It’s time to return to the issue of overall “national labour productivity”. By this we mean, what is the level of productivity of the whole available labour force – not just those who happen to have employment? See here:

Chart 1

Data: ONS

Very recently, David Blanchflower and David Bell have published a new report which provides an index combining unemployment and underemployment, a welcome addition to labour market analysis. They conclude:

“There appears to be significant slack in the economy. The primary argument made by the supporters of the government’s current macroeconomic stance is that what’s going on in the labour market shows that the UK economy is primarily supply not demand constrained, that the output gap is small, and crucially that the labour market statistics show that we are now quite close to full employment or the NAIRU. The paper [shows] that there is very substantial spare capacity in the labour market; the implication being that if demand were higher, output could easily be higher… without exerting any significant upward pressure on real wages.”

This also reminds us of what J.M.Keynes wrote in a letter to The Times in 1935:

“All our ideas about economics, instilled into us by education and atmosphere and tradition, are…soaked with theoretical presuppositions which are only properly applicable to a society which is in equilibrium, with all its productive resources already employed. Many people are trying to solve the problem of unemployment with a theory which is based on a theory that there is no unemployment.”

And in Chapter 2 of the General Theory he also refers to

“The question… of the volume of the available resources, in the sense of the size of the employable population”.

The aim of this blog is not to offer a General Theory (phew) but to demonstrate graphically (sic) the impact of unused labour force human potential on UK productivity, in an age where demand is so far quite insufficient to enable a substantial part of the national labour force to find work or enough work – even though wages on average have been falling consistently in real terms and our labour market is one of the world’s most deregulated.

In our report “Ailing economy, failing solutions” we put it like this:

“Curiously, the one measure of our national economy’s productivity that seems to us by far the most apporpriate is one not even mentioned by the ONS, nor does it feature in most discussions around the ‘puzzle’ of the UK economy.  That is, to measure national productivity not as “value of outputs divided by labour input (in its various forms)” but as “Value of outputs divided by the sum of the actual and potential labour inputs”, i.e. adding in the (wasted) potential of the unemployed.” (NB we received a comment saying we should also include those defined as inactive but wanting a job; good point but we have kept it simple for now.)

We show – it is clear from Chart 1 above – that this failure to generate demand has had a severe negative impact on the UK’s economic performance and productivity, and that constant GDP per “economically active person” has fallen dramatically from its peak and is – in real terms – back to the level of 2003. Hence, the UK’s decayed decade.

We also show that over a 10 year period, GDP per economically active person grew at a faster rate than GDP itself up to 2008.  This shows the benefits of employing a greater percentage of the available workforce. But from 2006, GDP has in general risen faster, or fallen more slowly, than the rate of GDP per economically active person, reflecting the opposite – a chronically high number of unemployed, around 2.5 million. Chart 2 shows the relationship between changes in in the index of GDP and of GDP per economically active person (2009 = 100 as this is the ONS base for productivity stats).

Chart 2

The classical methods of calculating overall labour productivity are output per hour, and output per worker. Chart 3 looks at the 15 year relationship from 1998 between their respective indices, also including the index of GDP change over the period.

Chart 3

Again, productivity seen in % terms of the whole potential and actual workforce (EA) rose fastest of all these indices up to 2008, and has now fallen back – more or less in line with the other measures.  Output per worker also rose faster than GDP itself till 2005, but has also now fallen back to its 2005 level.  Chart 4 looks at the same but over the last 10 years, which shows the recent changes more clearly, especially the opening of the “scissors” between GDP and the measures of productivity.

Chart 4

In conclusion, Chart 4 shows that UK labour productivity has indeed fallen back dramatically, whether looked at in terms of output per hour, output per worker, or output (GDP) per economically active person.  But the measures of productivity that focus on people in work are slightly less bad – output per hour in Q4 2012 is like that in mid-2006, while output per worker is at the level of late 2005.  But if you take the unused capacity of the unemployed into account, we are all the way back… to 2003.

Back to exactly where we were, 10 long years ago.

Nearly a year ago, we did several posts on this website (e.g. here) in which we explained the “productivity puzzle” as being significantly due to falling real wages, and the fact that more workers were working for less pay to produce “no more stuff”.  In other words, labour was being substituted for capital in a context of a deregulated labour market.  This was not a fashionable view at the time – we challenged the Sunday Times’ David Smith.  (And yes we got it partly wrong in assuming last year’s growth in part-time self-employed was a secular trend).

But on the main point, it is good to see others coming round to our point of view.  John Van Reenen, Director of the Centre for Economic Performance at the London School of Economics, has recently posted an article “Jobs, wages and poor growth”.  In it he says:

“The main explanation for the puzzle is that real earnings have fallen massively since 2008… Regular pay rose by only 0.8% this year – the lowest growth since records began. Cheaper labour means that employers do not have to lay off so many workers in spite of lower sales.

 This pattern of falling real wages in a recession is new: real wages did not fall in the early 1980s and early 1990s recessions. It is likely that this increased wage flexibility is due to the decline of union power and welfare-to-work reforms over the last three decades.”

Amen!  What we are seeing is people desperate to take part in the labour market, but with private sector debt deleveraging, and without major new demand, they are having to “share” the available output between them.

Ann Pettifor was invited to take part in a debate asking “The City and the Common Good: What kind of City do we want?” organised by St. Paul’s Institute and CCLA. Speakers included economic historian Lord Robert Skidelsky, Tarek El Diwany of Zest Advisory LLP and Paul Sharma of the Prudential Regulation Authority.  The debate was chaired by BBC Economics Editor Stephanie Flanders and attended by over 900 people.

The second of a series of three debates, last night’s event examined the moral underpinnings at the heart of the UK’s financial system.  It is clear that money is no longer just an objective measure of value and a token of exchange – if it ever was. But what has it become?  Is its social purpose in danger of being lost? Do we control money or does it control us? Is there such a thing as “good” and “bad” money?

The event’s keynote speech was given by Lord Skidelsky.  Borrowing from J.M. Keynes’ Economic Possibilities for Our Grandchildren, he distinguished between ‘the love of money as a possession’ and ‘the love of money as a means to the enjoyments and realities of life’.  He argued that despite the ancient wisdom of Aristotle, the Koran and Vedic texts condemning usury, or the making of money from money, the modern banking has carried it to new heights.  The result is the monetization of economic life; we increasingly think of activities not devoted to money making as carrying an ‘opportunity cost’ in terms of money foregone.

Turning to the City, Lord Skidelsky cited that in the years leading up to the crisis bank loans to the real economy increased by 50% while they grew by 260% to the financial sector. In other words, banks were increasingly lending to themselves, a good example of money breeding money.  He sums up the charges against the bankers made by reformers: 1) that bankers are paid too much for the services they provide and therefore caps must be placed on bonuses, and 2) banks are actually inefficient at allocating capital, and the Bank of England must provide regulation.  These reformers, he critiques, only want to improve the efficiency of financial services in meeting human desires without addressing the moral quality of those desires.

