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.
The negotiations between Greece and the Eurozone financial chiefs represent a typical game of ‘Chicken’. Chicken readily translates into an abstract game. Strictly speaking game theory’s chicken dilemma occurs at the last possible moment of a game of highway chicken. Each driver has calculated his reaction time and his car’s turning radius, which is assumed to be the same in both cars. There comes a time when each driver must decide to either swerve or keep going straight towards the other car. This decision is irrevocable and must be made in ignorance of the other driver’s decision. There is no time for one driver’s last-minute decision to influence the other driver’s decision. In its simulations, life or death simplicity, chicken is one of the purest examples of John von Neumann’s concept of a game. The way players rank outcomes in highway chicken is obvious. The worst scenario is for both players not to swerve – they crash and both are killed. The best thing that can happen is for you to keep driving straight letting the other driver swerving. The cooperative outcome is not so bad as both drivers are still alive although no one can call the other chicken.
As in the game of Chicken, both Greece and the Eurozone have the option to make concessions (Swerve) or hold firm in negotiations (Drive Straight). As with most negotiations, the best outcome for a party is to stand their ground while the other party makes the concessions. However, as both parties want this outcome, this raises the possibility of both sides holding firm and no settlement being reached. In the Greek-Eurozone crisis, this would mean a Greek default and the associated consequences that would ensue for the rest of the Eurozone.
Fortunately there is a third outcome that can prevail in Chicken – both parties can swerve their car at the same time. If both sides are willing to make concessions, then the second best outcome in this game can be attained for everyone. This co-operative outcome could be reached if the Eurozone extended further concessions to Greece, while Greece made binding promises to implement meaningful reforms to get their economy back on track.
However this is unlikely as each player achieves their best outcome by doing the opposite of their opponent. For example, if Greece believes the Eurozone will make concessions, it will achieve the best outcome by standing firm; if it believes the Eurozone will stand firm in negotiations, it’s best option is to make concessions to avoid the dire consequences of a full-blown default.
From the beginning of June until the end of December Greece needs to find another EUR28bn in total. After that point repayments drop off – one reason why Greece’s creditors are keen to ensure new reforms are enacted ASAP.
The inference however is clear: Greece won’t make it that far without a new deal. Greece is waiting on further funding from the IMF and the ECB (EUR 7.2bn) in order to meet some of these payments, but with both sides digging in, it isn’t a given that Greece will receive the funds. See graph below.
Sources: NAB Australian Markets Weekly, Christoph Schumacher Massey University, Open Economy – Open minded Economics, Prisoner’s Dilemma – William Poundstone
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.
Below is an article from The Economist that focuses on stagnation in the euro-zone economy. I have put together a worksheet on the passage that you may find useful.
THIS week’s figures for the euro-zone economy were dispiriting by any measure. An already feeble and faltering recovery has stumbled. Output across the euro area was flat in the second quarter. That followed a poor start to the year when the single-currency club managed to grow by just 0.2% (0.8% at an annual rate).
There were some bright spots in the bulletin of misery. Both the Dutch and Portuguese economies, which had contracted in the first quarter, rebounded, growing by 0.5% and 0.6% respectively. Spanish growth picked up from 0.4% in the first quarter to 0.6% in the second. But these perky performances were overshadowed by the poor figures recorded in the three biggest economies. Italy, the third largest, had already reported a decline of 0.2%, pushing it into a triple-dip recession. France, the second biggest, continued to stagnate. But the real blow came from Germany, the powerhouse of the euro zone, where output slipped by 0.2%.
The setback may reflect some temporary factors, as workers took extra time off after public holidays. German output was also depressed by a fall in construction, some of which had been brought forward to the first quarter thanks to warm weather. This effect should also be temporary. However, the tensions between Europe and Russia over Ukraine and the resulting sanctions may adversely affect German growth in the coming months.
The new GDP figures are yet more evidence that the euro-zone economy is in a bad way, not least since it has come to rely so heavily upon Germany, which had grown by 0.7% in the first quarter. It is not only that growth is evaporating; inflation is also extraordinarily low. In July it was only 0.4%, far below the target of just below 2% set by the European Central Bank (ECB). Consistently low inflation has prompted fears that Europe will soon slide into deflation. Prices are already falling in Spain and three other euro-zone countries.
Deflation would be particularly grave for the euro area because both private and public debt is so high in many of the 18 countries that share the single currency. Even if inflation is positive but stays low it hurts debtors, as their incomes rise more slowly than they expected when they borrowed. If deflation were to set in, the effects would be worse still: when prices and wages fall, debts, which do not shrink, become harder to repay.
The poor GDP figures will intensify pressure on the ECB to do more. Already in June it lowered its main borrowing rate to just 0.15% and became the first big central bank to introduce negative interest rates, in effect charging banks for deposits they leave with it. That has helped bring short-term, wholesale interest rates close to zero and has also weakened the euro. Both these effects will help to bolster the economy and restore growth.
