Europe’s economic performance

November 22, 2018 Michael Reddell Economic history, Euro area, New Zealand economic performance, Productivity

A commenter on yesterday’s Brexit post raised the question of how Europe (EU, euro area or whatever) had done overall relative to the rest of the advanced world. The question sparked my interest, not just about the last 20 years or so (since the euro was created, and the comparison in yesterday’s post) but about somewhat longer spans of history.

At around the turn of the 20th century no one would have doubted that Europe dominated the world geopolitically, and it no longer does that. That geopolitical rise was built on technology and associated economics, but just because the geopolitical moment has passed doesn’t necessarily mean the economic one has.

But who to compare Europe with? Relative to the situation 100 years ago, some east Asian countries (in particular) have caught up considerably. In most respects that is to be welcomed, and doesn’t tell one anything particularly enlightening about the performance of western Europe. And some (most?) of the European countries that aren’t in the EU are nonetheless in agreements with the EU that mean that in many respects the policy regimes are similar.

And so here I’ve focused on a comparison with the European “offshoots”, notably the Anglo-shaped ones (the United States, Australia, Canada, and New Zealand), but with some reference also to Argentina, Chile and Uruguay. Prior to World War One, Europe may have been the geopolitical centre of the world, but individuals in the typical offshoot countries enjoyed a better material standard of living than their peers in western Europe.

europe 1

The first two columns are the group of 11 western European “established” euro area member countries in yesterday’s post, and a subset of those that I’ve got interested recently (France, Germany, Belgium, Netherlands, and Denmark) which today have much the same level of average labour productivity as the United States.

In 1913, the Anglo countries were top of this particular economic heap, and the western European countries weren’t much different than average living standards in Argentina, Chile and Uruguay. In 1929 and again in 1955 (allowing some time for recovery from the war) the picture still wasn’t so different. The five top European countries were doing better and the UK a bit worse, but average GDP per capita in the 11 European countries group was only about 10 per cent higher than those in the Uruguay, Argentina or Chile group.

And here is the same chart for 2017, using Conference Board data.

europe 2

It doesn’t take too much study to see where the (relative) decline has been centred: the European offshoots and the UK. The picture is most vivid for the southern cone countries in Latin America, but isn’t less real for the Anglo countries. It isn’t that, as a group, they’ve been surpassed by continental western Europe, but that western Europe has caught up. (Since this isn’t a New Zealand-centred post, we will quickly pass over the way those countries now outstrip New Zealand.)

But what about some time series charts for more recent periods? In this chart I’ve shown the same two European groupings relative to the median for the Anglo offshoot countries (US, Australia, Canada, and NZ) using OECD data which start in 1970.

europe 3.png

(I don’t quite know what was going on around 1990, although I guess it is probably about the recession in many of the Anglo countries).

Over the full period since 1970, Europe has gained ground relative to the Anglo offshoots, on both groupings. But there is, of course, a big divergence in the two series in the last decade or so. For the top-5 north European countries, performance has remained pretty strong. The median of those five countries now has average per capita incomes almost equal to those of median Anglo offshoot country (and, as it happens, the Europeans work fewer hours per capita to achieve that outcome). But for the wider group, things have gone badly into reverse – the influence of the poorly performing tail (Greece and Italy in particular, but also Spain and Portugal).

What about a similar chart for productivity? The OECD doesn’t have labour productivity data for the whole period for Austria and Greece, so in this chart those two countries drop out of the comparison.

europe 4

It is a somewhat different picture. The cylical effects large drop away, but (not unrelatedly) so does the marked difference between the two groups of euro-area countries over the last decade. On this measure, Europe’s labour productivty growth has fallen behind that of the Anglo offshoots grouping over the last decade (although not in the first few years of the euro). But perhaps the bigger story remains just how much average productivity in Europe has improved relative to that in the Anglo offshoots world over the whole period since 1970. It is a huge relative gain for (western) Europe.

And what of a simple comparison between the leading group of European industrial countries and the US? After all, if Europe has its laggard, the Anglo world has New Zealand (and Canada). Here’s that chart.

europe 5

It is interestingly different. Relative to the US, these leading European countries did poorly last decade. But the underperformance hasn’t continued into this decade, despite the euro-area crises, even if little of the ground has been made up again. But again, taking the longer view, surely the bigger story is one of the improvement in Europe’s relative performance since 1970.

And of course, amid all of this there has been no mention of the rest of Europe, the bits that spent decades in the Soviet orbit, and weren’t beacons of prosperity prior to that. Many of those countries have been making progress in catching up with the Western European leaders even as, over longer runs of time, western Europe has been catching up with the (former) Anglo leaders.

And as one final chart here is snapshot of Conference Board estimates of the levels of labour productivity last year.

europe 6

Five of the top six are European, even if Singapore is almost at the heels of the European leaders. (Ireland, Luxembourg, and Norway have higher numbers again, each with their own idiosyncrasies.) Below Singapore, I’ve just put in a few countries out of interest – China as much because on my walk this morning I listened to a podcast interview with a former European politician convinced that by 2038 China will dominate the world, and that this will mostly be a good thing.

Europe has had its good and its (very) bad times in the last 100 years or so, but when one looks at the data as a whole it is hard not to think that in economic terms Europe’s performance (and especially that of the northern European top tier) relative to the rest of the advanced world has increasingly been as good as it has been at any time since the New World was really opened up to trade and settlement. By contrast, over the last 100 years or so, of the New World countries only the US has more or less managed to hold its own matching or exceeding the leading group (per capita income and productivity) of European countries.

For New Zealand, Uruguay, Chile and Argentina – and even Australia – (the Antarctic Rim countries) it all seems to have proved just too hard.

Hankering for normalisation

February 21, 2018February 21, 2018 Michael Reddell Euro area, Monetary policy

Really ever since the end of the immediate financial crisis in the first half of 2009 there has been a hankering – often more than that – among some central bankers, some former central bankers. and some agencies that associate with and support central bankers (ie the BIS – Bank for International Settlements) for things to “get back to normal”. What leaves these people particularly uncomfortable is the level of official interest rates, which in most of the major advanced economies (and quite a few smaller ones) have been very close to zero (sometimes modestly negative). And it is now almost nine years since the end of that first intense crisis phase. And, at least in nominal terms, there had been no precedent for such low official interest rates.

It was, perhaps, an understandable reaction in the immediate aftermath. I certainly shared it then. I was on secondment to The Treasury, and recall talking things over with a colleague who had previously been at the Reserve Bank. We agreed that the Reserve Bank (Alan Bollard personally) appeared to have done a thoroughly excellent job in cutting the OCR aggressively during the crisis/recession, but that it seemed likely – and appropriate – that many of those cuts should soon be reversed. We welcomed early indications that that was exactly the Bank’s intention. I also recall pointing out to colleagues that bond markets appeared to be pricing a reasonably prompt, and near-full, rebound in policy interest rates (not just in New Zealand but in range of advanced economies).

It all made sense at the time: very sharp cuts in policy rates had been appropriate in a sharp economic downturn accentuated by an extreme rise in uncertainty and liquidity preference, but once those fears eased (with time and various direct interventions) it didn’t seem obvious that anything very structural about economies had changed. If so, it wasn’t obvious that future average interest rates would be much different from those of the previous decade or two.

That was then. But now it is 2018. And the median policy interest rate among OECD central banks (that have their own monetary policy) is about the same now as it was in the trough in 2009. Some individual countries have lower rates now, and some higher (the US notably), some have tried to raise rates and had to reverse themselves (eg New Zealand twice, Sweden, and the ECB). No OECD central bank has simply left its policy rate unchanged since 2009.

And throughout that period inflation (headline and core) has remained pretty quiescent. Here is an indicator of core inflation across OECD countries (well, monetary areas, so the euro-area is a single observation).

CPI ex OECD jan 18

Not all central bankers like to own up to paying any attention to (indicative) measures of excess capacity, but over the decade unemployment rates have typically dropped back quite slowly (as in New Zealand) and output gaps are still estimated to be around zero, often negative. As a reminder, these outcomes have come about with interest rates very (historically) low. They aren’t themselves an argument for much higher policy rates.