Lord Skidelsky asserts that “good money” should not only be honest and efficient, but also directed towards good ends, such as health, respect, harmony with nature, and security.  He cautions that the worship of money as a possession rather than as a means to the ‘enjoyments and realities of life’ is socially damaging, and reminds us that the challenge is to create a social system which is efficient both economically and morally.

(All photos (c) Graham Lacdao, St Paul’s Cathedral)

Originally published in the Financial Times (log in required).

Sir, In “Why Reinhart and Rogoff are wrong about austerity” (April 18), Professors Robert Pollin and Michael Ash do a fine job of dissecting research errors with damaging real-world consequences.

Our mini-research on the UK’s postwar experience, is a modest test of the debt-austerity “thesis”. Using International Monetary Fund and Office for National Statistics numbers for 1949-2011, we found that UK gross domestic product increased at its fastest average rate – by 3.19 per cent – during the 18-year period (1949-66) when the debt-to-GDP ratio was more than 90 per cent (and mostly way over 100 per cent). This compares with an average of 2.60 per cent for the 36 years when the ratio lies between 30 and 60 per cent. For the other nine years (60 to 90 per cent), the average is 1.93 per cent.

What is more, during the 18 years when the debt-to-GDP ratio was more than 90 per cent, that ratio fell every year without exception. We do not, of course, seek to argue from this that a high debt-to-GDP ratio leads to, or is associated with, higher growth. We simply note that increased economic activity will tend to shrink the debt-to-GDP ratio, while falls in economic activity tend to increase it.

Ann Pettifor and Jeremy Smith, Directors, Policy Research in Macroeconomics, London NW1, UK

We’re sticking for the moment with this story because it exemplifies the perverse relationship between current UK and European political decision-makers and “mainstream” economists who have given intellectual succour and support to the now demonstrably failing austerity policies.  That is why the unveiling of the manifold errors and wrong conclusions of Reinhart and Rogoff in their now infamous paper of January 2010 “Growth in a Time of Debt”, which we referred to in our previous post, is so important.

To show how their “findings” have been used politically, here is an example from less than two weeks ago, when our old ‘friend’ Olli Rehn, EU Commissioner for Economic Affairs, addressed the International Labour Organisation on 9th April:

“Yet, public debt in Europe is expected to stabilise only by 2014 and to do so at above 90% of GDP.  Serious empirical research has shown that at such high levels, public debt acts as a permanent drag on growth. If it is not reduced, it will become an ever-heavier burden on our economies, eating resources that could otherwise be channelled into productive investment needed to support job creation.” (our emphasis).

Thanks to the Political Economy Research Institute of the University of Massachusetts, Amherst, we now not only an explanation of the severe shortcomings of the R & R paper and conclusions, but also to the data used by R & R having finally agreed to open up access to them.

The R & R study covers a fairly large range of countries and a very long (200+) year period, but we felt it would be good to re-look at the UK post-war experience for the period 1949 to 2011 and see how far the R & R conclusions – in effect those drawn by Mr Rehn in his speech – are supported or not by this period of over 60 years.  The answer is – the UK data go in the absolute opposite direction from that which the Reinhart and Rogoff ‘thesis’ would lead us to expect.  In our last post we came to the same conclusion, from instant research using IMF and ONS statistics.  And we have now obtained very similar results using the same data (plus adding the latest figures up to 2011, which do not alter the position) as was available to Reinhart and Rogoff.

What we find is this:

• For the 16 years from 1949 to 1964 when UK debt as a percentage of GDP was over 90%, annual GDP grew on average by 3.29%
• For the 7 years from 1965-70 and in 2010, when UK debt as a percentage of GDP was from 60 o 90%,  GDP grew on average by 2.73%
• For the 40 years from 1971 to 2009 and 2011, when debt as a percentage of GDP was under 60%, GDP grew on average by 2.43%

So by far the best average annual rate of growth was achieved during the very period when the UK debt to GDP ratio was highest, and the worst average rate of annual  GDP increase was when the debt to GDP ratio was lowest!  And as we noted, the high post-war debt kept on reducing year by year.

Data sources: ONS, Reinhart & Rogoff via PERI, University of Massachusetts at Amherst

Of course we don’t argue that a high debt/GDP ratio itself causes a higher rate of GDP increase.  But given how crudely the R & R paper has been used for political advantage by the Austerian camp, it’s important to highlight not just their spectacular failings in methodology, but also the absurdity of the ‘findings’ of what Mr Rehn told the ILO was “serious empirical research.”

Over the last few years, we have been told time and again that a public debt-to-GDP ratio that goes beyond 90% is dangerous, and leads to slower economic activity.  The main source for this thesis, which has been accorded the status of fact, is a paper by Carmen Reinhart and Kenneth Rogoff entitled “Growth in a time of debt”, published in early 2010.

By extraordinary coincidence, on the very day that blogger Rortybomb uncovered  curious discrepancies in the data used by Reinhart and Rogoff, casting much doubt on the correctness of the thesis, PRIME  are proud to announce the results of our own in-depth research (fieldwork took place this evening), covering the experience of the UK from 1949 to 2011.  Our findings? A bit radical, really.. A period of public debt-to-GDP ratio of over 90% is associated, on average, with a higher level of annual increase of GDP than is the case for periods with a debt-to-GDP ratio under 90%.  

What’s the evidence and methodology for this somewhat surprising set of findings?

Our researchers (well, me actually), took the IMF data for annual UK public debt-to-GDP ratios available here.  Then we took data on annual increases in GDP from the ONS database, available from here (see column BU) starting in 1949, and ending with 2011.  Using our complex  model (i.e. adding up) we found that for 18 years,  from 1949 to 1966, debt to GDP ratios were above 90%.  If one adds up the ONS annual increases and divides by the number of years, the average annual GDP increase over these 18 years when the ratio was over 90% is 3.19%.

We then looked at the periods when the debt-to-GDP ratio was between 60 and 90%.  There are two periods totalling 9 years, from 1967 to 1972, and recently from 2009 to 2011.  The average rate of GDP increase for these 9 years of 60 – 90% is 1.93%.

Finally, we looked at the rest of the period in question, when  the debt-to-GDP ratio was between 30 and 60%.  This was from 1973 to 2008, covering 36 years. For this period of 30 – 60%, the average annual GDP increase is 2.60%.

So our conclusion is that the UK economy grew more rapidly, in real terms, at a time when – for 18 years covered by this study –  it had a high debt-to-GDP ratio, and still managed to reduce that ratio almost year by year.  The 36 years when the debt-to-GDP ratio was between 30 and 60% achieved the next best rate of annual GDP growth, but also saw the crises and recessions of 1991 and 2008/9.  The worst rate of growth was during the 2 periods when debt-to-GDP was between 60 and 90%.

Ah yes, time for some charts. First, a nice simple one showing the evolution of the UK debt to GDP ratio.

Source: IMF. Vertical axis = debt-to-GDP ratio

Second, a chart that shows the annual increase (with a few nasty decreases in the era of liberalisation) in GDP, colour-coded for the relevant debt to GDP ratio band.

