A Tale of Two Faux Crises: Italy, Spain and the Euro Money and Development Seminar Series 29 February 2012 John Weeks Professor Emeritus, SOAS

Background: Two non-technical articles: "Democracy in Europe and the Italian Crisis" In Insight "Catastrophe Now: The Euro Runs its Course" In the Social Europe Journal Both linked on

Statistical Sources: 1. OECD (click on "statistics") 2. Eurostat Especially Supplementary Tables on the Financial Crisis

Definitions 1. Debt: gross and net OECD definition of the net debt is liabilities minus liquid assets. Examples: In 2011, Norway's gross debt was just below the infamous Maastricht criterion at 56% of GDP. Its net debt was minus 160 percent of GDP. For the UK the numbers were 90% and 64%. 2. Deficits Total fiscal balance is revenues minus expenditures. The primary balance is net of interest, which the IMF uses for its test of fiscal stability. For no obvious reason, the Maastricht criteria refer to the gross debt and total fiscal balance.

Simple algebra of deficits: Define: B = fiscal balance = revenue - expenditure B* = primary fiscal balance = revenue - non-interest expenditure = zY - (Ē - eY) z is the tax rate (average = marginal) Y is national income Ē is discretionary expenditure e is automatic counter-cyclical expenditure

B* = Y - [Ē - eY]  B* = [z  Y + Y  z] - [e  Y - Y  e] d' =  B/Y = [z + e]g If  z =  e = 0 g =  Y/Y, GDP growth rate, d' = first difference of the primary fiscal deficit,

The Italian Story: High borrowing rates in the 1990s and German trade policy in the 2000s

Yield on long term public bonds and interest payments as share of GDP, [Interest rates now lower than for ]

Italy: Total and primary deficits, [Lowest primary deficit in the euro zone and recent decline recession-generated]

Italy: Changes in the public sector balance has been GDP driven, (share of GDP)

Italy: The public debt "burden" has declined, [real value of net debt in 2011 same as 1997]

Fiscal balance in surplus, net debt steady, what is the problem? [Not real wage inflation as suggested by Krugman]

German trade policy is the problem: Italian-German trade balance & unit labour costs, [Falling German unit costs result of relatively faster productivity increases and export subsidies]

Inflexible labour market in Italy? Not according to the OECD

The Italian story summarized Italy has not had does not have an excessive fiscal deficit. On the contrary, for the last twenty years it has had the best primary fiscal balance in the European Union. In the 1990s it suffered from unwise borrowing at high interest rates. That problem is over. Present "unsustainable" interest rates are well below the level of the 1990s. Italy's public debt is no larger in real terms than it was twenty years ago. Its interest-adjusted "burden" is far lower.

Italy has a serious trade deficit with Germany, that results in great part from implicit and explicit export subsidies. The most important of these are: 1) suppression of domestic demand 2) VAT and pay roll tax relief on export commodities

The Spanish Story: No good deed goes unpunished.

Fiscal surpluses in Spain,

Even in Spain recession causes deficits GDP and the total deficit,

And growth reduces the deficit Spain: GDP growth and the first difference in the primary balance,

Spain & the euro During property speculation resulted in an asset bubble in Spain as or more extreme than in North America. The speculation included large exposures of Spanish banks in the US sub-prime market. When the bubble burst, the Spanish government embarked on a bank recapitalization ("bailout") that generated an annual average primary deficit of minus 7% of GDP. In the absence of the bailout the primary fiscal balance was minus 2% of GDP.

Spain: Public sector balance,

The Spanish story summarized: [technical term is "chutzpah"] To save the financial sector from collapse, the Spanish government [social democrat!] bailed it out. The bailout more than tripled the fiscal deficit. The rescued Spanish financial institutions used the bailout funds to speculate on government bonds, thus creating the fiction that public finances were unsustainable.

What to do in the euro zone Comment on Krugman & devaluation German expansion Deficit country export subsidies

The Great Euro Scam Along side the Tulip Mania of the 1630s, the South Sea Bubble (1720s) and other ponzi schemes will go the Great Euro Scam of the 2000s, characterized by both tragedy and farce. The farce: Central Bank of Europe leaning to banks at 2-3%, so the banks could buy Greek, Italian, Portuguese and Spanish bonds paying 7-15%.

The tragedy: The political purpose of the "crisis", the end of social democracy and weakening of representative government, is succeeding.