And yet the anguishing continues. Some of it has become almost pro forma in nature. The former Governor of the Reserve Bank used to regularly talk about how “extraordinarily stimulatory” he thought interest rates were and openly hankered for “normalisation” here and abroad. His temporary successor (the “acting Governor”) throws in occasional references along similar lines. I suspect it makes them more reluctant to lower the OCR than they otherwise would be but – in fairness – they do eventually seem to be led by the data rather than by their mental model of how the world should work.

Others seem to want to translate the model into action. I noticed one example yesterday, in the form of a new column by former ECB board member (in effect he served as chief economist) and former Bundesbank Deputy Governor, Jurgen Stark. Former BIS chief economist (and former Bank of Canada Deputy Governor) Bill White has had a succession of speeches and articles along similar lines, and his latest was published in the Financial Times a few days ago.

Stark opens his argument with the recent sharp dip in US share prices which, he asserts

revealed just how addicted to expansionary monetary policy financial markets and economic actors have become.

Possibly, but since the S&P this morning is still a touch higher than it was on 31 December 2017 – a mere seven weeks ago – I’m not sure it is particularly compelling evidence.

He moves to a somewhat more macroeconomic argument

The fact is that ultra-loose monetary policy stopped being appropriate long ago. The global economy – especially the developed world – has been experiencing an increasingly strong recovery. According to the International Monetary Fund’s latest update of its World Economic Outlook, economic growth will continue in the next few quarters, especially in the United States and the eurozone.

I’m not sure we should be particularly encouraged that “economic growth will continue in the next few quarters”, but nor am I sure how it is relevant. First, projections of continued growth – even growth a bit faster than medium-term potential growth – are, in part, reflections of – and, at very least, consistent with – the low interest rates. And second, inflation – or some other nominal variable – is supposed what central banks focus on first and foremost.

The US Federal Reserve has been raising interest rates, but it isn’t enough for Stark.

But the Fed’s policy is still far from normal. Considering the advanced stage of the economic cycle, forecasts for nominal growth of more than 4%, and low unemployment – not to mention the risk of overheating – the Fed is behind the curve.

It isn’t clear that “the advanced stage of the economic cycle” means much more than that it has been a few years now since the US had a recession. Nominal GDP growth – currently around 4 per cent – shows no sign of racing away, and has averaged 3.8 per cent per annum since 2010. And core PCE inflation – the Fed’s target variable – is currently 1.5 per cent, while the Fed’s self-chosen target is 2 per cent. Yes, the unemployment rate is low, but as on the one hand some analysts suggest the headline number is underestimating residual labour market slack, and on the other the Fed is actually raising policy interest rates (and is expected to continue to do so), it is hard to find any backing for Stark’s claim that the Fed is “behind the curve”. And even if, for example, the latest round of ill-judged fiscal stimulus does end up providing the boost that lifts inflation nearer target, it is hard to believe (and there is no obvious evidence for) that inflation expectations are so weakly anchored that a lift in inflation to target (after all these years) will destabilise expectations in a dangerous and damaging way. This isn’t 1974.

But if the Fed is bad, on Stark’s reckoning, many other advanced economy central banks are “even worse”

The ECB, in particular, defends its low-interest-rate policy by citing perceived deflationary risks or below-target inflation. But the truth is that the risk of a “bad” deflation – that is, a self-reinforcing downward spiral in prices, wages, and economic performance – has never existed for the eurozone as a whole. It has been obvious since 2014 that the sharp reduction in inflation was linked to the decline in the prices of energy and raw materials. In short, the ECB should not have regarded low inflation as a permanent or even long-term condition that demanded an aggressive monetary-policy response.

The ECB’s policy is also out of line with economic reality: the eurozone, like most of the rest of the global economy, is experiencing a strong recovery.

I think there is quite a bit to argue about over the way the ECB interjected itself into the euro crisis, and one can mount arguments – as Stark did – about the appropriateness of the quasi-fiscal policies the ECB ended up adopting. But what about inflation – the macro variable the ECB says it targets, under its treaty mandate to pursue price stability?

euro area CPI

The ECB targets something “below, but close to, 2%” (in practice something like 1.9 per cent). Headline inflation certainly fluctuates – there (as Stark notes) and other places fluctuations in oil prices make a big difference in the short-run. But the last time euro-area wide core inflation was at 1.9 per cent was the end of 2008. And there hasn’t been any obvious sign in the last 12 or 18 months that core inflation is picking up strongly again. Now Stark is German, and activity and demand in Germany have done better than in the rest of the euro-area. Inflation in Germany is also higher than in the euro-area as a whole but on neither headline nor core measures is it as high as 1.9 per cent – and monetary policy is supposed to be set for the region as a whole, not just for the single largest national economy.

As for the “strong recovery”, things in the euro-area are certainly a great deal better than they were, but in its last published forecasts the IMF estimated that for the euro-area as a whole, there was still a negative output gap last year, and forecast one around zero this year. And that with interest rates at (historically) very low levels.

The sort of argument that Stark uses might make a bit of sense if he wanted to argue that interest rates at these levels are having no effect (on demand/activity). If they were having no effect, there might be no harm in having them higher again. But that isn’t his argument. Instead

One of those consequences is that the ECB’s policy interest rate has lost its steering and signaling functions. Another is that risks are no longer appropriately priced, leading to the misallocation of resources and zombification of banks and companies, which has delayed deleveraging. Yet another is that bond markets are completely distorted, and fiscal consolidation in highly indebted countries has been postponed.

This “misallocation of resources” line often pops up in commentaries like Stark’s (it is there is White’s FT article as well) although it is never clear quite what is meant. It really only seems to make much sense if one can confidently assume that their model – in which interest rates should be so much higher – is correct, and thus relative to that benchmark choices are made differently than they would be in the alternative universe. Perhaps it is right, but we have no very obvious means of knowing that it is – after all these years. If neutral rates are lower than they think, “misallocations” might just be “choices”.

And the claim seems to involve the suggestion that some real activity is now happening which wouldn’t happen if only interest rates were higher. Stark actually states it more or less directly: in his view current policies have ‘delayed deleveraging”, and the “fiscal consolidation in highly-indebted countries has been postponed”. But had a whole succession of governments actually been under more pressure to run lower deficits/larger surpluses, cutting their debt levels, where and how does he suppose the replacement demand might have come from? It isn’t as if any monetary area in the advanced world has had consistent excess demand this decade. There are, of course, standard responses about confidence effects, and private demand replacing public spending – at times even the New Zealand experience in the early 1990s is cited – but those offsetting adjustments typically take place in part through lower interest rates and a lower exchange rate (governments cut spending, central banks ease monetary policy, and additional private spending is crowded in ). Stark’s model rules out that process almost by construction. Much the same story is likely to hold for corporate or household deleveraging: the process by which it occurs usually involves (incipient) weaker overall short-term demand and activity. Oh, and if Stark was right and the ECB raised policy interest rates in the current climate and it seems reasonable to expect that the euro exchange rate would be higher. There is no guarantee about exchange rate effects, but (probabilistically) it is another channel that would weaken demand and activity further.

I’m not convinced there is a particularly good case at present for the ECB to still be buying large volumes of bonds. But the case for higher interest rates – across the whole euro-area, or even just for Germany – seems threadbare in the extreme.

Stark ends his article this way, generalising beyond just the ECB.

Today, monetary policy has become subordinate to fiscal policy, with central banks facing intensifying political pressure to keep interest rates artificially low. As the recent stock-market turmoil shows, this is drastically increasing the risk of financial instability. When more – and more severe – market corrections take place, possibly affecting the real economy, what tools will central banks have left to deploy?

The evidence for these claims seems thin at best. There has certainly been a huge increase in net government debt in some of the larger OECD countries in the last decade – France, Italy the US, the UK, Japan, although not Germany – but it isn’t obvious that monetary policy is playing out materially differently in those countries than in places like Switzerland, Sweden or Israel (where net debt has fallen as a share of GDP over the decade – and where official interest rates are very low) or in places like New Zealand or Canada that have seen only modest increases, from low bases, in the levels of net public debt.