Source: ONS, IMF

Let’s return to Reinhart and Rogoff.  Here is what they profess to conclude:

“Our main result is that whereas the link between growth and debt seems relatively weak at “normal” debt levels, median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower. Surprisingly, the relationship between public debt and growth is remarkably similar across emerging markets and advanced economies.”

“Why are there thresholds in debt, and why 90 percent? ….A general result of our “debt intolerance” analysis.. highlights that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs.  Even countries that are committed to fully repaying their debts are forced to dramatically tighten fiscal policy in order to appear credible to investors and thereby reduce risk premia. The link  between indebtedness and the level and volatility of sovereign risk premia is an obvious topic ripe for revisiting in light of the more comprehensive cross-country data on government debt.”

It appears that the data and/or selection of data used by Reinhart and Rogoff are open to major question – and this set of conclusions are also now evidently wrong, for countries that have their own currencies and central banks.

Conclusion

We do not of course believe that having a high debt-to-GDP ratio causes growth in GDP to be higher or faster.  We looked at the data set out above in a spirit of tongue-in-cheek, since we have always considered the “90%” thesis to be absurd, and are not seeking to replace it with a similar ‘model.’ It just so  happens that in the UK after WW2, the economic policies adopted by Britain and internationally through the  Bretton Woods system on average worked out better than has been the case since the liberalisation of finance (which commenced under the Heath government) and the adoption of neoliberal policies generally, in particular from 1979 on.

The truth is that there is no level of debt which is in particular more risky or leads of itself to worse results.  It is always a matter of context, and of getting the right mix of policies.  But the (probably wrong) “findings” on public debt of Reinhart and Rogoff have been used as cover for contractionary policies of austerity which have ruined the lives of millions. For this they bear a heavy burden of responsibility.

Originally published in Open Democracy

The simple truth unpalatable to Eurozone authorities is that small peripheral EU economies and even big economies like Spain and Italy, are victims, not designers of the liberalised financial architecture that was built way back in 1992, repeating earlier twentieth century failed experiments that led to financial crisis, immiseration and war. 

“I think in Europe we must all ask ourselves whether the ECB should have the same powers as other central banks around the world,” the Spanish leader, Mariano Rajoy said at a press conference on Monday, April 7, 2013 .

Mr Rajoy’s plea for a central bank that serves democratic interests sounds like the plea of the little Dutch boy with his finger in the dyke, begging for the help of a firefighter.

The fact is that the Eurozone monetary order has been designed to deliberately deny Mr Rajoy and other European leaders the powers of a ‘firefighter’ – a publicly-backed central bank; one which can act as lender of last resort, and support the public sector as well as the private banking system.

The terms of the Maastricht and subsequent treaties deliberately shrank the economic policy tool kit available to democratic governments.  ECB mandates separate Europe’s banking systems from democratic states. This means that, unlike the US and UK, EZ governments are forced to place undue reliance on the private banking sector for funding; and on only fiscal, not monetary policy for managing the economy.

The Eurozone’s financial architecture is designed to remove democratic government control over two key policy levers: the rate of interest and the exchange rate – both of greatest importance to Europe’s economies; but also to private international creditors/ speculators. The Eurozone’s treaties ensure that these crucial levers of economic policy are left to the control of invisible and unaccountable creditors and speculators – described by neoliberals as ‘market forces.’

Unlike the leaders of totalitarian states, elected authorities must be responsive to democratic forces. To avoid economic failure, prolonged depression and the associated social unrest, it must be possible for politicians and policy-makers to respond and adjust to economic conditions, and to have the economic policy tools to do so.

Europe’s leaders are deprived of the ability to respond to democratic forces by the Eurozone’s monetary system and its statutes. They have been stripped of critical policy tools..

And to add to this, the total EU budget of less than 1% of GDP means the Union has no means to express ‘solidarity’ and address depressions in Member States. This is unlike the US, with its federal government deploying a budget of 18% GDP to smooth out differences between states.

The results of these economic and political arrangements are alarming.  Instead of democratic oversight of the Eurozone economy, governance is managed by a secretive ‘shadow state’ – “a patchwork of agencies…. facing growing criticism as undemocratic and illegitimate” according to Deutsche Welle, the German international broadcaster:

“Which cruel ruler is continually forcing new rounds of austerity measures on the Greeks?” asks Deutsche Welle. “And which dark power managed to break the resistance of Cypriots in just a few days? The answer is not Germany. It is the eurozone’s shadow state.”

A German banker cited in the article, goes on to explain:

“The basis for the euro shadow state comes from treaties that many Europeans have never heard of. Does anyone know what the “two-pack” or “six-pack” agreements are? Is anyone sure of exactly what the “fiscal compact” does?

“This network of treaties diminishes national sovereignty and imposes a degree of discipline on states so that they can operate in the system of public debt money,” said senior Deutsche Bank advisor Thomas Mayer recently. (Deutsche Welle, 6 April, 2013)

The ideological aspirations of the bankers, technocrats and politicians that make up  this ‘shadow state’ are utopian, as Karl Polanyi argued so effectively in The Great Transformation. We know, because this is not the first time they have attempted to bypass democratic governments to create an integrated global marketplace for financial interests. Financiers and technocrats corralled politicians to do the same in the 1930s under the Gold Standard: “the Golden Straitjacket.”

Just as today, their utopianism and dismissal of both democratic institutions and of the immiseration of Europeans led to an intensification of nationalism. Worse, 1930s financial liberalisation and austerity encouraged millions of Europeans to turn to authoritarian dictators who, in contrast to the technocrats, promised employment and the restoration of prosperity and stability.

Restore the drachma

I argued early on (in an Open Letter to the People of Greece: Restore the Drachma , June 2011)  that Greece should exit the Eurozone (EZ) and set up a central bank to protect the interests not just of private bankers and bondholders, but of Greek society as a whole.

The advice was not taken. Instead Greeks are exiting Greece, including 120,000 professionals. Unemployment at 26.8% is the highest recorded in the EU, which is why Greece’s young, smart and talented head for Australia.  Fascists are gaining a foothold in Greek politics. In the meantime the Troika’s clumsy 2012 Greek debt deal led to the fall of another Eurozone domino: Cyprus, which as Costa Carras argues on openDemocracy has become a revealing test case.

According to the Greek statistical service, the economy shrank at an annual 5.7 per cent in the last quarter of 2012, adding up to a massive slump of 20 per cent in real terms since 2008. As this goes to press, Greece’s official creditors, the Troika of the ECB, the IMF and the EU, have delayed release of a 2.8 billion euros ($3.5 billion) tranche due in March 2013. Media reports suggest this is because the government refuses to acquiesce to the sacking of another 25,000 public sector workers.

