The European Financial Crisis revisited: the Germanification of Southern Europe.

It has been an interesting few months in Europe. The Greeks have just had their first round of parliamentary elections and need at least another round before a government can be formed. The French have just elected a new president on an anti-austerity platform, making it a clean sweep around Europe: in every country populations have punished their government for the recession following the GFC. Meanwhile the Germans are being their obstinate selves, clinging to a fiscal treaty no-one else has any intention of sticking to.

Ingratitude on display

Ingratitude on display in Greece

The main mistake being made by European politicians, and in particular the German ones, has been to prevent countries going bankrupt that have no hope of balancing their books without radical reforms. The temporary bailouts allow those countries to avoid truly reforming, completely paralysing those countries and exasperating underlying problems (As the ECB bank-president said just yesterday!).

The mistake of getting involved in bailouts was made early on, but reached its crescendo with the 130 billion euro gift to Greece in March 2012. It was an act of gross folly but there simply was no mechanism at the time to avoid agreeing to the bailout; the Greek politicians were signing every insane promise asked of them and Germany ran out of excuses not to agree to the bailout. That generosity helped the Greek politicians to keep buying off their domestic supporters but is proving the old adage that there is little people resent more than charity, and it will in the medium run achieve the opposite to the financial stability some hoped to gain from it.

To start with the ingratitude, Germany is now depicted once again as the evil man of Europe in popular media in Greece, Ireland, Spain, and Portugal. Rioting protesters in Athens burned German flags and newspapers carried pictures of Angela Merkel wearing  a Nazi uniform. Cartoons in Greek newspapers depicted Merkel and the Finance Minister Schaeuble as running concentration camps for Greeks.

This despite the fact that the Germans not just directly sent huge amounts of money to the governments of these countries, but even allowed the European Central Bank to send more money to their troubled banks in the order of a trillion euros in total, which in effect is printed money and thus a form of tax on the whole of Europe. These populations should be thanking the Germans on their bare knees, but the reality is the opposite. Why and where is this going to?

For one, opportunistic politicians in all these countries have caught onto the trick of blaming the Germans and other European countries for the problems of their own making. They make ludicrous public demands for the rest of Europe to bail them out, or even blame them for the housing booms that preceded and worsened the financial crisis. And populations, with their exceptionally limited understanding of how financial matters go, lap it up and increasingly vote for anti-European political parties.

So far, German politicians seem to be oblivious of the damage that their generosity is doing. Instead of realising that they are setting themselves up for trouble, they insist other countries abide by Stability Pacts and austerity measures. They send financial experts to come and check the books, of course finding one discrepancy after the other. This makes it simpler for politicians elsewhere to pretend that the Germans are to blame for their problems and thus allows them to shirk their own responsibility.

A good example of irresponsible posturing in France is all the talk of using the European Structural Funds to give the European economy a boost. It sounds reasonable to call for the freeing up of money that is being idle, but a quick look at what these funds actually do and their size is sobering. For one, there are few funds in the world which do more useless and corruption-inviting projects than the ESF (see here for a nice discussion): lots of tunnels and roads that have only sheep as regular users. The idea that building some more concrete goat tracks will save France is fanciful, to say the least. More importantly, there is just not all that much money being idle in these funds. The European Social fund has no more than about 15 billion to spend per year and the European Regional Development Funds have a budget of about 35 billion a year. You thus need 3 years of their total just to cover the Greek deficit for 2012 and it’s not even a whole percent of European GDP. Add to that the dry realisation that the money ultimately of course comes from tax-payers and it should be clear that the call from some Southern European politicians and economists to raid these funds in a Keynesian gesture is a rent-seeking distraction from the main game.

Why do national politicians not get much more serious about internal reforms and instead blame others for their problems? Because it would cost them the next election and probably the one after that. It is in this regard handy to remind ourselves that the Germans themselves punished the last German leader who instigated serious reforms (the Hartz reforms, politically pushed through by Schroeder). It costs the German social democratic party ten years of being out of power, a clear deterrent for any other politician in Europe to be serious about reform.  So the governments of the countries in trouble don’t reform. Even a technocratic government, like that led by Mario Monti in Italy, has found it too hard to push the unpopular reforms necessary and has instead opted for symbolic tinkering, like handing out 500 taxi permits or allowing shops to open on Sundays. As if 500 taxis are going to make much of a dent on the millions out of work!