And what of the claim that “interest rates are artificially low”? Well, that simply seems to impute far too much power to central banks. Central banks set very short-term interest rates, and over those short-term horizons no one else can do much about it. Central banks do not set long-term interest rates and typically have very little direct influence on extremely long-term interest rates. The longest German inflation-indexed government bond matures in 2046: the current yield on that bond is negative. Perhaps Stark would argue that the ECB bond-buying programme directly or indirectly influences those yields. But in most countries, central banks aren’t engaged in bond buying programmes at all, and very long-term nominal and real interest rates are extremely low. Swiss 10 year conventional bond yields, for example, are basically zero. US 30 year inflation-indexed bonds (and the US currently has by far the highest interest rates among the larger economies) are currently around 1 per cent. And even in little old New Zealand – typically with the highest real interest rates in the advanced world – our 22 year government indexed bond is yielding just slightly over 2 per cent (down from 5 per cent 20 years ago). It is a global phenomenon, and it can’t just be down to the (misguided or otherwise) choices of central banks. Rightly or wrongly, some mix of demographics, weak expected productivity or whatever, seem to be at work. Central banks might not fully understand what is going on – nor might anyone else – but it would brave, nay foolhardy, for the central banks of the world to stake out a stance that relied on a completely different view (“interest rates should be much higher”).

Which, of course, brings us to that very last line in Stark’s article. When things really go wrong, what tools will central banks have left to deploy?

That is, of course, a serious issue, and it is one that ever central bank, every finance ministry, every Minister of Finance should be worrying about. After all, they’ve had years of notice of the issue now. When the next serious recession happens – and one will happen again – it looks as if most central banks in advanced countries will have little or no room to cut interest rates, the typical counter-cyclical stabilising policy instrument. Even countries like New Zealand and Australia will have far less room than typical (the Reserve Bank could probably cut the OCR by 2.5 percentage points, but had to cut by 6.5 percentage points after the last recession). Markets know that constraint, which in turn risks exacerbating the severity of the downturn once it begins. Most major advanced countries also have very little fiscal leeway left (whether as a matter of technical/market limits or political limits).

I’m all for growth-enhancing structural reforms. They would benefit countries now, and in the future (both lifting demand and activity, and raising market assessments of neutral interest rates). There are few signs of those sorts of reforms in most countries (indeed, often – probably including New Zealand – the reverse). But what is the best path now, around macro policy, to provide greater leeway when the next serious recession comes?

On monetary policy, the standard prescription is pretty clear: higher inflation expectations are the only thing monetary policy can do to underpin higher medium-term nominal interest rates. In other words, the best things central banks could have been doing in recent years was to aggressively pursue higher demand and inflation (there being no sign that weak inflation was a result, all else equal, of strengthening productivity growth). Cut interest rates so as to later raise them by rather more (the opposite of the Reserve Bank strategy which turned out to be, in effect, “raise interest rates only to cut them more later”). Few or no central banks have had the courage to adopt this course (or to openly consider higher inflation targets), partly (I suspect) transfixed by the desire for “normalisation”. And what of fiscal policy? In some of the countries with large deficits and high debt, it might well make sense to look to secure fiscal consolidation (giving, among things, more room for countercylical stimulus in the next recession). For a country like the US, more or less back to a fully employed economy, that makes particular sense. But it is far from obvious that the same logic follows in France or Italy (still with negative output gaps): all else equal, fiscal consolidation will tend to worsen economic activity now, and yet euro-area monetary policy has all but reached its limits and can provide no offset. Increasing the chances of a new recession now to slightly reduce the chances/severity of one five years hence is, to say the least, a difficult call (economically or politically).

At present, I’m reading one of the numerous books on my shelves about the politics and monetary policies of the inter-war period. It is, I think, now widely accepted that monetary policy problems were at the heart of the seriousness of the Great Depression in many of the major economies (even New Zealand for that matter); in particular the way the Gold Standard had been run – and patched back together (“normalisation”) during the 1920s after the extreme disruption of World War One.

Some of the abler observers in the late 1920s realised that problems were building up – including that perhaps two-thirds of the world’s monetary gold being held in France and the United States, without the natural stabilising mechanisms being allowed to work freely – but there was never a sufficiently strong shared sense among policymakers that something needed to be done, and promptly. In the US, for example, there was constant unease about the stock market boom, and thus a reluctance to allow the Gold Standard mechanisms to work as they should (when gold floods in interest rates fall, demand increases etc). As I read through the book, I was reminded of the Governor of the Bank of England deliberately accentuating the risks to the UK peg to gold, to keep the pressure on British ministers to make large fiscal cuts (that were probably never substantively warranted). And, even when the UK finally, reluctantly, went off the gold peg in September 1931, instead of embracing the opportunity, for some time all the great and the good (even Keynes) were focused on generating conditions that would warrant a return to gold. Economic historians are now pretty clear that monetary expansionism – made possible as countries slowly, and mostly reluctantly, broke the link to gold – was a significant part of economic recovery in the 1930s.

Historical parallels are never exact but is hard not to see the constant hankering for “normalisation” – and vigorous calls for it in some circles – and even unease about asset prices, as akin to the well-intentioned policy mistakes of the late 20s and early 30s, leaving our world badly exposed when and if the next serious downturn occurs.

(And if – as White and Stark claim – financial stability is your real concern, use financial regulatory instruments and agencies to attempt to tackle those issues directly. Sometimes monetary policy “mistakes”/shocks can be closely linked to subsequent financial stability problems. Arguably that was the situation in Ireland and Spain in the 2000s – interest rates that suited German conditions but not Irish or Spanish ones – but I doubt anyone can point to a single example today of an advanced economy dramatically overheating as those two did.)

France and some near-neighbours

April 27, 2017April 27, 2017 Michael Reddell Euro area

After a run of posts on immigration, or indeed on Reserve Bank issues, I often feel like something completely different. No doubt that is a relief to readers, but it also helps remind me that I intend to write about what takes my fancy and interests me, and not primarily pushing particular causes.

And it is not as if I want to weigh in to the Herald vs Winston Peters contretemps, in which (at least on my reading) the Herald was using numbers that were accurate but seriously misleading (whether with an agenda, or just because they weren’t famliar with the better data, or some combination of the two, I have no idea), while Winston Peters was also, as far as I can tell, factually accurate but really rather distasteful.

But France is coming towards the end of a fascinating election campaign, which (for political junkies) has meant lots of fascinating articles about French politics, French society, and so on. It has resolved to a race between two unconventional candidates, neither with strong parliamentary support, and so potential challenges in governing. And if, as seems likely, Macron wins, the challenge to the “globalist” establishment seems unlikely to go away any time soon.

No doubt there have been some articles around on the French economy, but I must have missed them. So I decided to download some data, mostly from the IMF World Economic Outlook database, and amuse myself by looking at a few comparisons between France on the one hand, and Belgium, Netherlands, and Germany on the other (with a sideways glance at the rather different UK economy from time to time). They seem like good comparators for France, as Australia often is for New Zealand. References to New Zealand will be few and far between, but just note that these are all countries with materially higher real GDP per capita than New Zealand has. And the productivity gaps – using real GDP per hour worked – are much larger again. For those four continental countries, the OECD estimates that average GDP per hour worked is now more than 60 per cent higher than that in New Zealand.

First up is a comparison of real per capita GDP growth, in national currency terms (although of course all four continental countries use the same currency now) since 1990.

real GDP pc growth Fr etc

Over that full period, France has been clearly the worst performer, but interestingly that has only been clear since about 2010. Until then, on this measure Germany and France had been tracking very closely together.

And some of the difference with Germany may still “just” be cyclical (things that economists put “just” in front of can still matter quite a bit in elections). Here are the IMF estimates of the respective output gaps.

output gap fr

There is materially more excess capacity in France than in the other four countries.

