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News : EU Economy Last Updated: May 30, 2013 - 8:25 AM

Austerity, growth and the European Commission's deficit procedure
By Michael Hennigan, Finfacts founder and editor
May 29, 2013 - 7:24 AM

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Net new jobs in France from the 1970s

The European Commission is set to announce its budgetary assessments on EU member countries today at a time when the debate on austerity versus growth has intensified a year after the election of  François Hollande, as French president, had raised false hopes that that a meaningful growth pact could offset the impact of fiscal measures in struggling economies. The so-called excessive deficit procedure (EDP) is important for Italy's new government as the closing of the process begun in 2009 when Rome breached the European Union's deficit ceiling of 3% of GDP (gross domestic product) would free-up resources of about €12bn, Graziano Delrio, regional affairs minister, told La Stampa on Monday. 

Pier Carlo Padoan, chief economist at the Organisation for Economic Development and Cooperation, said in an interview with La Repubblica according to Reuters, that he expected a further, significant fall in government bond yields once the EU closes the procedure.

La Stampa said that with a deficit-to-GDP ratio of 2.9%, fiscal policy cannot be relaxed, the Commission said, and has drafted six recommendations: continue the path on fiscal consolidation, strengthen the banking system, improve competitiveness in closed markets, reduce the tax burden on families and companies, reform central government, and promote more flexibility in labour markets. New EU funds would provide for a new scheme to fight youth unemployment.

On the other hand. it would cost Hungary more than 100 billion forints ( €346m) annually if it failed to exit the EDP this year, which dates from 2004, Laszlo Parragh, the head of the chamber of commerce and industry, said in Brussels late on Thursday according to Politics.hu.

At a forum of the Hungarian Economic Club in Brussels, Parragh criticised foreign banks, mainly Austrian ones, which he said took a “take the money and run” approach to business in Hungary and have drawn huge amounts of funds out of the country. He said Hungary’s banking system was 89% foreign-owned and this needed reform.

Enrico Letta, Italian prime minister, told the Senate last week that exiting the deficit procedure would ease conditions for small and mid-sized enterprises during the current recession -- the worst downturn since 1945.

Letta cited Italy's decision to pay down €40bn in commercial procurement arrears as an example of the kind of extra measures Rome could take if the strictures of the deficit procedure were definitively removed.

On the political front, the prime minister got some goods news at the week-end when his left of centre Democratic Party did better than expected in local elections, which saw a collapse in support for the anti-establishment Five Star Movement.

The Five Star Movement failed to get to the second round run-off, to be held in two weeks, in any of the 16 major towns and cities holding elections among more than 500 local councils.

Austerity v Growth

The overall Eurozone budget deficit dropped by 1.5% of GDP in 2012 to 3.7%, This compares with 6.4% in 2009 but a further 0.75% shrinkage is required this year, the Commission forecast this month.

The US plans to cut its budget deficit by 2% of GDP in 2013 from 2012.

Despite the US cutbacks, US annual city home prices in March saw the biggest rise in seven years and consumer confidence in April rose to a five-year high.

These indicators have of course have to be reflected in consumer spending and new house building.

The overall Eurozone consolidation will be only 0.1% of GDP in 2014, the Commission said, compared with 1% in the US.

The US budget deficit is set to fall from 7% of GDP in 2012 to 2.1% of the economy in 2015. By 2023, it is forecast to be up to 3.5% of GDP. Federal debt held by the public is projected to remain above 70% of GDP - - far higher than the 39% average seen over the past four decades. (As recently as the end of 2007, federal debt equaled 36% of GDP.)

Since the recession ended in 2009, the federal budget deficit has topped $1tn every year.
It is now shrinking far faster than anyone in Washington expected, and maybe faster than many economists think is advisable for the health of the economy with the broad rate of unemployment at 13.9%.

In an op-ed in The Guardian on Tuesday, Joan Burton, Irish minister of social protection, joined with four other European politicians and officials, in arguing that there can be no solution to the European Union's crisis without restructuring the economic and monetary union.

They call for 1) an EU-level banking union 2) consolidation in weaker member states needs to be balanced by higher consumption in stronger EU countries 3) they call for investments in a sophisticated industrial policy and support for entrepreneurship, so that restructuring produces sustainable business models 4) Europe's monetary policy must become more expansionary and the ECB must tolerate higher inflation 5) Europe must ensure that every young person gets a job, apprenticeship or learning opportunity within four months of becoming unemployed.

A banking union would be welcome.

As for the stronger countries counterbalancing the cutbacks in struggling economies, this is really about Germany spending more as France the second biggest economy in the union is struggling to sort out its own problems.

If the argument about Germany spending more is expected to be taken seriously there, some range of costs should be put forward -- without that it will remain an armchair mantra.