Cyprus now heads for collapse, its private banking system felled by the weight of huge debts. The botched bank bail-in  engineered by the Troika, caused Cyprus to effectively abandon the Euro.  The introduction of controls on both inward and outward movements of capital means that Cyprus’s currency now has a different value to that of the Euro, and cannot be traded freely. The ‘bail-in’ of depositors with over €100,000 – all of whom had their deposits decimated – means that most Cypriot firms have no working capital. Nor is there any chance of raising funds from banks.

The Troika’s record as a ‘shadow state’ in charge of economic management of the Eurozone is appalling. As George Soros argues, it has deepened the depression (of the Eurozone periphery), aggravated their debt burden and perpetuated their subordinate position.  “As a result the crisis is now threatening to destroy the European Union.”   The technocrats, bankers and politicians in charge are in denial of this truth, obvious to any close observer.

Such is the fate of utopians.

George Soros proposes to convert the entire stock of Eurozone debt into Eurobonds. This would provide temporary relief to EZ debtors, but it would not alter the compulsion on sovereigns to structurally adjust their economies to suit the interests of mobile finance.

Some old tunes

Throughout the clumsy and botched negotiations, Cyprus was blamed for its reckless and bankrupt banks, and for harbouring a tax haven for Russian oligarchs laundering misbegotten gains.

Similar attacks were made earlier on Greece. And these attacks echoed in turn the complaints of international creditors dealing in the 1980s and 1990s with the Third World debt crisis. There was not a single sovereign Third World debtor not considered corrupt, incompetent and fully responsible for the massive post-70s build-up of private and public debts. International creditors, by contrast, were considered beyond reproach; their co-responsibility for the crisis skated over.

While it is undoubtedly true that the Greek public sector had grown too large to be sustained by a weak economy; that corruption and tax evasion were rife; that some of Greece’s politicians were cosseted and crooked; nevertheless, Greece’s (and Cyprus’s) debts and finance sectors did not expand and then explode until both countries joined the Eurozone’s monetary order: the Euro.

When Cyprus began its accession to the European Union (four years before it adopted the Euro in 2008) the IMF executive board:

“welcomed the Cypriot authorities’ long record of good policy performance, which has led to low inflation, near full employment and, in 2004, a rebound in growth.”

In Greece nominal interest rates fell from 20% in 1994, when the government announced its intention to join, to 3.5% in 2005 after it had unwisely jumped on the Euro bandwagon. Unsurprisingly public and private sectors went on a borrowing spree. International loans to Greece stood at $161bn at the end of December, 2010, down $75bn from a year before.

Overseas lenders, excluding those in Russia, had $59.2 billion of outstanding loans to Cyprus, a country of just over 1 million people, at the end of September 2012, according to the Bank for International Settlements (BIS).

Cyprus represented low hanging fruit for the global finance sector, and the destination of choice for Russia’s freewheeling oligarchs. Mobile capital flows across Europe’s borders coupled with effective taxpayer guarantees for speculative lending, were as manna from heaven for both Russian oligarchs but also bankers.

They were not alone.  The Irish and Spaniards likewise could not resist the cheap, easy loans dangled before them.

Subsequent sovereign debt crises were highly predictable.

The Eurozone economic model

When the Euro was launched in 2000 one of the notes issued was a €500. As Neil Collins noted in the FT recently:

“The €500 note is one of the many mysteries surrounding the birth of the euro. For whom, exactly, was the equivalent of $600 or £400 designed? No other significant currency is available in a form that allows £1m-worth to be comfortably carried in a briefcase and which is effectively non-negotiable in everyday use.  The Spanish used to dub the notes “Bin Ladens”… the UK’s Serious Organised Crime Agency estimates that 90 per cent of the €500 notes in Britain are held by criminals….”

There is of course no mystery associated with the €500 note. Mobile, de-regulated money is at the heart of the Eurozone’s economic model, as it is of ‘globalisation’ or the ‘Washington Consensus’. Hence the ease with which drug-dealers, Russian oligarchs and criminals can operate across borders, and even establish narco-dollarised states and regions a la northern Mexico.

It must be acknowledged that the Cypriot, Greek and Spanish elites equally relished their new, mobile currency. Above all they rushed to borrow from the global private banking system, at very low rates of interest. They also positively welcomed those freewheeling Russian oligarchs and their billions, and set up businesses to service their interests.

Which brings us to another truth about the Eurozone economic model. It was designed to give bankers, investors and creditors the comfort of taxpayer backing and guarantees for all lending. International and domestic bankers were led to believe that Cyprus’s banking system would be back-stopped by the Eurozone; that Cyprus would not be allowed to default; that international creditors could ultimately rely on the ECB doing “all it takes” to defend the Euro; and that an endless stream of European taxpayers could be relied upon to guarantee Cyprus’s debts.

As a result of these justifiable assumptions, Cyprus’s private sector quickly became highly leveraged – i.e. burdened with debt. Both banks and households were fully exposed to the property bubble pumped up by the Euro monetary system’s ‘easy money’.

A system designed to fail democracies

The simple truth unpalatable to Eurozone authorities is that small peripheral economies like Greece, Cyprus and Ireland, and even big economies like Spain and Italy, are victims, not designers of the liberalised financial architecture that was built way back in 1992.

That monetary system was the work of aloof, unaccountable, neoliberal financial and bureaucratic elites, who never fully consulted, or disclosed to Europeans their plans to bypass the democratic process.  Technocrats, bankers and professional economists were largely responsible for drafting the monetarist Maastricht Treaty which created the Eurozone economic model, and which in turn was signed off by EU ministers in 1992.  (Some politicians, like Britain’s Kenneth Clarke MP, Chancellor in 1993, admitted to never having read the Maastricht Treaty.)

The reality that the ‘prudent’ northern states of Europe must face is this: the Eurozone’s economic model facilitates easy money, tax evasion, money laundering and fraudulent activity across Europe, while at the same time offering taxpayer guarantees against default; and imposing a one-size-fits-all rate of interest and exchange rate.

It’s a model designed to flatter Russian oligarchs, criminals and American hedge funds.

It is a model designed to fail democracies, in particular weak democracies like that of Greece.

No end in sight

The frightening truth is this: the Euro’s technocrats and politicians behind the shadow state have no intention of ending the crisis quickly, as Fred Bergsten of the Peterson Institute of International Economics explained in an article in Foreign Affairs (Sept/Oct 2012):

“it is the intention of neither Germany nor the ECB to end the crisis quickly. Rather, their goal is to use the crisis to further the economic reforms needed to create a strong European economy over the long run. This helps explain why the eurozone authorities have not built as large a financial firewall as the markets have craved.” (My italics)

Bergsten has spilled the beans on the crude, ideological aspirations of an elite detached from the millions of Europeans over whom they exercise economic and political power.

So, the Eurozone crisis will be allowed to drag on, and to follow the design and progression of earlier twentieth century crises.

Chickens coming home to roost

Back in the 1970s, the weaker economies on the fringe of the global economy were also ‘liberalised’ after the collapse of the stable economic order framed by western governments at Bretton Woods in 1971. (There were no financial crises anywhere in the world during the Bretton Woods era: from 1947 – 71).

