Ricardo Cabral – Assistant Professor at Economics and Management Department at the University of Madeira, Portugal
MAYBE AN EUROPEAN NEW DEAL, BUT NOT JUST QUITE THIS ONE
«I agree with the evaluation of the situation by Yanis Varoufakis, whose main points I would summarize as: (1) Austerity policies are counterproductive, self-defeating, and not grounded on sound economic analysis of data and alternatives (instead, these policies are based on ideology); (2) Unilateral transfers from euro-area surplus countries to deficit countries are not politically acceptable in surplus countries; and (3) The main EU policy makers are incompetent and stubborn: they failed to timely identify problems in the EMU architecture; and when the crisis stroke, they designed and implemented costly and irrational adjustment programs which aimed to keep the status quo going, i.e., to avoid any type of meaningful change to the architecture and functioning of the EMU. I also agree with the author’s argument that proposals must be “realistic”, not “grand schemes” and that crisis resolution cannot wait for federation. However, I see Varoufakis, Holland and Galbraith’s “Modest Proposal” as a grand scheme: it is too elaborate, complex, and requires changes to the EU Treaty, namely regarding the ECB role. While I like two of the policy measures proposed, I have the following criticisms:
(1) All of the 4 policy measures proposed have effects akin to fiscal transfers between surplus and deficit countries. It is only the case that the policies are too technical and convoluted to be perceived by the public opinion as outright fiscal transfers. But I think it is disingenuous to argue that fiscal transfers are not possible in the current environment and then propose policy measures that implement such transfers in an indirect form. EU policy making going forward has to change. It must be based on truth-telling, even if unpleasant. I do not think the “Modest Proposal” policies meet this treshold. The resolution of the euro crisis requires substantial transfers between surplus and deficit countries. The challenge is to design policies that are honest about this fact and that are still acceptable to the constituencies in surplus countries.
(2) The four “Modest Proposal” policies may be too small to be effective, and are to a large extent tweaks to the current architecture: (a) The eurozone currently faces the largest balance of payments and external debt peacetime crisis the World has ever seen. The author does not provide enough details about the 4 proposed policies. Nonetheless I infer from the text, perhaps incorrectly, that the policy with the largest macroeconomic impact is the “limited debt conversion program”. The macroeconomic savings from this program can be quantified, under some assumptions. If only medium and long term debt is converted to ECB bonds, achieving interest rate reductions of 3 p.p. on this debt, this would amount to fiscal transfers of 1,8% of GDP per year to the deficit countries governments’. But the overall effect would depend on whether the ECB would continue to provide low cost funding for these countries’ banking systems through TARGET2 lending. Note that national banks currently buy national public debt which they then offer as collateral to the ECB. Thus, the fiscal transfers already occur, but the difference is that currently fiscal transfers benefits private banks in the deficit countries, while the authors’ Modest Proposal sees these transfers benefiting the deficit countries’ governments directly. (b) An EU Investment Program led by the EIB and the EIF is a bad idea and is not sufficient given what is required. It is putting the lender in charge of the investment. The EIB has done that for a number of years, and their only worry is to make sure they can retreat graciously (without losses) if they make bad lending decisions, which they do far too often. They have shown little regard to the economic value of the project or the economic consequences of their lending decisions. In contrast, in my view, the investment program should be based on a budget, meaning that the EU investment program should based on projects that are only pure investment decisions and not joint investment- and lending-decisions.»
YANIS VAROUFAKIS’s response: Glad to see that Ricardo Cabral agrees with our diagnosis but slightly baffled by his assessment of the Modest Proposal’s policies as simultaneously too “grand” and “too small to be effective, and … to a large extent tweaks to the current architecture”. I believe they are neither, falling well within the category of pragmatic, necessary and sufficient interventions to stem the Euro Crisis. They are, contrary to Professor Cabral’s assessment, exceptionally simple to explain to the public: The ECB helps with the debt crisis, the EIB-EIF gives Europe’s economy a boost, the ESM cleanses the banks and breaks the umbilical cord tying them up with national governments (under the ECB’s supervision), and the TARGET2 accumulated interest (itself a byproduct of the Crisis) help feed Europe’s hungry and meet some very basic needs).