Consistent with this, the unemployment rate is materially higher in France than in the other countries. It is about 10 per cent in France, compared with a range of 4 to 6 per cent for Germany, Netherlands and the UK (with Belgium in the middle). France probably has a higher NAIRU. But here is the IMF estimate of this year’s unemployment rate, less the actual unemployment rate for 2007, the last year of the previous boom.

U rate France France is, again, the worst performer.

The government debt position is pretty poor too (although not that much worse than the UK’s).

govt debt fr

I’m never quite sure why people think Germany should increase government spending and increase its government debt – especially in a country with little or no population growth. France’s numbers – among the very highest in any advanced country – don’t look like something to emulate, no matter good the resulting school lunches might be.

govt spending france

Current account numbers aren’t that easy to interpret without lots of context, but even for an advanced economy with modest population growth, surpluses the size of Germany’s (or the Netherlands) look, at very least, anomalous. There isn’t anything inherently virtuous about France’s near-balance position, but it typically wouldn’t be an indicator of serious trouble either.

CAD Fr

With a bit more demand and a stronger cyclical position – hard to engineer with such high public debt, and no national monetary policy – the current account deficit would no doubt be a bit wider.

It isn’t all a bad news story. Here, for example, is total investment as a share of GDP.

investment fr

The investment share of GDP in France last year was higher than that of any of these countries – far higher, for example, than in cyclically more-stretched Germany. At least some of those big, really successful, global French companies must have been seeing some good opportunities at home.

Despite all that government spending and generous welfare provision, nothing really stands out about the French national savings rate either.

savings fr

Even within common currency areas, real exchange rates can move – at times quite considerably. We saw that a lot in the run-up to the crisis, with real exchange rate appreciations in peripheral countries (such as Ireland) relative to core euro countries. Perhaps such movements help explain, or mitigate, France’s disappointing relative performance?

These are the BIS’s broad real exchange rate measures for France and Germany.

exch rate fr

The two countries’ real exchange rates have moved all but identically ever since the creation of the euro. It isn’t clear why there hasn’t been more movement (especially in recent years) but it isn’t hard to suspect that if the franc and mark were again different currencies, we wouldn’t have seen anything like as strong a common trend.

Over the longer-term, it is hardly as if France is some hopeless case. If we look at meausures of labour productivity, real GDP per hour worked (in PPP terms) in each of France, Belgium, Netherlands and Germany are among the highest anywhere, averaging something very similar to the US numbers (the UK is quite a bit lower). The OECD’s series for that data goes back to 1970. Here is how France has done relative to the other three continentals.

fr real gdp phw France caught up over the first few decades and has largely held its own since, at least relative to these comparators.

Of course, one of the striking things about France is how little labour input is used.

employment rates fr.png

Since, as we saw above, the French unemployment rate is higher than usual, the picture is slightly exaggerated at present. but the difference between France (and Belgium) and the other three countries is stark. (In New Zealand, by the way, the employment rate in the same quarter was 66.9 per cent, while the US is similar to Germany, Netherlands and the UK.)

The differences are just as stark, if not more so, if we look at hours worked per capita. Here I use the Conference Board’s Total Economy database.

hours worked per capita Fr

The average French person – man, woman, child, young middle-aged and old – worked around 600 hours last year. The average New Zealander worked more than 50 per cent more – and still managed clearly the lowest real GDP per capita of any country in this chart. So little output for so much input.

There are lots of stories about the possible connections between hours and productivity. If, for example, you impose tough regulations and make employing labour very expensive, firms will have to adapt such that the people who are employed are highly productive (they have to earn their keep). The less productive firms and people are simply priced out. But higher taxes – certainly than somewhere like New Zealand – and provisions of retirement income policies also play a part in discouraging French working hours, and not just from the unproductive. Plenty of very capable people have long holidays, shortish work weeks, and relatively early retirements. As a result, French GDP per capita is lower than those of the other continentals in this sample, even though productivity per hour worked is very similar.

I don’t have strong lessons to draw from this post – it was a discursive tour, as much out of curiosity as anything. But I’ve long been a sceptic of the euro and – disruptive as a break-up or withdrawal inevitably would be – it isn’t obvious that French voters could look on the single currency as any sort of unalloyed blessing for them, and their country, especially in the years since 2007.

There are good reasons to be glad not to be in France – Islamic terorism among them. But when one looks as these data – not just for France but for each of the continental countries here – from a New Zealand perspective, aware of all the regulation and high taxes etc in France, it is a reminder of how much location really does seem to matter. I’m in the middle of reading a wonderful new book by a leading academic expert on trade, convergence etc – which I expect I will write about here soon. As he notes, technological innovations made extensive trade in goods possible from the 19th century, and then trade in ideas (all that ICT), but if anything face-to-face contact now seems to matter more than ever, and firms and global economic activity seems increasingly concentrated in cities and regions like those of northern Europe (or east Asia, or North America), not in the isolated peripheries.

More states or fewer?

June 27, 2016June 27, 2016 Michael Reddell economic geography, Euro area, UK

I was going to write something today about monetary economics, the 2008/09 crisis, and reform options for financial systems and economies, but….the Brexit aftermath is pretty much all-absorbing, at least to a politics/economics/geopolitics junkie. So far, it is difficult to see why anyone would be very surprised about what has happened since Friday, but of course it is very early days. Media coverage seems dominated by perspectives from those – including the journalists writing the stories – almost personally affronted that the populace of a major, quintessentially moderate, country could have voted as they did. The stories highlight, without really needing to try, the disconnect between what might be loosely described as a metropolitan urban liberal mindset that downplays the local in favour of a network of internationalist rule-setting, and what might loosely be described as a more small-c conservative mindset that puts a greater emphasis on the local and the national as the basis for rule-setting and governance. Peter Hitchens highlights this contrast in his column here – highlighting how detached the majority of MPs of both main UK parties have become from the views and attitudes/priorities of very large shares of their voters. The situation probably isn’t much different in a whole variety of advanced countries.

But what got me particularly interested over the weekend was talk of the United Kingdom itself breaking up. Of course, that started a long time ago. The Irish Free State (as it was then called) became independent in 1922. If Northern Ireland should eventually reunite with the Republic of Ireland – and frankly I would be surprised if it happens in the next few decades, given the risk of reigniting the decades-long civil conflict – it would only be the culmination of the Home Rule movement that was convulsing British politics as far back as the 1880s, and which saw Britain facing the possibility of an army mutiny and civil war on the eve of World War One.

The chances of Scotland becoming independent seem somewhat higher – after all, the Out vote got 45 per cent in the last referendum only two years ago. If the headline-grabbing opportunity to push for a new referendum is the desire to stay in the EU – and for all the hype, even 38 per cent of Scots wanted out – they had better hope there is still an EU to belong to a decade hence. But even if not, is the idea of Scottish independence so different from that of Irish independence – which we all now take for granted, even if (at the time) it probably came at a considerable economic cost? Scotland had been independent for hundreds of years, and if it did well economically from the Union and its people played a huge role in the British Empire, who could begrudge them the right to govern themselves?

After all, although it wasn’t always so, the people of England and Wales make up 90 per cent of the population of today’s United Kingdom. Even without Scotland and Northern Ireland, England and Wales would be the fourth most populous country in Europe, just a little behind Italy.

But then I got thinking about other countries. Hasn’t a move towards more countries been underway for some considerable time? The unification of Germany and of Italy were huge developments in the mid 19th century, but they were largely completed by 1870. Our own Land Wars finished around the same time, securing a single state entity on these islands. The US grew hugely (in territory) during the 19th century, but had largely reached its current size with purchase of Alaska (from another large state) in 1867. Even the acquisition of Hawaii was almost 120 years ago now.