But while Bretton Woods led to the ‘Golden Age’ in economics, its architects were hostile to mobile capital. The post-war designers of that economic model prioritised democratic management and regulation of the economy and the finance sector over liberalisation; preferred traders in real goods over traders in money; upheld the interests of the population as a whole and promoted full employment.

There was of course a backlash. The world’s financiers found the restraints on capital mobility intolerable. And so a successful economic model was gradually overturned in the late ‘60s and, emphatically in 1971, by President Nixon’s unilateral dismantling of Bretton Woods.

It was replaced by the old neoliberal economic order based on deflationary policies that had so failed Europe in the 1930s.  (For more on this, read Eric Helleiner’s “States and the re-emergence of Global Finance”)

According to Eichengreen and Lindert: “the three decades following World War II seem to have been…the fulfilment of the benediction “May you live in dull times”. Neither the bond markets nor the banks were leading agents in the process of lending to ….countries….”  With the re-emergence of the old liberal economic order after 1971, things took a revolutionary turn, and financial crises followed with increasing frequency.

The debt crises of the 70s and 80s began on the periphery of the global economy, in Latin America, Africa and parts of Asia. Then to everyone’s surprise, the crisis moved to liberalised, de-regulated Japan in 1990, when its massive credit-fuelled asset bubble burst violently. Tens of trillions of dollars were wiped out with the combined collapse of the Tokyo stock and real estate markets.  Japan’s crisis was however dismissed as an aberration, and of little relevance to western economies.

The Mexican Peso crisis followed in 1995; and then the crisis moved on to Thailand and Indonesia in 1997.

From there followed the Brazilian financial crisis and Russian default of ’98 after which the financial crisis gradually moved to the core (New York and London). Easy, de-regulated credit creation inflated speculation so that New York’s stock markets, e.g. NASDAQ registered a 682% increase from January 1995 to March 2000. This easy money fuelled the dot-com bubble which then burst between 2000-2001.

Finally, the crisis reached the core, beginning on ‘debtonation day’ August 9, 2007 and climaxing when the global financial system imploded with the collapse of Lehman’s in September, 2008.

It was at this point in time, in 2008, that Cyprus joined an economic order that had already ‘debtonated’, but one which the Eurozone authorities continued to defend.

What way forward?

George Soros has recently caused some flurry with his proposals for saving the European Union from this euro crisis. So now at least the systemic nature of the political and financial challenge is acknowledged along with its urgency, and open for debate.

Before the re-adoption of the neoliberal economic model in 1992 and the launch of the Euro in 2000, Europe’s nation states had money systems that supported their development and sustained the livelihoods of their people. Above all, their monetary systems provided democracies with economic tools that protected the sovereignty and autonomy of the nation. The Bretton Woods economic order did not prevent Europeans from co-operating across borders to ensure peace; or from engaging in more efficient cross-border trade. Nor did those money systems weaken Europe’s social welfare model, or European influence in the world.

Today, under the emergence of the old neoliberal economic order, Europe is more divided than ever between creditor and debtor nations. Rather than the promise of convergence, trade imbalances between Europe’s states grow more divergent, dividing north from south. The risk of conflict is rising. The social welfare model is fatally undermined; and thanks to prolonged financial crisis, European influence is waning.

Far from promoting convergence, prosperity and peace, the European economic model is now responsible for increasing resentment towards Germany; the demonisation of southern Europeans; and the rise of right-wing and fascist parties.

So the question becomes, can those of us who are democrats and greens and for want of a better word, progressives, find the political leaders of Europe willing to wrench leadership away from the neoliberal northern states, and take charge of the European project sacred to all Europeans?

Can we find political parties to represent us who are willing to take a joint European-wide approach, whether the countries concerned are in or out of the Euro, and build a pan-European project for inter-union co-operation, economic justice, solidarity and peace?

Can Social Democrat political parties and others extricate themselves from their love affair with Thatcherism and Blairism in order to regain political credibility with voters amongst Europe’s working and middle classes? This must involve a complete rejection of deflationary policies bankrupting sovereign nations, and be replaced by the kind of independent, fair (to both creditors and debtor) transparent framework for the orderly resolution of unpayable sovereign debts, proposed by Professor Raffer of the University of Vienna.

Such an alliance would mean that a real challenge could be mounted against the old monetary order that once again threatens peace in Europe, and that feeds the monsters of political populism and reaction.

Such a force could even form an ad hoc alliance with leaders from the right such as Mariano Rajoy, cited above, leaders starting to realise that the status quo is unsustainable.

Collectively they have the power to demand a new, just and democratic economic order, and the treaty revisions that would deliver such an order. They must be free to do so without the compulsion to engage in intra-European ‘competitiveness’ or in ‘exponential growth’.

If such demands hit a brick wall, this bloc could ultimately engineer a multilateral exit from the Eurozone, and drawing on their own central banking institutions, introduce a ‘Nuovo Euro’. George Soros proposes that Germany withdraw from the Euro. However Germany has a growing trade surplus with her EZ partners, and withdrawal from the Euro would threaten this advantage.

Does Europe have courageous, principled leaders? Could a European leader do what Roosevelt did in 1933 when he refused to attend the 1933 International Economic Conference organised by European central bankers? The conference had been convened to ensure compliance with the neoliberal principles of the gold standard which fixed the value of currencies and forced countries to adjust wages and prices downwards. Roosevelt boycotted the event because, as he argued in a telegram: “the old fetishes of so-called international bankers are being replaced by efforts to plan national currencies” around domestic needs.

Only by confident political leadership around a broad alliance for a new monetary order, based on the democratic right of Europe’s people to respond appropriately to crisis, can Europe hope to escape ‘the fetishes’ of bankers; prolonged depression, social degradation, political upheaval – and even war.

This political leadership must be based on a renewed understanding of what the European economy is for.  It is not for the encouragement and succour of the rich. An economy based on the interests of all who participate in it, will not be hijacked by bankers, Russian oligarchs and criminals. A well-designed economy provides an outlet for human creativity, and meets humankind’s deep desire to work.  It exists to nurture and protect the young, the vulnerable and the old – not just the fit and affluent. It helps a society meet and deal with major adversities such as climate change; and it enhances the pleasures of life for all those that live within it.

That is what an economy is for.

European politicians courageous enough to challenge the ‘shadow state’ would be attacked by the ‘hired guns’ of the economics profession; by bankers, monopolists, oligarchs and their friends in the media; and by politicians who have foregone their right to represent the people.

But the offer of a sound alternative to the Eurozone’s economic model and current immiseration would be wildly popular.

(The views expressed here are those of the author and do not necessarily represent the views of other members of the PRIME network of economists.)

Originally published in the New Statesman blog

Margaret Thatcher’s economic legacy was prompted by the 1976 Labour government’s capitulation to the IMF – but she took it much further.

