Peter Jungen: New member of the Governing Board of the “Institute for New Economic Thinking” (INET)
Recently, a contribution by Peter Jungen was published by the Chinese Caijing Magazine:
Europe may suffer a lost decade, by Peter Jungen
Published in the Lu Jiazui Conference Journal, Shanghai, on June 29th, 2012
1. Many people feel that the European debt crisis is the biggest problem in the world economy although the debt to GDP ratio in the US is higher than in the Eurozone average. In spite of all the difficulties the good news is a substantial shift of paradigm in Europe. At present we realise the end of more than 40 years of continuous deficit spending in most of the European member countries to finance the so-called European social model. These days we may see the end of this old European social model which is not sustainable. If one wants to make it sustainable Europe has to drastically change track, reduce public spending and give enough incentives for more private investment, for more entrepreneurship, for more innovation, for more Start-Ups and for more young people to start a business.
2. The whole debate about growth versus austerity is misleading. Fact is that austerity is an important condition for growth. There is no sufficient empirical evidence to prove that continuous deficit spending would create growth. To the contrary there is evidence that over time increased deficit spending would damage growth as Carmen Reinhart and Ken Rogoff have demonstrated in their book “This time is different”. Artificial growth beyond real demand had been financed by foreign capital flows inside the Eurozone. So basically, what we are now seeing is the return to a path of more sustainable sound growth. The lack of growth in Europe results not from too less but from too much deficit spending and too much public debt.
3. It is true that a number of Eurozone members have lost competitiveness which is the key reason for their problems. But this is not simply a north-south problem in Europe. They have rather lost their competitiveness vis-à-vis emerging countries like China. They also have lost their competitiveness vis-à-vis other European neighbour countries.
4. To call for wage increases in Germany as a contribution to relieve competition problems in Europe is a no-brainer. Industrial wages in Germany are already the highest in Europe. Also unit labour costs are among the highest in Eurozone and in the EU: Germany at about € 34 and Greece at about € 16 per hour in industry. The problems for Greece for instance are not wages in Germany but the fact that neighbouring Bulgaria has average industrial wages per hour of about € 2,50, Poland about € 6,50.
5. German exports as a percentage of GDP rank only number 12 in the EU and number 8 in the Eurozone. Germany’s export as a percentage of GDP reaches about 46% but is topped by countries like Slovakia, Hungaria, Czech Republic, Belgium, the Netherlands, Slovenia which have export rates as a percentage of GDP of between 55% and 80%.
Since the beginning of EMU the share of German exports into the Eurozone as a percentage of total Exports has decreased. There are members of the Eurozone and even of Non-Eurozone countries who have higher export ratios to the Eurozone than Germany.
6. In Germany the Government is not an exporter. It is the small and medium – mostly unknown – firms which are responsible for the bulk of German exports. In this context the so-called “Hidden Champions” play a decisive role. “Hidden Champions” have sales of up to 3 billion euro - with average sales of 400 million - and they are number one in the European respectively in the US market or number one to three in the world market. There are 2600 hidden champions in the world of which 1300 are in Germany. Their export ratio is about 60 to 70 percent. They account for about 2/3 of German exports if one includes the group of companies who are also leading firms in their respective fields. The most important feature is that these firms are actually not “export-oriented”. These firms are targeting the world market in a particular field of which Germany is a part but not the major part.
7. There is no way around than to increase competitiveness in some EU countries by implementing substantial economic reforms in the markets for labour, capital and entrepreneurs. So only by deregulating labour market, by reducing Government spending as a percentage of GDP, by reducing red tape, by encouraging entrepreneurship and in particular by encouraging young people to start a business economic dynamism has a chance. In the “Doing Business” Index of the World Bank and the “Economic Freedom Index” of the Heritage Foundation some European countries are ranked very badly. For instance Greece is ranked even behind Bangladesh. Youth unemployment in some European countries is not due to market failure but it is a political failure by preserving insider/ outsider systems which prevent the hiring of young people. The main responsibility for this is with politics and the trade unions who create this terrible experience of high youth unemployment.
