Remember the line in Monty Python movie ‘Life of Brian’, ‘What have the Romans ever done for us?’ This can be applied to the question of a British exit from the EU – ‘What has the EU ever done for us?’ Below is an informative video clip from the FT with a bit of humour. The questions in the Pub Quiz are:
- Which country I am describing in the year it joined the EU? Is the poorest European nation – incomes slipping behind its European competitors by £185 per year. Regular power cuts.
- In 2015 who was richer? The average person in German, France and Italy or England, Scotland and Wales?
- What caused Britain’s improved performance?
- How has Britain’s membership of the EU improved economic performance?
- Has the EU made Britain richer?
Basically the answers suggest that EU membership has been very beneficial to the British economy.
German Current Account Causes
- Germany’s labour costs have been approximately 20-30% lower that its Eurozone competitors and the German real exchange rate is strongly undervalued relative to the rest of the eurozone. This makes its goods artificially cheap, crowding out those of other eurozone countries from both eurozone and world markets. If Germany still had the D-Mark, it is almost certain that the increased competitiveness of German exports would have caused an appreciation in the German currency. This appreciation would have rebalanced demand – increasing the price of exports and reducing the price of imports. A flexible exchange rate would have moderated the rise in the German current account surplus.
- German manufacturing has been very competitive in recent years with improvements in productivity, and high-tech German exports have weathered the global downturn, better than many other countries. Germany had less exposure to financial services and has a very competitive manufacturing sector.
- Germany’s jobless rate is at a very low 4.7%. This should be stimulating demand but the German regulatory and tax structure is geared in favor of output and exports, and against consumption and investment. Furthermore, the German government are running budget surpluses which takes money out of the circular flow. This is when its infrastructure is looking very tired – canals, the rail network and autobahns need upgrading. Investment has fallen from 23% to 17% of GDP since the early 1990’s. Net public investment has been negative for 12 years.
German Current Account Consequences
- The large current account surplus and undervaluation of currency was good for Germany, but it was holding back exports in other countries. Greater German domestic consumption and targeting higher inflation would provide a boost to global demand and help to stimulate growth in terms of export demand especially in southern Europe. Surpluses steal demand from elsewhere and they export unemployment to other countries. This matters in an era of “secular stagnation” and excess global savings.
- Given the imbalances in the Eurozone, southern European economies face a long period of deflation as they slowly seek to restore competitiveness against their northern competitors. However, given European wide austerity, this period of deflation is proving very costly in terms of lost GDP and high unemployment.
With euro area finance ministers meeting to discuss the Greek debt issue there has been positive news with regard to the the overall growth in the euro economy. Driven by consumption (C) and Investment (I) the German economy grew by 0.7% in the Q4 which makes the annual figure 1.4% in 2014 – see graph below. This helped the overall growth rate of the euro zone area 0.3% in Q4. The German figure is surprising when you think of the economic sanctions against Russia which has hit hard the German export market (X) – export volumes contracted 2% in Q4 in 2014. By contrast the DAX (German Stock Market indicator) recorded an all time high of 11,013 and German real wages rose 1.6% which was helped by falling oil prices.
Other euro areas didn’t do as well as their German counterparts but the important fact was that figures were more optimistic and better than expected for Q4 2014:
Source: National Australia Bank
I got this image from The Economist and used it for a recent A2 Test on Macro-Economic conflicts. Recently the OECD and the IMF have urged the European Central Bank (ECB) to cut the bank’s main lending rate from the already low 0.25% to zero. How might this effect countries in the Euro-area? It will tend to impact euro zone countries differently because of where they are in the business cycle. If you look at the unemployment and inflation figures from the graph you see the following:
Austria 4.9%, Germany 5.1%, well below the EU average of 11.8%.
Spain 25.3% and Greece 26.7% very high unemployment.
Some countries have had unemployment dropped significantly during the period –
Latvia approx. 22% to 11.6
Estonia approx.. 18% to 7.8%
Highest rate Malta &Austria 1.4%, Finland 1.3%
Lowest – Greece -1.5%, Cyprus -0.9%
Reducing the interest to zero is an expansionary monetary policy which is a tool to increase aggregate demand, economic growth and employment. Monetary Policy, which is determined by the ECB, will have different effects in different countries. The ECB responds to aggregate levels of inflation and unemployment, not individual country levels – Unemployment is 11.8% and Inflation is 0.5%. Therefore it is a one size fits all policy. However some member states maybe experiencing rising levels of inflation and lower levels of unemployment whilst others might be the opposite – falling levels of inflation and higher levels of unemployment.