It is ironic that Margaret Thatcher’s funeral is to take place at St. Paul’s in the City of London. The world around Wren’s great monument is beginning to unravel as a result of the liberalisation forces she helped unleash. Banks are bankrupt, thousands of jobs lost, and the City’s hard-won reputation for honour and fair play is now in tatters.

The most fundamental economic action of the Thatcher era was to intensify the liberalisation of the financial sector. This was dictated by the City and endorsed by early monetarist economists.

The 1970s inflation was caused originally by this liberalisation and expansion of credit, at domestic and international level: too much money chasing too few goods and services. The Lawson boom of the late 1980s in the wake of attempted government retrenchment came as the money supply again became unhinged. Since the start of the liberalisation of finance at the end of the 1960s, the world economy has been on a roller-coaster, driven by repeated cycles of financial excess, inflations, economic failure and retrenchment. The almost unanimously celebrated 1992-2007 boom was an illusion made possible only by a debt inflation of a more severe kind than that of the 1930s.

As the debate over her legacy rages, economists are loud and united in the claim that Thatcher “fixed” the economy. Economists like Professor van Reenan of the LSE make vague assertions about improvements to the supply side, or to competitiveness. These hark back to arguments deployed by the original monetarists – Samuel Brittan of the FT; Brian Griffiths now of Goldman Sachs and an adviser to the Archbishop of Canterbury; and Peter Jay, ex-economics editor of the BBC. They were arguments used to justify liberalisation, and these policies caused the economy to deteriorate in every conceivable way.

An examination of the post-war economic experiences of Britain was included in a 2010 PRIME report, “The Economic Consequences of Mr Osborne“. 1976 is a key date: the point at which the Labour Government allegedly yielded “Keynesianism” to the IMF’s “reforms” that preceded and anticipated Thatcher’s policies.

The most obvious economic headlines pre- and post-1976 are:

• Unemployment averaged 2.3 per cent a year before reform and after 1976 rose to average 7.7 per cent a year;
• GDP growth was 2.7 per cent a year before reform and 2.2 per cent a year afterwards; and
• Income distribution narrowed almost every year before reform.

And then the real transformation occurred. “The scale of the rise in inequality over the ’80s was unparalleled both historically and compared with most other developed countries” according to the IFS in a 2011 report.

It is also a myth that the Golden Age that preceded liberalisation was burdened by an overreliance on the state, or the public sector.

Before Thatcher came to power, the UK had a thriving manufacturing sector. In 1970, 33 per cent of the economy was accounted for by manufacturing. Today that proportion is 10 per cent. Before Thatcher, the owners of firms felt confident to invest: in real terms, capital investment grew by 4.6 per cent a year before her reforms and only 2.6 per cent afterwards.

Economic activity extended beyond the state and traditional manufacturing; there was a golden age of theatre, of design and of course of popular music. Britain could afford healthcare and education for all; secondary and higher education was free; a safety net protected the few that had no work, and a working pension system looked after the old.

Contrary to the economic profession’s consensus, since reform, the size of government has grown as a share of the economy:

• The broadest measure of the size of government, general government expenditure as a share of GDP, grew from 37 per cent to 41 per cent, post Thatcher.
• In terms of the public finances, public debt measured as a share of GDP fell by an average of 5 percentage points a year in the period before Thatcherism. It rose by 1.3 percentage points per year in the period afterwards.

This growth is of course not the positive result of more government spending on goods and services or of government investment. Rather, it represents the costs of the failure of reform. As the economy deteriorated, the cost of welfare and interest payments rocketed.

In all this debate economists forget what the economy is for. It is not for the rich, or just about “growth” or “competitiveness”. Rather, it provides an outlet for human creativity, and meets humankind’s deep desire to work. It creates frameworks that nurture and protect the young, the vulnerable and the old; that ease the adversities and enhance the pleasures of life for all those that live within it.

On these terms the reforms promoted by the economics profession and implemented by Thatcher have failed the people of Britain – catastrophically.

Last week, we pulled together and tweeted a set of charts (including a few screenshots of charts we found) about the Thatcher government’s economic record. They show that on all key fronts, her government failed, absolutely or by comparison with other UK governments over the last 60 or so years. We have now added  some more charts, and offer the information they contain as an antidote to the British establishment’s evidence-lite but ideology-heavy eulogies of her government’s economic performance.

We look at the record on unemployment, GDP changes, manufacturing employment, inflation, current account… and note that her government had the political good fortune of near-peak UK North Sea Oil, whose benefits were thrown away in plugging short term economic gaps, rather than invested for the long term.

Above all, her deregulation of finance and the City of London (continued alas by her successors) set the UK on a false path, one that has severely damaged the UK’s economy and social fabric. And continues to do so. Near the end of this blog, you can find a chart on private sector (especially financial sector) indebtedness which -far outstrippping public sector debt – started to balloon in the late 1980s.

Unemployment

Under Mrs Thatcher’s government, UK unemployment reached its highest post WW2 record. It was over 3 million for 4 long years, a level it has not reached even in difficult times before or since. It was achieved with staggering speed as the economy was, from 1979, kicked into rapid de-industrialisation.

GDP annual changes – a declining trend

Under the Thatcher governments, GDP fell sharply in 1979/80, rose during the Lawson boom, and fell again sharply in 1989/90. But as the next two charts show, the overall trend was no higher than for the whole period 1948 to 2012. In fact, the average increase in GDP from 1948 to 1976 was considerably higher than for the period since then, even though much of it was – especially from the late 1980s –  private debt-fuelled. So much for the much-vaunted positive effect the Thatcher government’s economic policies compared to the earlier period.

Manufacturing jobs – the savage decline

The rapid and large-scale increase in unemployment from 1989 was largely due to the cull of manufacturing and industrial production.  The falls in employment came in two great waves: a vast 1.5 million manufacturing jobs (22.52% of the the 1979 total) were lost in just 4 years from December  1979-83, and there was a further fall of 16,83% (from the lower base) in the 3 years from September 1989 through to 1982. This appears in the two big steps down in the next chart.

The following chart shows manufacturing as a percentage of GDP, rather than simply in employment terms. Each point represents a 5 year period.  The UK started relatively low, fell sharply under the Thatcher government in its early phase, and has continued to decline till it is bottom of the “league table”.

Source Curious Cat economics blog

UK current account

The worst period for the current account (mainly our trade in goods and services) in our post-war history took place under the Thatcher government’s watch. The three years from 1988-90 were (with -3.9, -4.6, -3.5%) the worst three together post-war, and the only comparisons are with 1974(-4%) and…2012 (-3.7%).

Inflation

It is often argued that the Thatcher government saved the nation from the high inflation of the 1970s.  In fact, the record is very mixed.  RPI inflation increase had fallen in 1978 to 8.4%, before rising in the first Thatcher years (1979-81)to 17.2%, 15.1% and 12.0%.  It then fell back sharply until the late 1980s when it shot back up again – to levels not seen since – 1988 6.8%, 1989 7.7% and 1990 9.3%.  So it can be said that she inherited an inflation rate of 7.8% but rising, and finished with 9.3%!  This is hardly the stuff of which legends should be built.

