Posts tagged ‘austerity’
This week saw headlines appear about the possibility of another debt crisis in Greece. A multi-billion loan repayment to the ECB is due this summer; the European Commission and the IMF – the other two members of the “troika” governing the bailout arrangement – are divided on the scale of deficit reduction required to allow funds to be released; and in the meantime the country has just gone out on a general strike today in protest at any further “austerity”.
It feels, rather sadly, just like old times.
Yet things have changed in Greece since the pandemonium over her original bailout and debt restructuring. The governing leftist coalition, Syriza, has learned through bitter experience that it really does have no option but to comply with its creditors’ requests. And while books will doubtless continue to be written on the fiscal consolidation undergone by western countries since the Great Recession it is undeniable that Greece has been getting on with the job: the budget deficit there, as a proportion of GDP, has been falling from its 2009 peak of -15.2% at almost twice the pace at which it had grown during the course of Greece’s eurozone membership up to that point. This has had the effect of containing the national debt to GDP ratio, which while eye-wateringly high (177% for 2015) has fallen since 2014 despite the suffering brought about as a result of the Greek government’s hubris a year ago. Indeed, take out the effect of the debt restructuring in 2012 and last year’s fall in this ratio was the first since 2007.
There were also tentative signs of recuperation on the broader economic front too. The European Commission’s spring economic forecast was published on Tuesday and the expected contraction in Greek GDP this year was revised down from -0.7% to -0.3%. (Growth of +2.7% is projected for 2017.) The slow turnaround in employment might have halted for now, stuck between 24%-25% over the nine months to January, but with growth beginning to return again this should continue to tick down – and remains below the peak of 28% reached three years ago.
In the meantime, bond markets in Greece and elsewhere on the eurozone periphery are not showing any sign of panic. Ten year Greek government paper is trading down towards its lows for the year to date (just over 8% at present), well short of the over 11% reached during February’s market-wide funk. Italian and Spanish bonds have been priced around the 1.5% mark in recent weeks, just like ten year gilts.
It is worth reflecting that five short years ago – when many respected commentators were confidently predicting the demise of the euro – this was unthinkable. Greece might have been in the headlines again but there is absolutely no contagion in evidence today. Today, markets are not even bothering to try taking on Mr Draghi and his “bazooka”.
It is also worth reflecting that economic growth in the eurozone as a whole is projected at +1.6% this year and +1.7% next – a breakneck pace compared to the average rate of +0.9% over the last 15 years. And talking of headlines, it drew some attention last week when data emerged to show that the zone’s GDP had finally surpassed its pre-Great Recession peak in real terms. Numbers out last month showed its deficit falling as a percentage of GDP for the sixth consecutive year in 2015 to -2.1%, and confirmed that total debt to GDP peaked a year earlier. The unemployment rate might already have dropped back below 10% this month for the first time since April 2011.
There are political risks ahead for Europe but to say that the eurozone as a whole has moved on from the debt crisis is beginning to look like an understatement. It is to be hoped that Greece manages to continue her recuperation. If she does so the “European debt crisis” will soon be history.
Yesterday’s Autumn Statement by UK Chancellor of the Exchequer George Osborne was as political as expected. Impressively – and in a break with recent tradition – some of it was not leaked in advance. And beyond the Stamp Duty Mansion Tax, road building in marginal constituencies, wealth fund for hypothetical shale gas production in some long-distant future and customary crowing about how wonderfully the British economy is doing, there were a few items of actual economic interest. (There is a good summary of all the key points from the BBC here.)
It’s great that growth for this year is expected to come in at 3%, up from 2.7% in March, but as has been widely noted, the level of debt will be higher than forecast in spite of this. It is worth quoting the Office for Budget Responsibility directly (all documents here):
[W]age and productivity growth have once again disappointed, while national income and spending have outperformed most in those areas that yield least tax revenue … For these and other reasons, this year has seen a sharp fall in the amount of tax raised for every pound of measured economic activity. As a result, despite strong economic growth, the budget deficit is expected to fall by only £6.3 billion this year to £91.3 billion, around half the decline we expected in March. That would be the second smallest year-on-year reduction since its peak in 2009-10, despite this being the strongest year for GDP growth.