8. It is important to understand that there are substantial structural deficits which can not be overcome by further deficit spending. To the contrary: an increase of deficit spending called for by many economists and politicians would create an even larger problem. It would not solve but it would increase the present difficulties. There is no way around the truth that it may take 10 to 15 years for this adjustment process. At the end of the 1990s Germany was called “The sick man of Europe” by The Economist. Since then a number of reforms among them in the labour market have laid the basis for an increased labour force participation and for growth. The improvement of the labour market in Germany and the substantial increase in labour market participation has been decided about ten years ago in Germany.
9. The Eurozone may have to reconsider its membership. Members who are not able or not willing to comply with the rules consistently should really seriously consider whether they should not leave. It may cause disruption for a short period of time in the Eurozone but it certainly would be preferable to a slow dying of the Eurozone. If other countries would join - like Poland, Latvia and some of the Nordic states this would certainly strengthen the Eurozone. Latvia is a very good example how to restructure your economy and how to push through reforms leading to a resurgence of the economy. Poland for instance has placed a ten-year-bond recently at about 3.7% - much more favourable than Spain or Italy.
10. The whole contagion issue is a political invention by those who prefer to loosen the rules and create bad feelings in the public and in the markets. The market seems to much better understand these issues then a number of politicians. Therefore the markets should do their work and the politicians their job.
11. The alternative for Europe is either to completely return to the Maastricht criteria accepting the no-bailout clause or a fiscal union where Governments give up their sovereignity over their own financial means. The third option would be to continue to muddle through. Unfortunately the most likely option choosen by Europeans will be to continue to muddle through. It may be politically difficult in some countries to push through the reforms and to accept austerity policy as a condition for future growth. But it would be politically totally unacceptable to assume that in some of the stronger economies the tax payers are ready to take over the debts of other countries (Eurobonds), to guaranty banking deposits in other countries (Banking Union) and to continue financing the future deficits in other countries.
12. It is very important for Europe to line up with the IMF in the whole debt crisis. As long as the IMF is involved there is some guaranty that stricter rules are being applied. It is to be hoped that some of the IMF members will make sure that the IMF insists on stricter rules. It would be unfair to emerging market countries who encountered debt crises in the last decades and it would be economically stupid as well to apply other rules to the European debt crisis than these which had been applied to the debt crises in Latin America or in Asia before. Therefore one of the best hopes for Europe is that the emerging markets representatives in the IMF refuse to finance European debts on a permanent basis. This would support those in the European Union and in the Eurozone who are arguing in favor of austerity as a basis for growth. This would be the best chance for Europe. Without this the future of Europe will be uncertain to say the least. Its decline vis-à-vis the rest of the world and in particular vis-à-vis the emerging markets countries would continue.
13. The present situation offers incredible chances for China and emerging markets countries. While Europe may suffer a lost decade China has the means to use the situation. The European debt crisis will accelerate the relative decline of Europe versus the rest of the world and it will accelerate the re-emergence of China as a global player. We will see more Chinese FDI investments into Europe which are very welcomed. It is much more advisable for the Chinese Government, the People’s Bank of China and the Chinese corporates to invest into the best what Europe has to offer. This is not Government debt but this is the European corporate sector. So the next years will offer immense opportunities for Chinese investors in Europe. The decline of the Euro and the appreciation of the Renminbi will make investments in Europe even cheaper from the point of view of Chinese investors.
14. The biggest danger for Emerging Markets and for the world economy is that the debt crisis may lead to more protectionism. It would of course be foolish for the Europeans to start protecting themselves against foreign trade and against foreign direct investment. So the most important thing is that we keep WTO going, that there is a new push in the Doha round and that European countries are kept open for foreign direct investment in their own best interest.
Already FDI from Europe is shrinking in China. This only confirms a new trend shown in the last couple of months. While foreign direct investment into China slowed down in the last couple of month, outbound direct investment from China surged for more than 70% in the first months of this year.
15. So the European debt crisis is accelerating the rebalancing of the world economies. But there will be many turbulences on the road ahead.