Which brings us to the nub of why the financial crisis will not go away in Europe: because there is no serious reform in Southern Europe, growth there will remain negative and non-existent for quite a while. That in turn appears to be leading its smart young people to go to the North of Europe or emigrate outside of Europe. So the future hope and tax-base of these countries is being eroded as we speak which further aggravates the paralysis inside these countries and strengthens the interest groups that prevent real reforms. Only in the North of Europe are real reforms on the table, such as the UK where real banking reform and health service reform is being instigated.

I have in the past prophesised that the ECB would bail out the weaker countries in return for a weak financial stability pact. That political deal has indeed been made and is being implemented, complete with the immediate realisation amongst the big players that the stability pact is not worth the paper it is written on. However, the ECB bailout cannot solve the underlying problems of a Southern Europe that is in political and economic paralysis, with politicians who cannot afford to instigate real reforms and are instead merely posturing. As a result, the countries will keep coming back for bailouts from either the Northern European governments or from the ECB. Only very slowly are the leaders in Northern Europe starting to wizen up to the fact that their generosity will not keep the place together but will tear the European Union apart.

Hence the European financial crisis is on hold until several countries are allowed to go bankrupt: Greece, Ireland, Portugal, and maybe even Spain and Italy. Once these countries go bankrupt there will be a much greater internal political will to push through real reforms, simply because the governments won’t have the means to pay off the interest groups and will thus have to offend most of them anyway. And those who fear some kind of fascist resurgence or extremely xenophobic nationalism to arise in these countries are mistaken: these are relatively small countries kept afloat by international trade and wealthy foreigners who can leave in a heartbeat, so there is basically no-one rich and foreign they can lay their hands on and threaten. Yes, nationalism will rise as populations try to regain some sense of self-worth, but the only hope for these countries is to remain integrated in the European and world economy and that reality limits the degree of fascism and xenophobia these countries can slide into.

Who will lose out in the end? It will be the politically weak inside the Southern European countries, including pensioners, welfare recipients, minorities, migrants, the unhealthy, and the unskilled. And who will be amongst the surprise winners? The Northern Europeans because they will be the beneficiaries of a large brain gain from the South and it will be their companies that are best poised to take advantage of the eventual resurrection of the Southern European economies.

As to the long-run, the Portuguese, Spanish, Greek, and Italian scholars I talk to all agree: the way out for their countrymen is to become German, either by moving to Germany or by adopting similar institutions and policies inside their own countries. But current institutions and attitudes cannot change so quickly. It is a fascinating question of societal transformation whether the road of least resistance actually does indeed lead to a slow Germanification of Southern Europe or whether it leads somewhere else. I am inclined to trust greed and ambition and thus would put my money on slow Germanification.

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25 Responses to The European Financial Crisis revisited: the Germanification of Southern Europe.

  1. murph the surf. says:

    Germany 8 Southern Europe 0.
    All those appeals to the ref are just so much diving…..

  2. JB Cairns says:

    buying off their supporters?

    They are in a depression. how in the hell are they buying off anyone?

    It is ironic to be lectured by Germany who was the first country to break the fiscal ‘treaty’. Mind you it was sensible.

  3. Alan says:

    Germany made a large profit when the eurozone was working, including exports to the southern countries that were purchased with um borrowed money. It’s a charming fairytale that good Germans are besieged by bad Greeks, Italians, French, Spaniards, etc etc but it sadly forgets that the Netherlands and Germany are models of fiscal responsibility.

    The Dutch government lost the confidence of the parliament last month over austerity issues and faces a general election it is expected to lose in September. Merkel’s own party has suffered a string of electoral defeats in Land elections and is widely thought to be facing a very difficult challenge to retain power at the next federal election.

    It is, as I say, a charming story that all those frugal blonds up north support austerity and all those others down south don’t. It is also simply untrue.