There are two other major disagreements between us. First, it is not true that a treaty change is necessary in order to allow the ECB to issue bonds as part of our proposed limited debt conversion programme. Current treaties and the ECB’s charter ban monetization; i.e. printing money on behalf of member-states or opening credit accounts with the ECB on their behalf. They say nothing about the ECB acting as a go between money markets and member-states, which is what we propose. Secondly, Professor Cabral is right to say that the Modest Proposal cleverly introduces several surplus recycling mechanisms into the Eurozone, by which to solidify it and help it develop its immunity toward the various crises afflicting it. But he is wrong to say that any of these recycling mechanisms constitute fiscal transfers. They simply do not. Lastly, his take on the EIB’s track record is not reflected in reality and, indeed, out of step with the EIB’s own bond yields!
STUART HOLLAND’s response: (Professor Cabral’s text in quotation marks)
“All of the 4 policy measures proposed have effects akin to fiscal transfers between surplus and deficit countries.” No: they are aimed to recycle global surpluses of which there are $2 trillion in global pension funds alone which are seeking but not gaining investment outlets.
“The four Modest Proposal policies may be too small to be effective, and are to a large extent tweaks to the current architecture.” No: After gaining its wide social and green investment remits in the Amsterdam Special Action Programme , the EIB quadrupled its investments from 1997 to 2008 and, if co-financed by the EIF issuing € bonds, it could do so again from now to 2020, which is the target date to achieve the EU’s European Economic Recovery Programme. This would give some €180 bn (current € 45bn x 4) plus matching co-finance from the EIF (another €180 bn) which is €360 bn or the equivalent three per cent of current EU GDP plus investment multipliers of up to or more than 3, totaling over €1 trillion.
“Note that national banks currently buy national public debt which they then offer as collateral to the ECB. Thus, the fiscal transfers already occur.” No: these are debt transfers not fiscal transfers, and not between countries rather than between national banks and the ECB.
“It is putting the lender in charge of the investment. The EIB has done that for a number of years, and their only worry is to make sure they can retreat graciously (without losses) if they make bad lending decisions, which they do far too often. They have shown little regard to the economic value of the project or the economic consequences of their lending decisions.” This is wrong. It was governments which decided to extend the EIB’s remit at Amsterdam to invest in the cohesion areas of health, education, urban regeneration, the environment, green technologies and support for SMEs. The problems for the EIB that occurred from the Eurozone crisis were not unsound investment projects but lack of national co-finance as member states cut debt and deficits.
“(T)he investment program should be based on a budget, meaning that the EU investment program should be based on projects that are only pure investment decisions and not joint investment- and lending-decisions.” Professor Cabral seems not to have noticed either the profound, and in our view unneeded, reluctance of surplus country taxpayers to bankroll the rest of Europe but that, for the first time, the EU’s budget has been cut.
Emanuel Augusto dos Santos – Economist, Bank of Portugal
A KIND OF NEW DEAL MAKES SENSE
«Prof Varoufakis ideas on the economic consequences of the austerity imposed to the European peripheral countries are right. It doesn´t help to restore fiscal consolidation, on the contrary, Greece and Portugal are there to show that in spite of the austere fiscal measures implemented government debt has always increased. The problem is that the multiplier effects of spending cuts or rises in tax rates have been underestimated and the Greek and Portuguese economies came into a recession deeper and deeper. Quoting Paul Krugman, there is no reason for deflating the economy. Was there a locust invasion or so? I can assure (at least in Portugal) there wasn´t such a plague. Then all we need is a sound economic policy including some of an old-fashioned (for some economists) aggregate demand management. Neither Greece nor Portugal were devastated by the bombs of a terrible war so they don´t need a Marshall Plan. Of course, a kind of New Deal for all the Europe makes sense in light of the present weakness of aggregate demand. However, the financial and government debt issues should be, all of them, seen in the European monetary policy framework with the the role of ECB as central in this context. Never forget the basic principles of economics, as it stands now, the European Monetary Union is uniquely a fixed exchange regime for all the euro-zone countries. Think now about the consequences of such a regime for national economies with very different levels of competitiveness. Any solution for the crisis in Europe should address this inescapable economic issue.»
YANIS VAROUFAKIS’s response: Quite. The Eurozone, as it now stands, is Europe’s Gold Standard: a fixed exchange rate regime lacking the surplus recycling mechanisms that can help it survive our generations’ 1929 (i.e. the Crash of 2008). The Modest Proposal suggests simple, legal ways in which the missing surplus recycling mechanisms can be introduced today, without federation, Treaty changes etc.