Hmm. Wage growth has indeed been disappointing. As regular readers will know, UK wages have been falling pretty steadily in real terms since the Great Recession. This has been due to both sluggish growth in absolute terms, and – if you have been the Bank of England over the period – completely surprisingly high inflation. In fact, adjusting for RPI, average earnings are back down where they were in the summer of 2000. Putting this another way, British pay packets have not grown in real terms so far this century.
Part of the reason for this is that inflation has been pushed up by increases in VAT, necessary because of the vast level of government borrowing. Even in nominal terms, though, wage growth has averaged a measly 1.5% per year over the last half decade. Why so? Well, public sector wage growth has been capped at 1% for some time, a necessity arising from the vast level of government borrowing. Wages in the manufacturing sector have also been squeezed, which might be connected to the pace of demographic change in the recent past (the gap between real GDP growth and real growth in GDP per capita having risen to 0.8% over the last ten years, above even the high caused by the post war baby boom). And some higher-end pay, in areas of financial services for instance, has suffered too.
In other words, the higher taxes and lower wages caused in large part by the desperate state of the public finances have themselves contributed to a disappointing outturn for the public finances.
Lest one might think that, to coin a phrase, there is an alternative, remember this: the central government debt interest burden is projected to rise to £54bn this fiscal year and to £77bn by 2018/19, the year in which the government’s books might finally balance. Even this year the payments will be more than twice the total current budget for defence. Viewed sensibly, Britain’s debt is already out of control. Worsen the debt burden from here and it could end up entailing default.
This sounds a bit gloomy, because it is. However, was there anything in the statement to give encouragement?
In the context of sovereign debt, the only real positive is economic growth. So it is unfortunate that the anti-bank and anti-wealth elements of yesterday’s announcement will do nothing to stop London’s slide down the rankings of global financial centres in future years. Only a couple of weeks ago there was a survey out showing that New York’s lead over London as a good place for financial sector business had extended (London used to come top of these lists). Bits and bobs of capital spending were announced which will have some positive effects in the relevant areas over the medium term, but growth does not generally benefit from increased regulation of and taxes on business.
The UK is clawing its way slowly towards a balanced budget, having already amassed a punitively expensive burden of debt. Budgets and Autumn Statements / Pre-Budget Reports have been overwhelmingly dominated by political gimmickry for at least the last ten years. It is difficult now to remember budget speeches in which pound note figures for spending and receipts connected to policy changes actually got a mention (standard practice until the arrival of a Mr Brown in 1997). Our Chancellors have little leeway nowadays, but yesterday’s little attacks on banking and The Rich were fiscally unnecessary and potentially damaging. (Listed banks in the UK employ about 700,000 people, over 2% of the nation’s workforce, and that is already down from almost 900,000 in 2007.) Britain’s economic policy remains primarily a vehicle for electoral showmanship, and this is not encouraging.
There are a number of notable points which could be made about the Chancellor’s Autumn Statement yesterday. The political as well as the economic mood has clearly moved in his favour. Some of the measures announced, like the establishment of a moving target for the state pension age, were substantial. And of course the Office for Budget Responsibility has revised its economic forecasts up, meaning that the forecast level of government indebtedness has come down.
It is not the first time that this has happened. At the time of the Autumn Statement in 2010 and of the 2012 Budget, OBR debt to GDP projections drifted ever-so-slightly lower, with the peak level of indebtedness on a Treaty basis coming down by 0.8% and 1.2% respectively – before shooting up again in subsequent reports. But the difference this time is much more material: back in March, debt to GDP was forecast to peak at 100.8% in fiscal 2015-16; now the peak is to reach “only” 94.7% in the same year.
The full text of the OBR’s Economic and fiscal outlook attributes the difference to higher nominal GDP and lower borrowing about equally over the two years 2014/15 – 2015/16. It is worth quoting the following directly from the text:
While most public discussion of economic forecasts focuses on real GDP, the key driver of our fiscal forecast is nominal GDP – the cash value of economic activity – and its composition. The level of nominal GDP is higher across the forecast period than in March. … Whole economy inflation – as measured by the GDP deflator – is little changed from March.
In recent years there has been some debate about the possibility that governments would try to inflate their way out of debt (e.g.). Some economists even advocated this as policy. Regular readers will know that the idea isn’t a serious one – and the UK’s new numbers give some proof of this. In debt terms, the tide might just have turned, and higher inflation has played no part in this projection.