Assume an EU member experiences an asymmetric shock. It will have a different inflation and unemployment rate than the rest of the EU. With the ECB setting a common interest rate for the whole area, countries have lost an important part of their monetary policy. This is a major problem if a countries economy is at a different stage in the business cycle. For instance in 2014, Austria and Germany are growing with falling unemployment and a further lowering of interest rates may not be the best option for them. This is in comparison to other countries who need lower interest rates and a more stimulatory environment. With low interest rates and falling unemployment, Austria and Germany could experience inflation levels above the 2% target of the ECB and also a tight labour market which could put pressure on prices. Furthermore a lower interest rate affects those who want to save money in those countries.
At the other end of the spectrum Slovakia, Portugal, Cyprus, Spain and Greece are experiencing deflation and very high levels of unemployment. They therefore require more stimulus through lower interest rates to try and boost growth and employment and get out of the dangerous deflationary cycle.
Other countries with low inflation and high levels of unemployment will benefit from the cut in interest rates – Ireland has had unemployment fall from approx. 15% to 11.8% and an inflation rate of 0.3%. Therefore monetary stimulus is warranted. However the interest rate whether expansionary, neutral, or contractionary is unique to where each country is in the business cycle. The loss of monetary sovereignty clearly poses problems for members states whose economy is out of line with the euro zone norm.
With the change of government in France and the calamity of the Greek economy there has been a flight of Euros into the London property market. New French President Francois Hollande has proposed significant changes to the tax structure in France:
– 75% tax on income earned above €1million
– 45% tax rate for people making €150,000 more.
In recent months the real estate market in London’s most exclusive areas have become a safe haven for those holding euros as they fight to maintain the value of their money with the euro depreciating rapidly. Furthermore as Greeks start to withdraw euros from their own banks one wonders how long they can stay in the eurozone. What is for sure is that the London real estate sector is doing very well out of this. Below is a clip from CNN.
With increasing debt, out of control unemployment and a general strike Spain has some serious economic problems. However, before the financial crisis of 2008 Spain was seen as a prudent member of the Eurozone with GDP debt being half that of Germany at 36%, and a well regulated financial sector. But since the aftermath of the financial crisis it has been all downhill for the Spanish economy with unemployment now at 24% and public debt at 66%.
Causes of the downturn
Like most economies before the financial crisis Spain had access to cheap credit. This was especially prevalent since entering the Eurozone interest rates, which were set by the European Central Bank ECB) in Frankfurt fell from 12.75% in 1995 to 3% in 2005.
Spain’s banks and households realising that they had massive debts whose collateral was overpriced housing. Property values have fallen 27% and the building of new home is down 80% and given the size of the construction sector mentioned above this has some major implications for the Spanish fundamentals.
The Spanish economy is in serious trouble. With unemployment at 24% and the subsequent fall in consumer spending can it get much worse? Well, rating agency Standard & Poors have proceeded to downgrade Spain to BBB+ rating, which means “adequate payment capacity” and is only a few notches above a junk rating.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.
The New York Times ran an article on the Polish economy and how it can learn from the mistakes of the Irish. There are similarities between Ireland of the 1990’s and Poland with huge amounts of foreign investment being injected into the Polish economy. But Poland, with a population of 38.5 million people, seems to have learnt that countries should not adopt the euro until their economies and labour markets are flexible enough to compensate for the loss of control over exchange rates. During the financial crisis because the currency was still the zloty the Poles could use their currency to assist their economy – a weaker currency makes exports cheaper and imports more expensive. The zloty has fallen about 18% against the euro but this has made Polish products competitive on world markets and insulating Poland from the effects of the sovereign debt crisis. Poland was the only European Union to avoid a recession and none of its banks needed to assisted during the global credit crisis.
But Poland was lucky that, in contrast to Ireland, its banking industry was still small compared with the total size of the economy, with less potential to do damage. Household debt is relatively modest. Poland also benefited from the strong economy in neighbouring Germany, which accounts for a quarter of exports. One risk for Poland is that some of its growth is based on an influx of European Union aid and other one-time factors, like the construction of new stadiums and other projects related to the European soccer championship, which Poland and Ukraine will co-host in 2012. The country is practically one big construction site, with numerous road and bridge projects and public works, including a new subway line in Warsaw.
If those projects are done well and make the economy more productive, they will contribute to growth. If not, there could be a slowdown when the flow of money ebbs. Nor can Poland completely isolate itself from problems in the euro zone. It would be vulnerable to an unexpected slowdown in Germany.