  4. conrad says:

    “That in turn appears to be leading its smart young people to go to the North of Europe or emigrate outside of Europe. ”

    I imagine the smart young people of Europe are going to leave their countries no matter what happens. Even if the countries you are talking about really did reform, it would takes years and years for things to get better, let alone for salaries to catch up, and so leaving is going to be attractive even with reforms. Given that all of those countries have low birth rates, it must be becoming like a prisoner’s dilemma situation for many young people. You can see a much milder pattern on a little micro scale with Kiwis coming to Aus (although there are obvious language barriers that would help keep Europeans at home) even though NZ is a comparatively decent place in terms of opportunities, which suggests many people will migrate for relatively small benefits in terms of lifestyle, let alone big ones.

  5. sdfc says:

    The prospect of years of recession, which is the inevitable outcome of the current course, is a recipe for political instability.

    • john walker says:

      Yes the worst thing that the great depression gave was not low incomes……. it was Adolf and WW2

      • sdfc says:

        Yes. The great myth is that the Nazi’s came to power on the back of the hyperinflation of the early 20s. They came to power on the back of the deflation of the early 30s.

      • Alan says:

        A deflation caused almost exclusively by the austerity policies applied by Chancellor Brüning and his finance minister in response to the Depression…

  6. Tel says:

    From, Greek Default Watch:

    “Greece has changed from being a fat kid that was going on a diet to a fat kid that wants to sue the candy company.”

    From Krugman (last month):

    “1. Greek euro exit, very possibly next month.”

    I think that as long as Germany and France are in the Euro, the Greeks will stay because small handouts are better than no handouts at all. Politicians who give the appearance of being inept in every imaginable way, still seem to have an almost spooky clarity when they need to know where the butter comes from.

    Besides, for the Greek government to print their own money is completely useless… they can’t enforce tax collection so why would anyone want their paper?

  7. Tel says:

    “This despite the fact that the Germans not just directly sent huge amounts of money to the governments of these countries, but even allowed the European Central Bank to send more money to their troubled banks in the order of a trillion euros in total, which in effect is printed money and thus a form of tax on the whole of Europe. These populations should be thanking the Germans on their bare knees, but the reality is the opposite. Why and where is this going to?”

    You seem to be under some confusion here: the money went to the Greek government, and to the Greek banks, so it’s the government and the banks who should be on their knees. Even better, the government and the banks should be working for the population, but working for which members of the population? There’s the difficult bit.

  8. conrad says:

    “Besides, for the Greek government to print their own money is completely useless… they can’t enforce tax collection so why would anyone want their paper?”

    They could enforce tax collection, they just don’t want to. Many countries have this problem, and there are many solutions, some very innovative and not big-stick like. Taiwan, for example, has a government lottery where you send in your receipts which then go into a free lottery. Not surprisingly, everyone wants receipts for things they buy which they then send to the government to go into the draw. This meanas the government ends up with piles of transactions they they can check.

    • Tel says:

      I doubt Greeks would fall for a lottery, they have been doing math for rather a long time. That’s all besides the point, if the Greek government can enforce tax collection in one currency, then can enforce tax collection in any currency, so might as well get some benefit from staying on the Euro.

  9. Nicholas Gruen says:

    Paul,

    There’s nothing in your analysis that I’m sure I disagree with but the reason all this is happening is a cocked up monetary union. Yes there are states that are mired in low level corruption, Greece being the prime example, but basically all the countries other than Greece could have gone happily along with higher levels of inflation than the core and correspondingly declining currencies. They had done so for decades before the Euro.

    Spain and Ireland had budget surpluses when the GFC struck. But your post says nothing about all this. Yet it’s the really big thing about the situation we are now in – that the magnitude of the problem has very little to do with the moral depredations of the countries that are in trouble, and everything to do do with cocked up governance at the European level. It’s the difference between all the moralising about the great depression by so many during it and Keynes’ diagnosis that it was a technical problem “We have magneto trouble”.

    Of course it’s kind of nice to think that the euro might discipline countries to really clean their act up. If it did, perhaps it would all be worthwhile. But as you observe, it doesn’t. When bad things happen people and nations sometime lift their game (like Australia did in response to the recessions of the mid 70s and early 80s) but often they don’t. Things just go from bad to worse. I think Germany has some experience of that, in the middle of last century – it apparently caused quite a bit of trouble and not just in Germany.