What we can say is that a little growth goes a long way. While the forecast for peak debt to GDP has fallen by over 6%, the cumulative change in real GDP to 2015 since the OBR’s March forecast is only +1.3%. As well as growing the denominator of the debt / GDP calculation, higher growth also reduces planned expenditure and increases projected tax receipts, thereby causing the cash amount of borrowing to fall. For economies with uncomfortably high debt, a growth spurt is the best possible cure.
This week’s data from across the Atlantic is warmly encouraging in this regard. US GDP for the third quarter was revised up in the second estimate to 3.6%, right at the top of the forecast range and the highest rate for one and a half years; confidence has rebounded from the blip of the shutdown; and unemployment fell unexpectedly to 7%, its lowest level in five years. (It is interesting to observe that this is the level which, arriving in 2014, was supposed to see the end of the Fed’s QE3. The press conference at which this was announced panicked the markets. So far this afternoon, by contrast, the S&P 500 is up by almost 1%.) If this is all beginning to add up to a proper global recovery it will be the best possible news for indebted developed-world economies.
As always we need to be careful. Reducing borrowing over the medium term will require continued fiscal discipline, and to borrow one of the Chancellor’s phrases, it can be human nature to focus on “fixing the roof” only when we are being rained on from a great height. And we should not give him too much credit either: he boasted proudly that the budget deficit as a share of GDP is expected to have fallen by 11.1% over the nine years following 2009-10. Another way of putting it is that it will have taken nearly a decade of continued borrowing for the UK to have not quite balanced its books again. Back in 1993 on the other hand, when the deficit peaked at 7.9% of GDP, it took only seven years to bring it up to a surplus of 3.5%: a larger improvement of 11.4% in total.
Still, falling government indebtedness is good news, and long may it continue. With a strengthening and prolonged global recovery there is every reason to think that it will.
This coming Sunday sees a presidential election in France and parliamentary elections in Greece. In the case of France it looks probable that we are to lose one half of the “Merkozy” double act that has presided over the eurozone crisis so far. When it comes to Greece the only certainty is that caretaker prime minister Lucas Papademos will no longer be in charge. Would a left wing President of France mean the abandonment of fiscal consolidation? And could popular discontent in Greece bring about demands for a renegotiation of the country’s bailout agreement, with all the chaos that could entail?
The risk from France would seem to be the lesser of the two. M Hollande, the socialist frontrunner, has certainly used the austerity issue as a stick for beating his rival. He has also threatened to refuse to ratify the European “fiscal compact” agreed at one of last year’s many emergency summits unless various measures are taken to boost growth. Crucially, however, he is committed to a remarkably similar domestic fiscal path to that envisaged by M Sarkozy. Both men would see France’s budget deficit reduce to 3% of GDP by 2013 (from an expected 4.4% this year), and both want to balance the budget thereafter – though M Hollande would see this goal reached only in 2017, a whole year later than his opponent, and favours a 50:50 split between tax increases and spending cuts, as distinct from the radically different 35:65 split on the table at present.
At the European level, even the threat to scupper the fiscal compact would depend on failure to agree measures such as those in M Hollande’s four point plan for growth: eurozone-wide bonds for infrastructure projects, more lending by the European Investment Bank, a financial transactions tax and more efficient use of EU structural funds.
Now the idea of using EIB lending to stimulate growth appeared as far back as last July’s EU agreement over Greece, so this could be a serious runner. Chancellor Merkel has already indicated that the next EU summit, in June, will have a growth agenda. If M Hollande manages to secure backing for even one or two of his proposed ideas he would be able to present this as a transformative victory for a more pro-growth politics across the Continent – especially if more EU money for France should happen to be an incidental consequence of the plan. Having already accomplished his most important task – getting elected – his need to tear up the fiscal agreement would be greatly lessened. (This is certainly the way markets are betting, with French bond yields showing no signs of panic.)
The Greek situation is altogether more unpredictable. The electoral system is a model of proportional representation in action. Like the Spartan force at Thermopylae, the legislature has 300 members. 250 of these are allocated proportionately, with a threshold of 3% necessary to win the minimum 8 seats in parliament. The remaining 50 are awarded to the party with the most votes. That will almost certainly mean the centre-right New Democracy party of Antonis Samaras; with poll numbers in the low 20s, ND is several points clear of its nearest rival, the centre-left PASOK, at the head of a very divided field.