European Commission research shows that a 1% rise in German domestic demand would mainly benefit domestic production and its effect on the German trade balance would amount to about 0.2% of GDP; the greatest benefits would be for the Czech Republic, followed by Slovakia, Hungary, Austria, and the Netherlands.

The trade balances of Spain, Italy and  Portugal would gain 0.02% of  GDP, and the Greek balance would be less.

France's debt is projected to be 92.7% in 2013 and the IMF expects Germany's to be 80.4% of GDP.

Germany cannot counter the plunge in cross-border flows during the crisis.

There is a need to spur demand and in 2008/09, the G-20 comprising the 19 leading advanced and emerging economies, deployed stimulus of $2tn with the US and China providing $1.3tn.

China was the main driver of the stimulus spending in Asia as it had a stimulus package worth 12.7% of its 2008 GDP. Meanwhile, advanced economies spent 3.4% of their 2008 GDP on stimulus. 

Today, China is downscaling its huge investment spending and the US political situation will not even countenance a credible infrastructure budget - - the US gas tax that goes into an infrastructure fund, has not been increased since 1993, and its buying power, accounting for inflation, was estimated by The New York Times at only 11 cents in 2011. 

In London last month, David Lipton, first deputy managing director of the IMF warned: "If recovery does not materialise, the euro area could find itself facing the spectre of policy quicksand—in which relentless balance sheet deterioration drags the economy in deeper and blunts the impact of even bold policy adjustment. We saw that scenario play out in Japan over the past 20 years. It has only been in recent months that the new government and BOJ leadership have started to take more vigorous action to escape deflation decisively."

In Europe cross-border capital flows are seen as culprits of the crisis but not all of them were for speculation. The level has plunged since 2007 and it's simply foolish to think that governments can  fill this breach. However, big European companies have over €1tn in cash but they are inclined to invest in emerging markets.

Cross-border capital flows rose from $0.5tn in 1980 to a peak of $12tn in 2007 and down to less than $5tn in 2012. Eurozone banks have cut such cross-border lending and other claims by almost $4tn since 2007, and central banks now account for more than 50% of capital flows within the region.

Greece, Spain and Portugal were able to raise their exports to non-EU countries substantially between 2009 and 2012. Greece's non-EU exports rose by 181%, compared to only 19% in the four years from 2005 to 2008. Spain and Portugal as well were able to boost their extra-EU trade by 70%. Italy and France recorded the smallest increases.

However, Austria exports roughly three times as much to non-EU countries as Portugal or Greece.

In 2000-2007, 3m of 14m additional jobs in the EU related to rising trade with ex-EU27 countries.

The European Commission says that almost all Eurozone member countries saw an expansion of private indebtedness up to 2007, and this was particularly so in Spain and Ireland. The major exception was Germany, with private indebtedness increasing by only 6% of GDP between  2000 and 2007, compared to an average of 51%  for the Eurozone.

On competition from China, the Commission says intense competition was concentrated in a few sectors: mineral products, miscellaneous manufacturing (which includes furniture and toys), textiles and footwear. On the contrary, in some other sectors, such as chemicals or vehicles, overlapping is very low in relative terms.

Some surplus countries, particularly Germany, benefited from demand from emerging and also oil-producing economies for machinery and investment goods while it was particularly the peripheral Eurozone countries whose exports competed with those of emerging countries, and "the core countries led by Germany coped rather well."

Among the bigger economies, it is in Germany that the extra-EU exports made the largest contribution to total employment (9.6% in 2007), followed by the UK (8.1%), Italy (7.7%), and France (7.1%). In contrast, in Spain this ratio was notably lower (4.1%). in 2007, the largest number of jobs supported by extra-EU exports could be found in Germany (3.8m), UK (2.4m), Italy (1.9m), and France (1.8m).

The European Commission has commented:

"The elusive recovery of income in many EU Member States despite the swift recovery of exports during this recession points as well in the direction of the weight of internal factors. To see this, note that countries without internal imbalances, whose income is recovering from the initial contraction, are also those countries in which imports are recovering as fast as exports. Countries stagnating show a recovery of exports – external demand is independent of internal developments – but not of imports or other components of internal demand.  It may be worth noting that an immediate corollary to this observation is that devaluations are only one of the instruments in the policy toolbox to fight the consequences of a recession. Both euro and non-euro Member States are witnessing strong increases in exports, but some countries see their income stagnate while others are recovering fast, and this in both groups. Factors other than price competitiveness seem to be playing a determinant role."

In Ireland, Joan Burton has endorsed a dual labour system in the public service and the number of apprenticeships in Ireland is 10 per 1,000 employed compared with 39 in Germany, 44 in Switzerland and 20 in the UK. There is hardly any female participation in the Irish system.

There is a community role in returning to growth but each country also has a crucial role in the process.

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