Júlio Marques Mota – Faculty of Economics, University of Coimbra, Portugal
A MINIMUM PLATFORM
«Inside that frame the admissible scenarios are so many Dantesque that we think preferable another route, a change within the euro area and therefore also a change in the European Union. And, here we are in complete agreement with Yanis Varoufakis, Stuart Holland and James K. Galbraith on the Investment-led Convergence and Recovery Program, a kind of New Deal for stricken European zone. And, we take this as an ideal platform to find a way to end this downtrend spiral. It should be noted that compared to the disaster, it is even a minimum platform and still within the framework in which this problem has arisen, within the framework of existing European leaders’ thought. So, full of limitations regarding the political context in Europe in general and Germany in particular.»
YANIS VAROUFAKIS’s response: Indeed, this was our aim. A minimalist program for helping end the downward spiral and giving Europeans a chance to think about our shared future, liberated from the fear of disintegration.
Uwe Bott – founder and principal of Bott Consulting, located in New York and contributing Editor to The Globalist
THE SOLUTION IS TO FIND AN EXIT STRATEGY
«I agree with the analysis of the authors as to the shortfalls of efforts made by the troika in resolving this crisis. However, I disagree with the potential that they see in their proposal. Frankly, their proposal represents nothing else but to “re-arrange the deck chairs on the Titanic”. There will be no resolution to this crisis until European policy-makers come to grips with fundamental economics. The Eurozone never was and less and less is an optimum currency area. In theory the flaws in the construct are fixable, in reality there is not enough time or political will. It is the inescapable consequence that the Eurozone must be dissolved. In applying the lessons of German unification onto the Eurozone, it becomes unmistakably clear that even a willing Germany could never pay the price to make monetary union in the Eurozone work. The price tag for such exercise would be exponentially greater than the cost of German unification. Moreover, the ability to freely migrate in order to mitigate some of these problems simply does not exist in the Eurozone given cultural and language barriers. So, the solution is to find an exit strategy. Cyprus is a good test case. For all practical purposes Cyprus is no longer in the Eurozone. It no longer meets any convergence criteria and with capital controls in place a Cypriot euro does not carry the same value as a German euro. Even without capital controls the inherent value of the euro as determined by interest rates differs in every member state today. Now, Cyprus has made all the sacrifices of leaving the euro without any of the benefits, i.e. a devaluation of its “own” currency and the freedom of implementing monetary policy specifically suited to Cyprus. Monies will be required to finance an orderly dissolution of the Eurozone, capital controls will be necessary throughout much of Europe and there will be bank failures. Massive sovereign defaults will also – in the short term – weigh heavily on the region. But it is time to accept reality, stop experimenting and correct the mistakes of the past. Only then, will growth re-emerge and only then will young people in almost every country of the Eurozone begin to gather some hope in their own future. The authors’ proposals are well-intentioned, but it is just another patch doomed to fail in overcoming the insurmountable defects of the monetary union. »
YANIS VAROUFAKIS’s response: That the Eurozone was designed disastrously is something that Mr Bott and I happen to agree on. We also think that it wold have been better if this Eurozone had not been put together. Where we disagree is that Mr Bott believes that, given where we are now, we should dissolve the Eurozone forthwith, without even attempting to re-shape it in a manner that stops its disintegration. We, on the other hand, believe that the stakes (from a disbanding of the Eurozone) are terribly high. That dissolving the Eurozone will not take us to where we would have been had we not put it togeher in the first place. That it is worthwhile to have one last try at resolving the Euro Crisis without dissolving the Eurozone – but by re-designing it in a minimalist, rational manner. Our Modest Proposal is this last ditch effort.