I found a list of countries ordered by population in 1900. Here was the 25 largest:

China	415,001,488
Indian Empire	280,912,000
Russia	119,546,234
USA	75,994,575
Germany	56,000,000
Austria-Hungary	51,356,465
Dutch East Indies	45,500,000
Japan	42,000,000
United Kingdom	38,000,000
France	38,000,000
Italy	32,000,000
Ottoman Empire	30,860,000
Spain	20,750,000
Brazil	17,000,000
Mexico	12,050,000
Korea	12,000,000
Northern Nigeria	8,500,000
Egypt	8,000,000
Morocco	8,000,000
Philippines	8,000,000
Southern Nigeria	7,500,000
Siam	7,200,000
Persia	7,000,000
Romania	6,630,000
Belgium	6,136,000

Of these, the two parts of Nigeria (both then administered by the UK) are now one country. Quite a few of the other countries are much the same as they were then, subject to some (mostly relatively minor) border adjustments (eg the return of Alsace-Lorraine to France).

But the bigger story surely is the break-ups. What was the United Kingdom is now two countries, the UK and Ireland. What was Korea is now – at least for the time being – two countries, North and South Korea. India as it was is now Sri Lanka, India, Pakistan, Bangladesh and (depending where the boundary lines were drawn) Burma. And the erstwhile Russian, Austro-Hungarian, and Ottoman Empires have split into dozens of new independent countries between them.

What of today’s 25 most populous countries?

China	1,376,048,943
India	1,311,050,527
USA	321,773,631
Indonesia	257,563,815
Brazil	207,847,528
Pakistan	188,924,874
Nigeria	182,201,962
Bangladesh	160,995,642
Russia	143,456,918
Mexico	127,017,224
Japan	126,573,481
Philippines	100,699,395
Ethiopia	99,390,750
Vietnam	93,447,601
Egypt	91,508,084
Germany	80,688,545
Iran	79,109,272
DR Congo	77,266,814
Turkey	78,665,830
Thailand	67,959,359
United Kingdom	64,715,810
France	64,395,345
Italy	59,797,685
Tanzania	53,470,420
South Africa	54,490,406

Of these countries, only the last two comprise what were smaller entities in 1900 – and neither is, perhaps, an advert for the cause of ever-larger unions. Tanzania was previously the colony of Tanganyika and the protectorate of Zanzibar (ruled by a Sultan, under British oversight). Zanzibar was granted independence in 1963, but this was quickly followed by a bloody revolution, at the end of which Zanzibar was absorbed (semi-autonomously) into the new Tanzania. And, of course, South Africa in its current legal form was the fruit of the Boer War, essentially a war of conquest in which – at great cost – the British Empire and the British colonies beat the Afrikaaner states.

Have there been other mergers attempted? Well, yes, after World War One the artificial state of Yugoslavia was created by the powers. That has now long gone. Czechoslovakia also emerged from that settlement – also (peacefully and successfully) gone. In the 1950s there was political union between Egypt and Syria: it last for all of three years. The British created the Federation of Rhodesia and Nyasaland in the 1950s, and it was also gone a decade later.

Can one think of exceptions? No doubt. Various colonial enclaves have been reabsorbed by the surrounding power, peacefully or otherwise – Goa, Hong Kong, Macau. But there isn’t much else for more than 100 years, and none that I can think of where the voluntary choice of the respective populaces has led to the formation of larger states from smaller states (happy to hear if I have forgotten any). Germany reunited – but then it never separated voluntarily, and indeed in 1945 the intention was never two separate states.

None of this should really be very surprising. The other great trend of the last couple of hundred years has been towards democratic government. People clearly seem to want to rule themselves with – and be governed by – people with whom they feel some significant sense of common identity and shared perspectives (which might be ethnic, or religious, or linguistic, or simply historical). Little really – in the scheme of things – divides New Zealand and Australia, and yet there is no great appetite for the two to become one. The metropolitan elites might wish it were otherwise – and might even believe quite genuinely that everyone could be better off it only things were done their way – but the citizens of the world show little sign of being convinced by their story. Are the people of the world poorer as a result? Possibly – despite the huge volumes of cross-border trade – but some things seem to matter more to most of them.

And it isn’t as if the trend towards more and smaller states looks like having run its course. Even in Western Europe, there is Scotland, demands from Catalans for independence, and the ever-present question of what unites Belgium other than, say, a football team.

In that light I was quite puzzled by Wolfgang Munchau’s FT column today. In many ways it was a hardheaded piece, noting that the risk from the UK referendum for the rest of Europe may be greater than those for the UK. Highlighting Italian risks in particular – and Italian stocks fell savagely on Friday – he ends

To prevent such a calamity, EU leaders should seriously consider doing what they have failed to do since 2008: resolve the union’s multiple crises rather than muddle through. And that will have to involve a plan for the political union of the eurozone countries.

How he imagines that the citizens of the Eurozone countries will ever agree to political union, especially now, is beyond me. I guess the traditional European elite approach is not to give them a say.

UPDATE: For anyone wanting a more systematic treatment of some of these issues, see Alesina and Spolaore The Size of Nations (my copy of which I finally found on my shelves). They devote an entire chapter to the EU. In a book published in 2005 – with an expanding EU, and the general contentment with the early years of the euro – they seem (perhaps understandably) slightly uncomfortable with how the EU fits with their general model in which lower trade barriers and fewer wars would typically result in more states, not fewer. But they conclude their EU chapter boldly: “Quite simply, it is not possible for Europe to become a federal state”.

Brexit thoughts from the Antipodes

June 11, 2016June 11, 2016 Michael Reddell Euro area, UK

My wife suggested a post on the contrast between British entry to the EU (or EEC as it was then) and the looming possibility of British exit. She is young enough that British entry was a featured topic in New Zealand history when she did School Certificate history in the 1980s (for me, it was closer to being current affairs). By contrast New Zealand media coverage of the British referendum is largely devoid of any particular New Zealand dimensions. On a day when the British papers are highlighting a new poll suggesting that the Brexit cause could win, it seems like a good day for a few thoughts.

A lot has changed in the years since the early 1960s when New Zealand first faced the possibility of Britain entering the EEC, and the threat that posed to New Zealand’s major markets for dairy and lamb exports. So important was the issue that, apparently, at New Zealand economists’ conferences in the 1960s a toast was often drunk to Charles de Gaulle, for his two vetoes of UK entry.

The make-up of our population has changed over that time, but in some ways less than one might think. In the 1961 Census, 9 per cent of the population had been born in the United Kingdom, and in the 2013 Census, 6 per cent had been. And in most years, the United Kingdom is still the source country for the largest group of those given residence permits to live in New Zealand. The UK still seems to be the favoured destination for New Zealanders looking for an OE, at least one beyond Australia. Sporting ties, and rivalries, seem as strong as ever. But if state high schools still sing “Jerusalem” and cathedral choirs still sing Stanford and Parry, the emotional ties are much less strong than they were. In the early 1960s, it was less than 20 years since the end of World War Two, and less than that since the conflicts in Korea and Malaya where New Zealand and British troops had fought side by side.

But it is probably the economic ties that have changed most. One of the after-effects of the war – and the huge overhang of debt the UK had taken on – was the Sterling Area, of which New Zealand was a part. With a fixed exchange rate to sterling – unchanged for almost 20 years – and our foreign exchange rate reserves held in sterling, overall sterling area access to US dollars affected each country in the area. Private international debt markets were much less developed than they had been in the past, or are now. And New Zealand government offshore borrowing had been undertaken in the UK for more than 100 years – it wasn’t until the very end of the 1950s that the first, expensive, New Zealand government loan was raised in the US. Britain had been keen on New Zealand joining the IMF and World Bank – we didn’t until 1961 – partly because it would facilitate access to dollars for New Zealand’s capital needs.

And, most of all, the United Kingdom was a major export market – as late as 1967, 44 per cent total exports went to the United Kingdom. In the 1960s, almost all our dairy and lamb/mutton exports went to the United Kingdom. As the New Zealand Ambassador to the US put it, in a prominent lecture he gave in New York in 1963, “the problem which we faced….was the threatened removal of the one remaining important free market for primary produce at a time when the highly industrialised countries of Europe are intensifying the trend to self-sufficiency in these products”. There were, at the time, no credible alternative markets for some of the largest chunks of our exports. And if Continental leaders were willing to consider UK entry to the EEC, they certainly didn’t see continuing New Zealand easy access to UK markets as part of the deal, Indeed, one of the attractions of UK entry to them was detaching Britain from the Commonwealth and traditional suppliers of agricultural products (Australia as well).