The North Sea Oil boost

As we said at the start, the near-peak years of North Sea Oil were used to bolster the economy in the short-term, not to build a lasting asset for the future like Norway.  The first screenshot chart below shows that a staggering 6+% of GDP came from oil and gas production in the first Thatcher government years.  Without this windfall of political luck, her economic strategy for the early years would have been even more disastrous (our screenshot on this for some reason won’t show!).  The second chart shows how oil almost peaked under the Thatcher government, though oil and gas together climbed higher from 1990 to 2000 before falling sharply in recent years.

 Source of charts : ONS/DECC

Inflating the private debt balloon

Financial liberalisation and deregulation had begun in the 1970s.  However, the Big Bang and prioritisation of the City of London above the productive economy – the flagship policies of the Thatcher government – led to the start of the process of inflating the private debt balloon, that was to grow ever larger under the Major, Blair and Brown governments.  It reached almost 500% of GDP before the gigantic balloon started to deflate with households and non-financial corporations ‘deleveraging’ slightly. This decision to reduce the productive sector and inflate the finance sector – started by the Thatcher government but maintained by her successors – is a strategic error of vast proportion.

Source: ONS & McKinsey, from UK Budget report

Inequality

Inequality worsened extremely rapidly under the Thatcher government period, from a relatively low level (in terms of Gini coeeficient) to a much higher level, where it has more or less plateau-ed or slightly risen until the present government.  But the rise from 1979 to 1989 is truly remarkable. Here is the chart for the Thatcher, Major, Blair and Brown governments:

Conclusion

Far from laying the foundation for future economic success, the Thatcher government caused the UK’s economic development to worsen in comparison with the previous period since the end of WW2. The productive base of the economy was weakened greatly, whilst the finance sector was let of the leash, ultimately with disastrous results. While some progress was made on inflation, by the end of Mrs Thatcher’s term of office in 1990, it was back almost up to 10%, while the UK’s trade balance and current account reached their worst ever points since 1945.  Inequality was ratcheted up, and social divisions exacerbated.  The British establishment’s outpouring of praise for the ‘achievements’ of the Thatcher government is out of kilter with the reality of its actual record.

Political parties in Britain have once more begun to talk about immigration, especially in the wake of the Eastleigh by-election. Unfortunately the debate is usually an all-informed one and typically just a cover to introduce racist notions about the impact of immigration. Therefore it is useful to examine some of the more important economic aspects of immigration.

Immigration

There are a number of countries in the world which have a higher per capita GDP than Britain. There are also a number of countries in the world who have a higher proportion of migrants as a proportion of the population. Both those facts are worth stating simply because discussion in Britain often seems to be dominated by the implicit assumption that Britain is both uniquely attractive to migrants and that it alone experiences immigration.

The chart below shows the countries with higher levels of per capita incomes than Britain. It also shows those countries proportion of the population which is migrant, that is not born in the host country. The table below specifies the data shown in the chart.

Chart 1

Table 1

There are 13 countries in the world with a higher per capita income than Britain. Of these, 10 countries have a higher proportion of migrants. Some of these, such as Australia, Switzerland and Luxembourg have very much higher levels of immigration and have a much higher level of incomes.

There are 3 countries which have higher incomes but lower levels of immigration. However, of these 2 countries, Norway and Iceland have higher per capita GDP because they have a very large energy resource that comes pumping out of the ground (oil and geothermal energy). The remaining country is Belgium, whose geographic position means it has an exceptionally high proportion of people who work in Belgium but commute there from other countries.

By contrast, among the 18 OECD countries with a lower per capita income than Britain 12 also have a lower proportion of the population as migrants. The remaining 6 countries are small economies which generally have specific geographic or historical reasons for unusually high levels of immigration, or both. (The exception in this group is France).

Migration is part of growth

According to the IMF the total number of migrants in the world rose from 75 million people in 1965 to 195 million in 2005. Official data shows that most of that is to high income countries, about 80 million and most of the remainder to middle income countries.

The growth in the world’s migrant population is far more rapid than the growth in the total population. Over the same 40-year period to 2005, the world population doubled while the migrant population grew by 3 times.

However, this cross-border migration captures only a fraction of the world’s total migrant population. From a strict economic perspective there is little difference between cross-border migration and internal migration. This is especially the case when internal migration encompasses vast distances and differences of language or dialect.

According to China’s National Bureau of Statistics in 2008 there were 285 million internal migrants in China. This is far larger than the world’s total number of cross-border migrants. For the migrants themselves this frequently encompasses far greater geographical distances than is required, say, in intra-Western European migration. This level of migration is certainly the greatest level of internal migration in human history. It is also associated with the greatest rate of growth for any major economy in world history.

In India the level of internal migration is over 300 million people according to UNESCO. India’s medium-term growth rate is below that of China, but both countries have been growing at a rate considerably faster than the high income countries. The rate of internal migration has been a necessary accompaniment to high growth rates.

Correlation does not prove causality. But within the high-income countries higher levels of income are associated with higher levels of migration. Within the middle income countries, higher growth rates are associated with higher levels of internal migration.

Economic development depends on two key factors, the proportion of national income devoted to investment and increasing participation in the division of labour.  Migration is a key part of the division of labour, allowing workers to migrate where production (and wages and jobs) are expanding. It also allows production to increase on the basis of employing the most adaptable workers.

Opposition to immigration

The government has recently produced a video to show potential migrants from Romania and Bulgaria that Britain is not a great country to emigrate to. There is a certain logic to this. The only way to stop immigration over the medium-term is to reduce the growth rate of the economy to zero or below. This is the basis for the government’s self-proclaimed success in reducing net migration in the most recent data; by curbing overseas students growth is directly reduced. Of course prolonged economic stagnation would also lead to a more rapid swelling of the 5 million British people who now live overseas.

Immigration of all types provides a substantial net benefit to the British economy, which a Home Office report clearly demonstrates. Growth attracts immigration but is also increased by it. The proportion of workers leaving a country will increases when there is an economic downturn and the proportion of the workforce arriving from overseas will tend to decrease. The reverse is also true: net immigration increases when the economy prospers.

There are a series of reactionary myths about immigration, which are perpetuated in the labour movement by outfits such as ‘Blue Labour’. These tend to focus on the supposedly local or microeconomic effects of immigration, particularly that they drive down wages. These arguments are a rehash of Labour notions which opposed the growth of women in the workforce and even supported restricting their wages relative to men.

Jonathan Portes has done very good work in countering the assertions that immigration drives down wages, even for the very lowest paid workers in Britain. As the Home Office study shows, the average wages for migrant workers in Britain are also about 5% higher than British workers, because on average they are more highly qualified. The relationship between unemployment and immigration is also equally clear; immigration increases while unemployment falls and vice versa.