As well as these interest-rate cuts, the ECB announced that it would lend copiously to banks for as long as four years, as long as they pledged to improve their own lending performance to the private sector. The plan, which resembles the Bank of England’s “funding for lending” scheme, has some merit but may not boost lending as much as expected due to the feeble state of the banks. It will also take a long time to work its way through the economy.
The ECB’s critics say that this is not enough and urge the central bank to introduce quantitative easing—creating money to buy financial assets. The ECB is likely to hold off; it seems to consider QE as a weapon of last resort. For his part Mario Draghi, the central bank’s president, urges countries like Italy and France to get on with structural reforms that would improve their underlying growth potential. Patience on all sides is wearing thin.
Read the article from The Economist and answer the questions below:
a) What happened to the GDP figures for the euro-zone economy in the second quarter for 2014? (2)
b) What have been the surprises in the contributions of the six countries mentioned in the articles? (3)
c) Although the GDP figures are dispiriting there is the indication that this is a temporary problem. Explain (2)
d) Comment on the level of inflation in the euro-zone and the target set by the European Central Bank (ECB). (4)
e) Why is deflation particularly grave for the euro area? (4)
f) Explain negative interest rates. Why has this policy been implemented by the ECB? (4)
g) What have the ECB’s critics suggested they should do and explain how this policy works. (4)
Franz Nauschnigg wrote a piece in Project Syndicate about an emerging imbalance in the goods and services deficits that Portugal, Italy, Ireland, Greece and Spain (PIIGS) have with China. Up to 2004 the biggest deficits of the PIIGS economies was with the rest of the eurozone. But in subsequent years the figures were the following:
From the figures you can see that over the last 4 years the deficit with China has remained significant while it has narrowed with the eurozone especially with Germany. There are two reasons for this:
1. The euro has appreciated against the renminbi.
2000 – € = ¥7.4
2007 – € = ¥10.4
With this appreciation the eurozone countries exports became less competitive. The early 2000’s saw a lot of investment into the PIIGS economies which increased inflation and prices.
2. With the southern economies dependent on textiles, footwear etc the stronger euro made Chinese imports a lot cheaper than the domestic alternative. The IMF acknowldeged the fact that Chinese exports were responsible for the deficits in the PIIGS but Northern Europe wasn’t as badly affected as their export focus is more machine based which China is not able to compete with.
With monetary and fiscal expansion becoming ineffective external adjustments under three conditons might be the answer:
1. Stronger external demand
2. A less onerous financing environment
3. A weaker euro
Much of the above could be achieved by a weaker euro against the renminbi. This would provide the boost to export revenue and reduce fiscal and external deficits.
The 10bn-euro (US$13bn) bailout of Cyprus’ economy, agreed by the EU and IMF, demands that all bank customers pay a one-off levy and has led to heavy cash withdrawals.
Under the currently agreed terms, depositors with:
* Less than 100,000 euros in Cyprus accounts would have to pay a one-time tax of 6.75%.
* More than 100,000 euros would pay 9.9%.
The BBC says the president may want to lower the former rate to 3%, while raising the levy on the larger depositors to 12.5%. Some EU source told Agence France-Presse there could be a three-way split on the level of levy, grouped into accounts holding less than 100,000 euros, between 100,000 and 500,000 and more than 500,000. The clip below is from Al Jazeera – it shows at one bank in the Limassol district, a frustrated man parked his bulldozer outside and threatened to break in.
David A. Rosenberg an economist with Clusken Sheff in Canada, has likened the world economy to that of a car being driven by a drunk – that is the car is moving back and across the centre line just missing the ditches on the side of the road. Currently he sees the car in the middle of the road although he questions as to whether this is due to the driver becoming more sober or steering towards the ditch on the other side.
Recently the US stock market (Dow Jones Industrial Average) went above 14000 for the first time in more than five years for the following reasons:
1. Better job figures – employers added 157,000 jobs in January and hired more workers in 2012 than had previously been thought. See chart below.
2. Corporate earnings have been stronger than expected,
3. US Federal Reserve has indicated that it will keep interest rates at near zero levels as well as continuing their policy of monthly $85 billion purchases of bonds and mortgage-backed securities, which injected $3 trillion into the banking system last week.
This third point is particularly important. In the New York Times, Rosenbery stated that he didn’t see the US economy in a recession as yet but could quickly go in that direction. “Anemic growth is my baseline scenario.” Also how long can the US Fed keep propping up equity markets and pumping money into the system? The conditions in Europe are not much better – unemployment rose to record levels in December last year and currently stands at 26.8% in Greece and 26.1% in Spain. Add to that the austerity measures which have impacted greatly on overall aggregate demand and the consumer slowdown in Germany, the eurozone area has its problems. So the car might be in the middle of the road right now but it might not take too much for it to deviate from a safe path.