Possible British entry was a huge issue for politicians and economic advisers in New Zealand in the 1960s and early 1970s, but it wasn’t a trivial issue in the British debate either. Some of that was about past ties of blood, shared military sacrifice, shared family bonds and so on. But some of it was economic too: New Zealand lamb and butter – known as coming from New Zealand – had an established and significant place in the British retail market. It would have been difficult – perhaps impossible – for Britain to have joined the EEC – for British public opinion to have allowed it – without “acceptable” arrangements for New Zealand and Australia.

At the time, material living standards in New Zealand were still higher than those in the United Kingdom – ours were still among the best in the world. The prospect of UK entry, with all that risked implying for markets for New Zealand produce, was a very dark cloud over those living standards. (In that same lecture, our Ambassador to US, presumably citing received official opinion saw import substitution by building up local manufacturing, combined with rapid population growth – natural increase and immigration – as part of the solution).

The situation is nothing like symmetrical today. The United Kingdom is still our sixth largest trading partner, but lagging a long way behind Australia, China, the United States and the euro-area. If London remains one of the most important financial centres in the world, open capital accounts mean that the UK is not a particularly important source of financial capital at the margin – and, of course, our government doesn’t borrow abroad, and our exchange rate floats. There might be opportunities for New Zealand individuals and firms if the UK actually leaves the EU – our lamb exports to Europe (including the UK) are still restricted, and there are some hopes that revised immigration policies might treat New Zealanders the same as, say, other Europeans. But these are probably second or third order issues for the New Zealand economy as a whole. Some of those strongly campaigning for Brexit would favour a much more market-oriented approach to trade and regulatory policy, and anything that lifted medium-term productivity prospects would be good for the world (including us). Whether there would be much improvement in the quality of policy is perhaps debatable – other Anglo countries, not caught up in the web of Brussels, have not exactly been at the forefront of market-oriented liberalization in the last decade or so.

If Brexit isn’t a great economic opportunity for New Zealand, what about the risks on the other side? The great and good of the economic establishment – in Britain and internationally – have been weighing into the debate to urge British voters to vote “Remain”. Even President Obama has been recruited to the Prime Minister’s cause – as if the views of a foreign leader should influence British voters views about the future of their own country. Hundreds of economists have been writing to the papers urging the voters to vote to stay in the EU. It is a curious spectacle. One might have supposed that agencies such as the IMF and the OECD would have little credibility with anyone these days, and nor is it clear that they have (or even should have) British voters’ best interests at heart when they offer their advice.

The economic debate seems to turn on two, separate, issues. The first is about the transition, and the second about the medium-term. Actually, the two quickly converge.

We’ve already seen markets rattled each time polls suggest a heightened probability of Brexit. It will, almost certainly, get much worse in the next few weeks if the latest polls are picking up something real. And if Britain votes to leave, the days after that result is declared could be very very messy indeed. Apart from anything else, the path ahead – even for Britain – is quite unclear, starting with who will be leading the British government to negotiate the exit terms.

The world economy and financial system are hardly in fine robust health. And the policy buffers if things go wrong are few and very limited – in monetary policy alone, almost everyone is already starting with interest rates around zero. Britain itself just isn’t that important – nukes, a Security Council seats, and London as a financial centre notwithstanding. Then again, it is only a year or so since the Scottish referendum was unnerving markets, and Greek crises have repeatedly wrought havoc for the last few years. Why? Because what starts in one place probably won’t stop there. No one was really comfortable that the wounds to the euro could be cauterized if Greece left. What of the EU itself?

It isn’t as if euro-skepticism is a uniquely British phenomenon. I thought this Pew Research chart from a few days ago was fairly telling

eu favourability

Public opinion in France is less favourable to the EU than that in the UK, and the UK numbers are little different than those in Spain, Germany and the Netherlands.

Which is why a lot of the economists’ contributions to the UK debate seem rather moot. They come up with estimates – really not much better than back of the envelope ones, despite all the apparent sophistication – suggesting a potential loss of income to the average Briton if the UK leaves. But that all assumes that the rest of the EU holds together largely as it is. And that doesn’t seem very likely at all. In fact, as with the cause of Scottish independence, a defeat in a single referendum seems unlikely to make the exit issue go away even in the UK. As with the euro itself: break-up fears wax and wane, but it will be a very very long-term (most likely never) until that risk disappears altogether.

So really the economic establishment – in the UK and globally – is urging British voters to vote “Remain” to hold the whole EU project together. They can’t actually say that – that would suggest a fragility they just can’t publicly acknowledge – so they have to pretend that it is all about the British voters’ own best interests. This week it reached ludicrous extremes with David Cameron suggested that people who voted “Exit” weren’t being patriotic and didn’t believe in their country.

But very few British voters really want any part of an “ever-closer union”. Actually, few voters in most of the rest of Europe do either. And yet everyone recognizes that the euro in particular can’t credibly hold together without further progress in that direction. Probably most voters are quite keen on free trade in goods – and to a lesser extent in services – among European countries, but they don’t want their laws made by unelected officials in Brussels, or even by majorities of ministers from other countries. And they don’t want their laws interpreted, and application decided, by foreign judges. It is quite a bit about what being a nation state is. Many aren’t too keen on a lot of immigration either – no matter how often the elites assert that benefits flow from it. That seems like the sort of choice citizens of each country should get to make. And to be able to toss out the people who make laws and regulations they disagree with.

I’m not a Brit – all my ancestors were, but they left in 1850 and shortly thereafter – but of all the countries in the world other than New Zealand, Britain is probably the one I care most about. Were I a British voter, I’d vote for Exit. Not because Britons would necessarily be better off economically – they could be, with the right policies, but one doesn’t decide the future of one’s country based solely on narrow economic considerations. Had it been otherwise, perhaps New Zealand in the 1960s could have done a Newfoundland, and given up our independence to become part of the UK (in case anyone is wondering, I’ve not found any who suggested doing that).

Voting to leave the EU would be, to some extent, a step into the unknown. But big important choices often are – whether to go to war, to marry or to break-up a marriage, to split a country, or an empire. People in Ireland were probably worse off (economically) for decades from leaving the United Kingdom, but who is to say their choice was wrong or illegitimate. One must be prepared to count the cost of those choices. But if British voters want their country to be as independent – but still, inevitably interdependent – as New Zealand, or Australia, or Canada, or the United States, then Exit seems like the way to vote. It might be a rocky ride, even for the rest of us – perhaps it might even be the unwelcome way in which Graeme Wheeler gets the TWI down – but it is a perfectly reasonable choice. And one voters in other countries are likely also to make before long. The EU as we see it today looks a lot like a project that has badly over-reached.

Thinking about the euro and common currencies

November 16, 2015November 16, 2015 Michael Reddell Euro area, Exchange rate regimes

There was interesting and stimulating piece by Matthew Klein the other day on the FT’s blog Alphaville headed “The euro was pointless”. I’ve been a euro sceptic from way back, and am still counting the months until it dissolves. A common currency should be an intrinsic part of common nationality, and if the latter isn’t going to happen neither, generally, should the former. The exception, where there might be some gains from a common currency, and no real costs, could be if countries’ economies were so similar that they faced the same shocks and the same stresses.

That said, I’m not persuaded that Europe’s current plight can be attributed largely to the creation of the euro. After all, the whole region is at or near the lower bound for nominal short-term interest rates. If each of the countries had their own currencies, perhaps some would be doing a little better than they are, but on average interest rates couldn’t be lower, and there is no reason to think that, on average, the real exchange rate would be lower. The zero bound looks as though it binds more tightly in countries/regions with little or no population growth than in others.

But what caught my eye was when Klein got into his stride with a discussion of “the most natural currency union never to exist: Australia and New Zealand”.