Now Mr Samaras has already committed himself, in writing, to Greece’s bailout terms, on the insistence of his country’s creditors. He intends to govern with the aid of PASOK in a continuation of the coalition which has been in place since the fall of George Papandreou last November. But the problem is that the main parties are so unpopular that even with that 50 seat bonus they might still struggle to achieve a majority. The communists, the other leftist parties and most of the nationalist right is against the austerity programme.
In other words, there is a more obvious worst case outcome for Greece. While the communists, nationalists etc. are highly unlikely to join a formal coalition against the political mainstream, they could easily unite to oppose specific votes / budgetary measures, holding out the prospect of fresh elections and constant political uncertainty into the bargain. Anything short of a clear majority for the main parties, therefore, could spell more market drama.
There are of course many observers who would like to see the country’s present rulers out of office, democracy restored, Greece out of the euro, austerity ended and the EU itself given an enormous bloody nose. Despite everything, however, while the most recent polls show that 60% of the electorate oppose an ND / PASOK coalition, 77% “would like the next government to do everything possible for Greece to remain in the euro area”. Whatever else it might be, the political situation in Greece is not that straightforward.
In conclusion, then, the French election over the weekend will be interesting. But the Greek elections could be important.
As some commentators have pointed out, this year’s Budget took place in the context of a threat to the UK’s AAA credit rating. Only last week, ratings company Fitch put the country on “negative outlook”, meaning that it sees a slightly greater than 50% chance of a downgrade over a two year horizon.
It was accordingly fortunate that some improvements in his economic forecasts meant that Chancellor Osborne was able to announce a slight fall in the projected peak of the UK’s national debt, revised down to 76.3% of GDP in fiscal 2014-15. He made specific mention of the figure in his statement. Fitch has since gone on the record to say that the reduction is modest and that their stance is unchanged: should the Chancellor deliver on his targets the AAA is likely to be affirmed, but in the meantime it remains vulnerable to shocks.
The number they cite, however, is a peak of 92.7% of GDP in 2014-15. At first glance this might appear confusing, or even incorrect. But in fact both numbers are right.
The government’s preferred measure of borrowing is “net debt” – the value of its liabilities less the value of its liquid assets (e.g. the cash it keeps in the bank to cover spending). This is where the 76.3% comes from. The 92.7% reflects the country’s “gross debt”: liabilities only.
That the difference is so large – 16.4% of GDP, or some £293bn in future cash terms – is interesting in itself. What is also interesting is that the UK reports the 92.7% figure (on p. 109 of the full Budget document for those interested) as the “Treaty debt ratio”: the treaty concerned being the Maastricht Treaty of 1992, under which the calculation of government borrowing statistics is governed across the EU.
In fact it is gross debt to GDP which is generally quoted in respect of Europe’s indebted economies. Italy’s fabled 120% debt-to-GDP ratio, for instance, falls to 100% on a net basis according to data from the IMF. In the case of Japan the difference is even more astonishing: the IMF projects a whopping 238% debt ratio for 2012, but on a net basis the figure is only 139%.
The real point, however, is that we must be careful to compare apples with apples. A casual listener on Wednesday might well have thought that the highlighted figure of 76% was directly comparable with the 120% for Italy, for instance. The truth is a little less flattering.
Nevertheless, progress is being made in Britain. This is underlined by yet more excitement from page 109: the figures for “Total managed expenditure” (government spending) as a % of GDP. On current policy this is projected to fall from 45.8% this year to 39% in five years’ time, at which time the budget is broadly expected to balance.
One final international comparison: 39% of GDP is about what Greece has been raising in revenue over the last few years. This may come as a surprise to those who believe the country somehow went broke through tax evasion. The problem for the Greeks was that while raising 40% of GDP, their government was consistently spending even more. Such evasion as undoubtedly takes place might be regarded as evidence of the Laffer curve: the economic theory stating that once tax rates reach a certain level, revenues stop increasing (and begin to decline if rates keep going up). Here in the UK, the disappointing results from the 50% rate of income tax provide a parallel illustration.