    So I think this is all terrible, and don’t really hanker for the great stick to get taken out. If Italy wants to gradually decline in relative living standards and population owing to little reform, then there are perfectly benign institutional arrangements in which that can happen – and declines in relative living standards are not declines in standards – just lower growth. They existed before the megalomaniacs of Brussels fitted most of Europe up with a straightjacket made of barbed wire.

  10. JC says:

    T

    o start with the ingratitude, Germany is now depicted once again as the evil man of Europe in popular media in Greece, Ireland, Spain, and Portugal. Rioting protesters in Athens burned German flags and newspapers carried pictures of Angela Merkel wearing a Nazi uniform. Cartoons in Greek newspapers depicted Merkel and the Finance Minister Schaeuble as running concentration camps for Greeks.

    Paul:

    The Germans are causing most of the hardship. They are corseting the non-core in seriously tight fiscal measures. Now I have no problem with that as the non-care is basically unable to borrow, seriously hobbled in accessing the bond markets.

    But for christ sake, ease up on monetary policy much more. Or rather stop hard-talking the regrettably stubborn/stupid ECB from conducting substantially easier monetary policy.

    The Germans are looking like they want to kill the rest of Europe which is really dense because 70% of German exports are in the EU.

    The non-core should simply read the riot act to the Germans. Either get off the ECB’s back of leave the Euro. Yep, Germany leave the Euro. They will quickly see reason once that threat is made with the possibility of carrying it out. German doesn’t stand a chance of surviving unhobbled outside the Euro as the new currency would appreciate materially and make them uncompetitive. They could of course peg like Switzerland has done which would make the departure even sillier.

  11. Paul Frijters says:

    conrad,

    yep, agreed. They are in a fix whatever they do and these countries will look unattractive to their own young populations for quite a few years. They need to generate a positive sense of emergency, giving their talented youngsters the job of cleaning up and taking things forward. Alas, the political logic is for the old guard to hang on to all the positions of power.

    Tel,

    yep, also agreed. I have talked about how unlikely a Euro exit is before. The mechanics make it hard to see how it would happen: inside Greece the Euro is very popular so which Greek politician wants to take the blame for that? Bankrupcy without Euro exit seems likeliest to me and the question for the rest is mainly what to do about the banks.

    Nick,

    yep, agreed also. Sentimentalism and even apportioning blame has no place here, but shrewd politics does and giving loans that cant be paid back IMO is a disastrous policy, rather like giving a junky more money so that he doesnt have to kick the habit. Having said this, it is important to point out that being inside the Eurozone allowed more ill-discipline than would otherwise have occured: the Irsih and Spanish property booms would not have been possible without Ireland free-riding off European taxation ad Spain having an influx of 5 million others, neither of which was possible outside the Euro. Greece and Italy too have for similar reasons been corrupted by access to cheap capital within the Eurozone. It cannot go on however because no-one has the ability to economically support it anymore.

    JC,

    yes, I too would advocate a bit more money printing. Indeed, my prefered policy is what economists call a ‘helicopter drop’ of cash to all citizens of the Eurozone. Yet, even if the ECB would agree to this, it would probably still not be enough for Southern Europe and indefinite bailouts will simply make things worse.

  12. Katz says:

    And those who fear some kind of fascist resurgence or extremely xenophobic nationalism to arise in these countries are mistaken: these are relatively small countries kept afloat by international trade and wealthy foreigners who can leave in a heartbeat, so there is basically no-one rich and foreign they can lay their hands on and threaten.

    Interwar European fascism didn’t initially threaten violence and dispossession against local corporate interests, though it is notorious that in Germany Jewish businesses were later confiscated. And it should not be forgotten that during the 1930s Germany was a lucrative market for a range of US corporations, including Coca Cola and IBM.

    Hitler’s initial act of confiscation was against the banks that underwrote scheduling of the repayment of Versailles reparations.

    In 1929 only 13% of Germans voted in a referendum essentially supporting repudiation of reparations debt. I guess that today many more Greeks and Spaniards would vote Yes to a similar measure.

    Repudiation in the Eurozone doesn’t equate to fascism. Indeed, the broad Left tend to be today’s Eurorepudiationists.