I presume he is unaware that for the first 89 years of its modern existence, New Zealand to all intents and purposes did enjoy a currency union with Australia. To the extent that one can even think of a NZ/Aus exchange rate until 1929 (or NZ/UK or Aus/UK ones) they were each 1. After 1914 it was no longer a matter of law, but the private sector still found it worthwhile to manage the exchange rates to retain parity. (Of course, prior to 1901, “Australia” was a geographical expression only – a continent made of up of several different self-governing colonies). There was no banking union or fiscal union (but a great deal of debt), although labour flowed pretty freely between the two countries in response to differences in economic performance. In those days, of course, both countries traded primarily with the United Kingdom, and trade between them was not overly important. Some of the shocks – see the Australian financial crisis of the 1890s – were nastily asymmetric.

(Here is a link to an earlier post on the longer-term developments in the NZD/AUD exchange rate.)

What about now? We largely share the same banks, but not the same banking system (having different currencies and different regulators). Australia is New Zealand’s largest trading partner, but it is by no means a dominant partner (and some of the trade is simply commodity exports – oil notably – where it really doesn’t matter if the product is shipped to Australia, or to, say, Singapore or Japan.) Foreign investment flows are substantial, although in terms of Australian foreign investment in New Zealand the largest single component is the banks.

Klein argues that we do just fine with separate currencies, but I suspect he undersells the possible costs and benefits in the economic case for a common currency. If the NZD/AUD is typically one of the least variable of New Zealand’s exchange rates, it is much much more variable than the exchange rate between, say, the Netherlands or Germany. In just the last three years, the monthly average NZD/AUD exchange rate has fluctuated between 79c and 98c – a difference of around 25 per cent. Commodity exporters in the two countries have to live with that sort of variability (and more) in world markets for those products, but in the rest of tradables sectors most of the pricing variability comes through the nominal exchange rate. Economists haven’t been very successful in identifying the empirical magnitudes of the costs of exchange rate variability, and Klein usefully reminds us of the cases of Hungary and the Czech Republic which, even with floating exchange rate, have become highly integrated with Germany (gross exports to Germany in excess of 20 per cent of each country’s GDP, compared with well under 10 per cent of New Zealand’s GDP in exports to Australia).

Nonetheless, it doesn’t seem plausible that the degree of variability in the NZD/AUD exchange rate is not reducing the amount of trade between the two countries to some extent. Much of the integration of Hungary and the Czech Republic with Germany is, as he points about, about large scale FDI by the highly capital intensive (and highly internationalised) German car industry – a scale of manufacturing that neither New Zealand or Australia has. Fluctuations in the exchange rate can be managed within the balance sheets of the car companies themselves (and for them, FDI is often a way of managing the variability of exchange rates). But that is not an option for smaller producers. Typical Australia firms considering supplying New Zealand, and vice versa, have to manage themselves the still-substantial fluctuations in the exchange rate, in a way that small firms in the Netherlands don’t face in dealing with Germany, or those in the South Island don’t facing in dealing with the North Island. Physical distance is still a barrier that is not going away, but it is hard to believe that the exchange rate is not also an obstacle to growing that foreign trade. The overall effect on potential GDP might be small, but it must be bigger for New Zealand than for Australia, and….after our performance in the last few decades, every little would help.

But the other side of the picture is interest rates. As Klein notes, we have had similar inflation rates (actually Australia’s have been a bit higher, reflecting the higher inflation target) but real interest rates in New Zealand have been persistently higher than those in Australia. There have been brief exceptions, but consider the current (not unrepresentative) situation: Australia’s policy interest rate is 2 per cent, and its inflation target is 2.5 per cent, while our OCR is 2.75 per cent against an inflation target of 2 per cent. Putting an Australian interest rate on the New Zealand economy in the last 20 years would have been a recipe for rather more rapid credit growth, a bigger boom, higher inflation, and a more serious risk of a nasty economic and financial adjustment somewhere down the track.. That is, after all, pretty much what happened in Ireland and Spain, where a German (or Franco-German) interest rate was put on economies that typically needed rather higher interest rates.

It is why, unless we are signing up to a full political union with Australia, I’d be pretty reluctant to think that a common currency was a reasonable proposition, even though such an arrangement might boost real trade. Perhaps it would be different if we’d seen a couple of decades in which New Zealand’s real interest rates had persistently averaged very close to those in Australia.. And even then, there would still be that nagging “are you sure about what you are getting yourself into”.

After all, one could easily look at France, Germany, Austria, and the Netherlands and think that a common currency and single policy interest rate worked fine there. Real exchange rates had been pretty stable for decades (in contrast to, say, NZ/Australia or NZ/UK real exchange rates).

But notwithstanding that, or perhaps even because of it, the unemployment rates in New Zealand and Australia have tracked materially more closely over the last 20 years or so (data for all countries only exists since 1993) than the unemployment rates of France, Austria, or the Netherlands have tracked with that of Germany. If stabilisation is a concern – and it is usually does count for rather a lot in modern macro and modern politics – it isn’t obvious that the euro has necessarily been a great economic choice even for this core group of countries. In principle, microeconomic policy can deal with these difference, but somehow New Zealand’s and Australia’s arrangement look practically better – not optimal necessarily (few things are) but not too bad as things are.

Then again, if your countries are merging, and becoming a single state none of that may matter. But there has never seemed much public appetite for that in Europe, and perhaps even less now than there was six months ago.

Greece: fourth weakest export growth among OECD countries since 2007

July 11, 2015July 11, 2015 Michael Reddell Euro area, Greece

I was reading this morning Robert Waldmann’s critique of Olivier Blanchard’s defence of the IMF’s involvement with Greece since 2010. I agreed with much of what Waldmann had to say, and remain fairly unpersuaded by Blanchard’s case.
But one of Waldmann’s comments caught my eye. It was the suggestion that Greece has achieved a massive internal devaluation over the last few years.

I’ve pointed out previously that that doesn’t seem right. The measure of a successful internal devaluation is surely in the degree of resource-switching that has gone on.

Those wanting to put an optimistic gloss on the data can certainly produce real exchange rate measures that seem to show some gains in competitiveness. Perhaps, but it is difficult to adjust for compositional effects (the least productive people will have lost their jobs, but presumably want to be employed again one day).

These two charts just look at some of the key aggregates, drawing from the OECD’s quarterly national accounts database.

Exports have been recovering somewhat since the trough after the global recession of 2008/09, but the volume of exports is only now back to 2007 levels. In an economy with unemployment in excess of 25 per cent, there is no crowding out of the export sector.

Import volumes have certainly fallen, very substantially. That might reflect competitiveness gains, and greater opportunities for domestic import-competing tradables producers. But it looks a lot more likely to mostly reflect a severe compression in demand. The collapse in real investment is particularly telling.

Out of curiosity I also dug out from the OECD data on export volumes for all the OECD countries since 2007. This chart shows export volume growth from the 2007 annual level to the most recent quarter (mostly the March quarter of 2015).

Of the 35 individual countries shown (OECD members, plus Latvia), Greece has had the fourth weakest export volume performance over that period. The result isn’t particularly sensitive to the starting point: I also looked at growth since the 2007-2008 quarterly peak, and Greece was second worst on that. With so much spare capacity, and no room to use domestic macroeconomic policy tools to stimulate demand, Greece needed export growth more than any other country in the group. But it has simply not achieved it – and not even really begun to achieve it.

Who knows what the outcome of the weekend’s meetings in Europe will be. But it looks as if Greece still desperately needs a substantial real exchange rate devaluation. For Greece, resource-switching has not occurred within the euro, despite years of extraordinarily high unemployment. It is hard to see how any of the recent “austerity plans” will materially alter that situation any time soon. Flexible exchange rates tend to make the adjustment easier. They provide no guarantee, but what does staying with the status quo offer economically?

In passing, the New Zealand export performance has not been that impressive – around the median of this group of countries, and not much different from the euro-area countries as a whole (and these aren’t per capita data, and we’ve had stronger population growth than most).