If there is one lesson for governments to draw from the recent crisis it is that spending must have its limits. Europe has been forced to acknowledge this in the most brutal manner. In Britain we have had an easier ride from the markets but the arithmetic points to the same conclusion.
There are still plenty of commentators who see fiscal consolidation – “austerity” – as some kind of demand-dampening mistake. The fact is that there is a limit to what states can raise in tax and borrowing. Sometimes spending cuts are all that is left. Sometimes there is, to coin a phrase, no alternative.
This week saw the publication of “advance estimate” (first stab) UK GDP data for the final quarter of last year. As expected it showed a setback, with output down 0.2%.
This was inevitably reported to be a disaster. Her Majesty’s loyal opposition blamed the government’s not-terribly-drastic austerity programme; the Chancellor blamed goings on in the eurozone.
The real culprits are more likely to have included a stronger pound, with trade weighted sterling over 4% stronger over the second half of 2011, and the continued squeeze on real incomes arising from Britain’s unusually high rate of inflation. (The latter effect in particular goes a long way to explaining why the recovery in our GDP since the bottom of the recession in 2009 has not only lagged that of the US but also that of Japan and the eurozone.)
Be that as it may: if the eurozone is not yet finished, neither are we. Last year began in similar circumstances with a -0.5% fall in GDP reported for Q4 2010. It proved to be transitory. And other data released over the last few days also suggest an economy which is experiencing a bump in the road to recovery rather than a fall over the cliff into serious recession: retail sales growth of 2.6% in the year to December was stronger than expected, BBA data on mortgage lending continued to post a modest improvement and industrial orders data for January saw a welcome bounce.
Most importantly, data on government borrowing – specifically the figure for public sector net borrowing excluding financial interventions, “PSNB ex” – was stronger than expected despite the weak outturn for GDP. According to the Office for Budget Responsibility, the UK may now even be on track to outperform its debt target for the current fiscal year.
None of this is to suggest that a contraction in GDP, however slight, is good news. Apart from anything else the data could well trigger another cavalier display of pointlessness from the Bank of England in the form of more “quantitative easing“. Nor does it alter the fact that the UK’s debt burden is an ugly one and that we have been lucky so far in that bond markets have given us the benefit of the doubt. But there is a world of difference – here and elsewhere – between standstill and collapse. Markets are beginning to bet more on the first than the second of those alternatives. This week’s data from the UK suggests that they might be right.
This week, Greek Prime Minister Papandreou reminded the world that his countrymen didn’t just invent drama and democracy: they also invented the circus.
Doubtless he saw his shock call for a referendum as a Machiavellian masterstroke – a means of suborning domestic opponents while strengthening his bargaining position abroad. But it was clear within hours that he had overreached himself. (The full extent to which he has done so remains to be seen.)
It is worth looking at some of the consequences for his country should his implicit threat of unilateral default / euro withdrawal ever be carried out.
First of all, the currency. Most commentators assume that unilateral Greek default would entail the sacrifice of eurozone membership. (This is not necessarily true. Neither the default of Cleveland, Ohio in 1978, nor – if you prefer to think of the eurozone as a fractured collective – the default of Ecuador thirty years later resulted in either borrower choosing, or being encouraged to leave, the US dollar. But let’s assume Greece went back to the drachma.) There would be rapid depreciation – indeed, the possibility that the currency could cease to be transferable internationally. (The Icelandic krone threatened this at the nadir of the recent crisis with the result that the supply of imported food was jeopardized.) Even if the drachma were tradeable, immediate, rapid inflation would occur. At the same time, bank deposits and other assets would have to be re-denominated, decimating the wealth of the nation overnight. These twin effects would demolish household and business consumption and consign the country to a further period of sharp economic contraction.
All well and good, say the defaultists. But at least Greece would be free of her debt!
Yes, and no. Greece is still running a budget deficit and in the catastrophe scenario this would get worse. So unless the Greeks wanted total state shutdown, they would still have to borrow money. Who would be the lenders? The EU; the IMF: exactly the same people who are lending to them at the moment. The conditions imposed by those lenders – who would still have effective control of the country’s economy until their loans were repaid – would be at least as punitive as the conditions they’re imposing now. In other words, there would be at least as much austerity to contend with, and possibly more.
The trajectory which is currently planned for Greece amounts to a relatively benign version of sovereign default. The alternative would be harsher, crueller, and much more damaging.