    On the contrary, it is possible that the Greek Right, with the involvement of the Greek armed forces, may represent the forces of compliance with the demands of Greece’s creditors. Thus we aren’t talking about Greek fascism so much as we are talking about the inhuman face of European finance capitalism.

    None of this is inevitable and perhaps not even likely. But much hangs on the outcome of the forthcoming Greek elections. Will Greeks prove to be as friendly to foreign financiers in 2012 as Germans were in 1929? And given what happened in Germany after 1929, will Greek compliance have much significance in the light of the sacrifices they are required to endure?

    • Patrick says:

      In short, left good, whatever their historical tendency to savagery and oppression, right evil, just because, and um, Nazis?

  13. Paul Frijters says:

    Katz,

    the Greeks cant pay their debts, no matter whom they vote in. The question is not whether but how they will default again(the 70% haircut was a default by another name).
    Whether the Greek military forces could be involved in the internal struggle for control is an interesting question. They have only recently turned democratic. You would need to know how their armed forces have been reorganised since to say something about the possibilities of coups and the like. Knowing the fairly strict rules on entry to the EU that Greek had to go through, it seems likely the military would have been thoroughly reorganised since the days of the junta. Still, I doubt the military would be interested in protecting foreign finance interests. The more realistic worry is that the Greek left gets into power and tries to actually collect on the tax debt of rich and powerful Greeks.
    In the wider scheme of things though, Europe is not the world force it was in the 1930s and is far more pacified. And in the vast majority of Europe the problem is not a huge decline in living standards, but `merely’ a continued stagnation of high living standards.

    • Tel says:

      “Still, I doubt the military would be interested in protecting foreign finance interests.”

      Foreign finance interests have this clever trick to encourage local militia to take their interest to heart… it’s called money, just needs to fall in the right pockets. Ultimately tax is protection money, it can only be collected by use of force (and regular demonstration of force), so in order for Greece to increase its tax base, either a strong police or a strong military will need to get involved. The other choice is for government spending to collapse, in which case there will be transition as the half of the workforce that were government employees need to find other jobs (and such a massive transition will always be painful). Even after all loans have defaulted (which they will of course) this problem still exists.

      What was that? Corruption in Greece? No way!

      • Paul Frijters says:

        agreed on 80% of this (though i wouldnt call tax protection money. Let’s call the monopoly of violence of the state part of the social contract with its citizens, shall we? Still, the end result is quite similar.). Yet, Greece has no private militias and hence one would would indeed have to co-opt the state police and military. It is possible to do, but normally takes a lot of time and money. There simply is not enough money to be made out of Greece for big foreign interests to bother: it has no oil or diamonds as its economy’s main strengths are tourism, some shipping, and other such medium-yield sectors. Dont count on the Greek military organising a coup for those few foreign holiday operators!

  14. Katz says:

    Paul, interwar fascism was the product of European geopolitical strength. Rather it was the product of various kinds of economic and social failure.

    I take your point that the Greeks have already defaulted. So had the Weimar Republic long before Hitler took power.

    We need here to make a distinction between default and repudiation. The former is done with consent of the creditor or at least without the threat of major retaliation. The latter is a political act of defiance, daring major retaliation.

  15. Katz says:

    Should read:

    Paul, interwar fascism WAS NOT the product of European geopolitical strength.

    sorry.

  16. Paul Frijters says:

    Katz,

    I would say geopolitical strength was in the mix, though indirectly: some countries had a self-image of being major world powers (Germany in particular) and, when humiliated and in recession, their thwarted sense of pride helped spawn the fascist movement. Individual countries in Europe simply no longer believe they are really major world powers which really will dampen the fascist movement. If anything, their wish `to count’ will keep them together.

  17. Katz says:

    The Greek Colonels were certainly fascist. But as deluded as they may have been, Greek fascists never had major geopolitical aspirations.

    The closest analogies, I suppose were the tinpot fascistas of Latin America. These folks served US geopolitical interests in that they were a bulwark against the Left and they ensured a political economy amenable to US corporate interests.

  18. murph the surf. says:

    “stagnation of high living standards.”
    Is this really the limit of the experience in Greece? Are the demos relatively small scale or is the widespread unemployment biting some hard now?

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