Greece: only the third worst performing euro-area country

July 8, 2015August 12, 2015 Michael Reddell Euro area, Greece

Amid the focus in the last few days on Greece, I was reading an interesting New Yorker profile of Matteo Renzi, the Prime Minister of Italy It is a very upbeat piece, so upbeat that the authors seemed not to have bothered to look at just how badly Italy has been doing.

From the IMF WEO database, I extracted the data on growth in real per capita GDP from 1998 (just prior to the 1 January 1999 start of the euro) to 2014. Not all the countries have been in the euro for the whole period, and there is no data for 1998 for Malta.

The results were mostly unsurprising. The four countries formerly in the communist bloc have done best of all over that period, followed by Ireland. But at the other end of the chart, I was surprised. Greece has a 27 per cent unemployment rate, and has had one of the deepest declines in GDP in any advanced country in modern times. And yet over the sixteen years taken together, Italy has done slightly worse than Greece. It wouldn’t have surprised me if this had been a measure of real GDP per hour worked – Greek labour productivity has held up reasonably well through the recession – but this is GDP per capita.

Italy has had a less rocky ride than Greece: even now its unemployment rate is “only” 12.4 per cent. But it is not as if the economy is now rebounding either. In the last eight quarters, cumulative real GDP growth has been zero. No wonder people think that Italy might be the next link in the chain to break, if and when Greece leaves the euro.

Out of interest, here is how the euro area countries have done since 2007, just prior to the recession and initial crisis of 2008/09.

Never send to know not for whom the bell tolls

July 6, 2015 Michael Reddell Euro area

A remarkably decisive vote coming in now from Greece. I’m school holiday bonding with my son, watching CNBC’s coverage (Steve Keen and all). No one can say with any confidence how things unfold from here. No doubt, establishment leaders in other vulnerable countries desperately don’t want the Greeks to leave the euro, but those in other countries might be glad to be rid of them. No doubt, the ECB won’t want to find itself as the agent who finally determines whether or not the first brick is removed from the wall. No doubt, Greek opinion is still reluctant to face up to leaving. But further default is surely coming very soon. And the banks must re-open eventually and even if there is more ELA support, who would sensibly leave more than transactions balances in a Greek bank account. It is very hard not to see Grexit happening some time very soon. And that is unlikely to be the end of it. Yes, the ECB and national authorities can ensure adequate liquidity buffers for banks in other countries for the time being. But central banks can do nothing about the tide of public opinion, which – in the north and the south – seems increasingly unsure about just what good the euro is doing.

In reflecting on Greece and the wider edifice of the euro, John Donne’s 17th century words spring to mind.

No man is an island,
Entire of itself,
Every man is a piece of the continent,
A part of the main.
If a clod be washed away by the sea,
Europe is the less.
As well as if a promontory were.
As well as if a manor of thy friend’s
Or of thine own were:
Any man’s death diminishes me,
Because I am involved in mankind,
And therefore never send to know for whom the bell tolls;
It tolls for thee.

John Donne

A few thoughts on Greece

June 30, 2015August 12, 2015 Michael Reddell Euro area, Greece

It is a pretty difficult period for the world economy. The new BIS Annual Report (on which more later) keeps repeating that world growth has been back at around long-run averages. But a quick glance down the headline stories on MacroDigest this morning (and it is much the same on the FT or the WSJ) reveals this collection:

Puerto Rico “can’t pay $72bn of debt”

Greece threatens top court action to block Grexit

Double bubble trouble in China

A failed euro would define Merkel’s legacy

BOE’s Haldane: Record-low rates necessary for continued recovery

My 12 year old has asked me to start teaching him economics, and we are bombarded with stories to discuss. This morning, at least, there are no good-news stories.

Of course, most focus is on Greece. I’ve recently lost a long-running wager on Grexit. Three years ago I bet a senior official who was much closer to the politics of the euro area that at least one country would have left the euro by mid-June 2015. His story was, essentially, that the European authorities would do whatever it took to hold the euro together and make it viable for the long run, partly because the alternative was so awful. My story was that the economic stresses were sufficiently severe, and choices would ultimately be made in individual nation states, that euro was most unlikely to hold together, at least with anything like the number of countries it had then.

In 2012 I certainly underestimated the political determination, and probably also the extent to which Greek public opinion would want to stay in the euro, no matter how bad the economy got. Getting into the euro seems to have been a mark of a successful transition to a modern democratic state. This was, recall, a country that had been ruled by the colonels as late as 1974, and had had a civil war only thirty years prior to that. Even now, there is no certainty that a “no” vote this Sunday – in respect of a package which is no longer even on the table – will lead to Greece quickly leaving the euro. With tight enough capital controls, and the rudiments of a parallel currency, perhaps they will limp on for a while yet. The political imperative still seems to be that if Greece is going to leave, the narrative has to be one in which “other countries forced us out”. Greece doesn’t seem to be ready to positively embrace exit – political dimensions aside, the path through the first year or two beyond exit is pretty difficult and unclear. For those of you who have read Pilgrim’s Progress, it is perhaps reminiscent of Christian’s fear as the river rises around him – the river he must cross to enter the celestial city. Grexit is no path to nirvana, but it does promise something better.

Because if exit looks frightening, going on as things have been in the last few years shouldn’t be remotely attractive either. The simple mention of 27 per cent unemployment should really be enough. Add in no sign of any sustained growth in the external sector of the economy, and it is a picture of any economy that has made no progress at all in reversing one of the very deepest recessions of modern times. None of that is to deny that there have been useful reforms. But, as I’ve said before, there is no sign of any politically acceptable deal (politically acceptable to creditor countries and to the Greeks) that in consistent both with Greece staying in the euro, and with securing a strong rebound in economic activity and employment in Greece. “Tragedy” is an over-used word, but surely this is one?

Part of the sheer awfulness of the situation is realising the part that other countries played in bringing this about. And here I include even remote countries like New Zealand, which did not speak out – or even speak quietly – against the IMF involvement in the deal. Without the bailout package in 2010, this crisis would have come to a head five years ago. It is now hardly controversial to suggest that the case for the 2010 bailout package, rather than a widespread Greek sovereign default, was mostly about the French and German banking systems, and concern with the possible ramifications for the wider world economy and financial system. None of this absolves the Greeks of some responsibility. Technically, no one forced them to take the deal. But as the Irish and Italian authorities also found, it can be very difficult to resist the pressure to accede to the wishes of the ECB and core euro-area governments.

Where to from here? As Gideon Rachman put it in his FT column today

If the Greek people vote to accept the demands of their EU creditors — demands that their government has just rejected — Greece may yet stay inside both the euro and the EU. But it will be a decision by a cowed and sullen nation. Greece would still be a member of the EU. But its European dream will have died.

And if Greece does leave, who will be next, and when? It might take some time, but with no sign of a strong or sustained rebound in European growth, it is difficult to see the euro surviving in anything like its current form. It probably isn’t a risk in the next few months – the ECB and the Commission can deploy support mechanisms to manage any resurgence of external market pressures. The threat is more from public opinion – of realising, a year or two from now, that there is viable life outside the euro. Places as badly managed as Argentina didn’t lapse into permanent economic depression after default and the abandonment of a fixed exchange rate.

The euro has not delivered the promises of its advocates and founders. Further integration of national policies seems increasingly unlikely to happen. Breaking up is hard to do, and in this case could be very disruptive to the wider world economy (with so little policy firepower left anywhere) But the end of the euro, one of the more hubristic policy experiments in the modern West, would probably be good for the longer-run health of the member countries, and especially for their ability to respond to future shocks. What it might mean for the future of the EU itself is a bigger question. One could envisage very bad outcomes – a reversion to the controls of 1957, before the EEC was first negotiated. That doesn’t seem very likely – trade barriers are much lower now than then around the world. Perhaps over time what might emerge is something more like a free-trade area without the overlay of other controls and bureaucratic apparatus of Brussels. For citizens, even if not necessarily for officials, politicians, and lawyers, that might be rather a good thing. It might even make membership of a much more modest EU attractive in the UK.

croaking cassandra

Economics, public policy, monetary policy, financial regulation, with a New Zealand perspective

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