-wide consensus at a time when nobody was talking about sovereign defaults in Europe at all. Germans hate sovereign debt and inflation, and markets know this. Moreover, Germany has already devalued internally and its growth prospect is not bad at all.
Thus, there are plenty of more obvious reasons for Germany’s current position on the sovereign debt market. They, admittedly, don’t fit so well with Kash’s overall position on the Euro crisis.
3. Germany’s gain from being in the Euro
Kash is a prominent voice that suggests that the Euro has benefited Germany before this crisis. For instance, he writes:
The core eurozone countries like France and Germany were in the driver’s seat when it came to setting up this system, and they were happy to take advantage of the common currency when it was to their benefit. They now need to recognize that the responsibility for fixing this mess should really rest largely with them.
And yet he seems to be aware of the fact that Germany had to painfully devalue internally over 8 years. Anyone else noticing the contradiction here? To paraphrase Kash’s statement: Germany benefited from the Euro before this crisis, and the periphery is benefiting now. Doesn’t make sense, does it?
So let us recap a few things here. First, the benefits of facilitated trade were shared by everyone in the Eurozone – not only, in fact not even to a larger extent as is commonly suggested, by an exporting nation like Germany. Second, the other countries consciously traded the ability of adjustment through their exchange rates for lower interest rates, the Euro was not forced on them. The responsibility of fixing this mess should rest with everyone who participated.
4. German policy during the devaluation
As Kash rightly points out, the internal devaluation in Germany happened under pressure. But this supports my argument: as I have said before, pressure is probably needed for a quick adjustment. The 2000 stock boom delayed German adjustment to some extent, and an unconditional liquidity support by the ECB wouldn’t help much either in that respect.
How, then, can we keep up the pressure on Italy and Spain when the ECB is committing itself to buy unlimited amounts of debt? Am I the only one who sees the difficult bargaining game here?
And can Italy and Spain pull it off, once they are forced? I don’t know and it surely is hard. But unless the answer to this question is an unequivocal „yes“, these countries are not solvent. Quite frankly, I am astonished that Kash writes that Italy and Spain are „quite clearly … the victims of a self-fulfilling illiquid-not-insolvent sort of crisis“. Nothing is clear about that.
Let me end with a Dani Rodrik quote from 2010, being asked what Spain needs to do:
First, expenditure cuts are not going to do the job on their own, unless accompanied by policies targeted directly at improving competitiveness.
Second, „structural reforms“ (which in the Spanish context means largely labor market reforms that aim to reduce firing costs and decentralize wage bargaining to the firm level) are not a substitute for competitiveness policies. Insofar as they eat up political capital, they may even backfire in the short-run.
Third, there are no easy solutions to Spain’s competitiveness conundrum. But the least bad solution is to engineer an economy-wide reduction in nominal wages and the prices of services (utilities, etc.) through some kind of social compact.
Easy? No. Any other practical alternative to a prolonged period of recession and high unemployment? Probably not.
That would be the kind of commitment or signal we need. As long as people keep telling Spain (Italy) that they are the victim of a self-fulfilling panic, that it is in fact Germany’s and France’s fault that they are where they are, and that it is Germany’s fault that the Euro crisis is not long solved, it will be harder to convince the people in Spain (Italy) what needs to be done.