STUART HOLLAND’s response: You are making the case for exit from the Eurozone and for its dissolution, on which you need no suggestions…
Constantin Gurdgiev – Russian economist, adjunct lecturer in Finance with Trinity College, Dublin, author of Trueeconomics blog
A STRONGER DOSE OF THE OFFENDING VIRUS
«Prof Varoufakis’ ideas are well-intentioned but misguided. Since the beginning of the crisis, European policy analysts have been seeking to find sources for more Government investment, more leveraging of private savings, and more debt mutualisation. Public capacity to borrow restricted by a temporary return to sanity in the markets pricing of European risks, Europe has now (in various countries) raided pension, insurance and investment funds, savings, and deposits. In reality, what Europe needs is a policy environment in which the Governments live within their means not in a hypothetical 20 years or 30 years time, but tomorrow, the electorates are not reliant on constant uplifts in public spending, and investment is based on a transparent, open and purely voluntary system of risk-return pricing. None of these are deliverable via Mr Varoufakis and his colleagues’ ‘modest proposals’. In effect, thus, the ‘modest proposals’ are a de facto replay of the road that has led Europe to the current crisis – a set of policy epicycles to perpetuate and vastly expand the corporatist system of economic and social governance, equivalent, on the one had to the indefatigable search for yet another credit card, and on the other hand to the tireless pursuit by the public sector of every private saving cent still left untouched. Good luck, Mr Varoufakis, in curing the disease by an application of the ever stronger doses of the offending virus.»
YANIS VAROUFAKIS’s response: From one extreme (Uwe Bott’s belief that the Eurozone is un-salvageable) we have come to the other extreme (the view that we must, come what may, stick to the Eurozone’s original design. Dr Gurdigiev believes that it is possible, and desirable, that the Eurozone continues along the lines of the principle of perfectly separable debts and of perfectly separable banking systems within the same monetary union. Alas, this is neither feasible nor desirable. He tells us that “…Europe needs … a policy environment in which the Governments live within their means not in a hypothetical 20 years or 30 years time, but tomorrow”. This is precisely what the Modest Proposal is aimed at. Lest we forget, under the current arrangements, governments (and not even southern ones; e.g. the Netherlands is included here) can simply not repay their debts while also responsible for recapitalizing their banks. Our first two policies create precisely the environment that Gurdigiev wants and is now missing: “one in which governments can live within their means”. Bafflingly, he admonishes us for pursuing “…the indefatigable search for yet another credit card” when, in reality, it is the present system of enforced bailouts that ‘extends and pretends’, effectively giving credit cards to insolvent governments.
STUART HOLLAND’s response:
Dr Gurdgiev write: “The ‘modest proposals’ are a de facto replay of the road that has led Europe to the current crisis – a set of policy epicycles to perpetuate and vastly expand the corporatist system of economic and social governance, equivalent, on the one had to the indefatigable search for yet another credit card, and on the other hand to the tireless pursuit by the public sector of every private saving cent still left untouched.”
(1) The Modest Proposal is not an action replay. The EU never has had a US style New Deal. Even Marshall Aid was grant financed, not bond financed.
(2) Bond financed investment is not a credit card since investment is not consumption.
(3) Nor is the Modest Proposal “the tireless pursuit by the public sector of every private saving cent still left untouched”. As indicated above, global pension funds are seeking but not finding investment outlets.
Paulo Pereira de Almeida – Professor at ISCTE in Organization and Management of Business, Labor and Internationalization Business, Lisbon, Portugal
SOUTHERN EUROPEAN COUNTRIES MUST TAKE COMMON ACTION
«The recent political developments in Portugal suggest that although no political consensus seems possible it is – in my point of view – urgent that the Southern European Countries take some common action and make their voice be heard in the European Union. Besides, it is of absolute necessity to revise – and eventually abandon – the the Public Expenditure Review imposed a permanent public expenditure cut of €4.7 billion (or 2.8% of GDP) for 2013 and 2014 as a pre condition to the follow-up of the bailout program in Portugal until June 2014. As Yannis Varoufakis suggests it is “like petrol thrown onto a fire” and the social situation in Portugal is at its limits. A final note on the social implications of the crisis: the Portuguese people are beginning to feel the troika measures as some kind of “neofeudalism” of the north towards the south and any steps taken make the situation more balanced will certainly be very welcomed.»
YANIS VAROUFAKIS’s response: Professor Pereira de Almeida brings out and highlights, very helpfully, the worst deficit that Europe is currently developing: the democratic deficit which builds up in response to the self-reinforcing crisis caused by the dead-end austerity policies as well as the denial by Europe’s leadership that we desperately need reforms like those put forward in our Modest Proposal. I wonder if politicians understand that Europe’s legitimacy is suffering, perhaps irreversibly, in the eyes of Europeans.