Chart 2

In reality the debate on immigration in Britain is not about the economic causes and consequences of immigration at all. It is overwhelmingly a ‘debate’ that allows politicians and others to whip up xenophobia and racism, while posing as being concerned about the interests of workers or the poor. The cause of migration is growth, to which migration is a decisive contributor. The consequence is stronger growth. The contrary argument is being raised now as a reactionary diversion from the current economic crisis, and the policies which are responsible for it.

This article was first published in Socialist Economic Bulletin, 29th March 2013

Exactly a year ago today, Jens Weidmann, President of the German Bundesbank, made a really important speech at Chatham House, London, on “Rebalancing Europe”.  It was clear, concise and to the point.  It is also utterly contemporary –  could have been given today. And it said loud and clear – don’t expect Germany to budge one centimetre.  The whole burden of adjustment rests on the deficit countries.

This issue also came through in the last few days in the extraordinary negotiations over Cyprus, with newspapers reporting on differences and friction between the IMF and German government (on the one hand) and the European Commission.

In our view, the differences are not merely tactical but divide even the pro-austerity camp and pose the question - is the burden of adjustment in the euro area to fall solely on debtor/deficit countries?  Or do the creditor/surplus countries have their own responsibility to adjust policies in the interests of the whole zone?

The Commission’s Director-General of financial and Economic Affairs, Marco Buti, and senior adviser Nicolas Carnot, recently said this (in an article in Vox mainly defending the Commission’s record from critics such as ourselves):

For vulnerable countries of the Eurozone that face a large external sustainability gap, external growth is the only sustainable way to grow out of their debts. They must undergo rebalancing. But their adjustment should not be hampered, and ideally be fostered by concomitant changes elsewhere. The improved current balances in the periphery thus have to be matched by rebalancing trends also in Eurozone countries that feature large current account surpluses.

They argue that there is some (we would say modest) sign of German movement, with real wages rising slightly over the last year.  But even their mild comments run utterly counter to Jens Weidmann’s argument set out so clearly a year ago and will have been ill-received in Frankfurt and Berlin.

We thought PRIME readers would like to read what Mr Weidmann said – here goes, with acknowledgement to Chatham House:

The first [question] relates to the macroeconomic imbalances. Their most prominent symptom are diverging current accounts – countries such as Greece run persistent current account deficits, while countries such as Germany run persistent surpluses. The question is: which countries have to adjust? Those with a current account deficit? Those with a surplus? Both? ..

Normally, exchange rate movements are an important channel through which unsustainable current account positions are corrected – eventually, deficit countries devalue, while surplus countries revalue their currencies. The reaction this triggers in imports and exports then helps to bring the current account closer to balance.

 In a monetary union, however, this is obviously no longer an option. Spain no longer has a peseta to devalue; Germany no longer has a deutsche mark to revalue. Other things must therefore give instead: prices, wages, employment and output. [our emphasis]

Which brings me back to my original question: which countries have to adjust?

The typical German position could be described as follows: the deficit countries must adjust. They must address their structural problems. They must reduce domestic demand. They must become more competitive and they must increase their exports.

But this position has not gone uncontested. Indeed, a number of renowned economists take a different view. They fear that it would be too much of a burden for the deficit countries alone to adjust. They consequently suggest that surplus countries should shoulder at least part of the burden.

To avoid confusion, it is important to make a distinction at this point. A distinction between the adjustment as such and the burden it entails. Only the burden can be shared. I think most people would agree that the adjustment itself has to take place in the deficit countries. It is true that surplus countries have benefited through higher exports. But ultimately, it was the deficit countries that operated an unsustainable model defined by a credit-fuelled boom in domestic demand, and this model has to be reformed. Not every deficit country needs the same reforms, of course, but all require some sort of adjustment.

By contrast, it is sometimes suggested that rebalancing should be undertaken by ‘meeting in the middle’, that is by making surplus countries such as Germany less competitive. This suggestion implies that the adjustment as such would be shared between deficit and surplus countries. But the question we have to ask ourselves is: ‘where would that take us?’

The competitive edge some economies enjoy did not come for free. It is the result of often painful adjustments among workers and within firms. Giving part of it up to ease the pressure on deficit countries might make these countries better off in relative terms. But would it not make everyone poorer in absolute terms?

 We have to acknowledge that Europe is not an island but part of a globalised world. And at the global level, we are competing with economies such as the United States or China. I ask you: how can we, how can Europe succeed in this world if we willingly give up our hard-won competitiveness? To succeed, Europe as a whole has to become more dynamic, more inventive and more productive.

In my view, we will gain nothing if we try to rebalance by actively shifting weights at both ends of the scale.

A second point is this: a large proportion of the current account deficits and surpluses result from trade with countries outside the euro area. Even if surplus countries expanded their imports, this would help their fellow euro-area countries to increase their exports only marginally. The latter must first offer something other euro-area countries would want to buy from them rather than from someone else.

 To achieve this, the deficit countries must take measures that unlock their potential to increase productivity and improve competitiveness. This would considerably reduce the cost of adjustment and the time it takes.

 Such an adjustment will initially place a huge burden on the people in deficit countries, even taking into account the extraordinary boom in the years prior to the crisis. But will the burden be too heavy to bear? A central fear is that of deflation. Unless productivity growth increases miraculously, it is certainly true that prices and wages will have to fall in many cases. But we must not confuse such a one-time adjustment with full-fledged deflation.

And we must acknowledge that surplus countries are already helping to ease the burden of adjustment. What are the rescue packages other than publicly guaranteed interim loans to facilitate the adjustment?

Another thing we should not forget is this: of course, surplus countries will eventually be affected as deficit countries adjust. Not every country on earth can run a current account surplus – unless we trade with ‘space aliens’ as Paul Krugman recently suggested.

As the deficit countries import less and become more competitive exporters, surplus countries will run lower surpluses. The key issue is whether this happens as a result of market processes or as a result of efforts to fine-tune aggregate demand in the euro area. I would welcome the former, but I object to the latter.”

This is not the place for a detailed critique, but we can’t resist commenting on the curious picture which emerges of every country in the Eurozone – and we assume the EU – being in surplus.  This implies that most of the rest of the world is in deficit – and by the same logic, would need to adjust in similar ways.  By cutting “prices, wages, employment and output”. Meanwhile, the value of the Euro would have risen sharply, making Eurozone exports less competitive again, at least in the weaker countries.  And this would lead back to Eurozone imbalances once more.

Weidmann strongly denies, though without reasoned argument, the case for more policy-driven demand within the Eurozone, which seems very strange given the 20 years of drive for a stronger EU internal market with greater internal trade in goods and services.  And in fact, the Eurozone taken as a whole suffers from little by way of current account imbalances.

One year on, we have seen terrible continuing economic weakness and decline in many Member States, and recession or near-recession in the supposedly stronger states.  Unemployment is many countries is at an all-time high.

The German-led EU and Eurozone policy of coordinated austerity – based on a phantasy quest for universal extra-Eurozone trade surpluses on the part of the Eurozone countries – is proving deadly in practice.  It is time to change course.  Mr Weidmann is a clever and articulate spokesperson for adjustment through austerity.  But he has been proved wrong.