An ILO report on the eurozone crisis highlights the possibility of a jobs-centred recovery strategy that will also redress the current account imblances.
AS the eurozone crisis lurches on with no apparent sign of recovery and, even worse, no apparent plan on the part of European leaders to address the fundamental issues, more and more people are beginning to think that it is time to throw in the towel. There is a growing sense of hopelessness, because the problems seem intractable within the legal arrangements defined by the European Union (E.U.) and the political constraints that are affected by angry and nationalistic responses on both sides of the divide. In such conditions, supposedly reassuring statements by leaders about doing whatever it takes often have the opposite effect because the words are not matched by serious and systematic actions that really indicate such determination.
As a result of the uncertainty and gloom, private investors in the bond markets, in banks, in the real economy, and so on have been voting with their feet (or wallets, in this case) for some time now. Yields on government bond markets not just for Greece but for other economies under stress, such as Spain and Italy, keep rising to ridiculously unsustainable levels despite all the declarations of further austerity measures.
Obviously, would-be investors fear that future repayments will either be incomplete or perhaps even in another currency altogether. Bank deposits are being run down in all the European periphery countries, even as they rise sharply in Germany, Austria, Switzerland and other supposedly safe havens.
Investors in productive activities are cutting back on expanding capacity or even ensuring more production partly because of the uncertainty and depressed expectations about the future. In the case of small and medium enterprises, it is also because they cannot access bank credit for investment and sometimes even for working capital. And, of course, all the fiscal austerity measures make everything that much worse, compounding the problem by reducing current economic activity and effective demand and creating a deflationary spiral. This then creates a negative feedback loop with the financial system, such that even the strongest surplus countries are now coming under fire from finance.
Is there any way out of this mess without a complete collapse of the eurozone and/or at the very minimum a disorderly exit of some of its members? Certainly the odds are shrinking, but that is also because the still viable alternatives have not got the political traction that is required among the current European leadership.
A recent report produced by the International Labour Organisation ILO (Eurozone Jobs Crisis: Trends and policy responses, Studies on Growth with Equity, International Institute of Labour Studies, ILO, Geneva, July 2012) provides an excellent example of fresh thinking about how to resolve the crisis with some clear and systematic policies that can be undertaken at the European level as well as within individual countries.
The report notes that in addition to all the other problems a prolonged labour market recession is in the making in Europe, which (unless it is arrested by proactive policies) will prevent a return to any kind of stability and growth in the medium term. It also makes the important point that the current focus on fiscal austerity has sidelined the much-needed reform of the financial system, which was the epicentre of the crisis and will continue to plague these economies unless stricter regulations are imposed and implemented effectively.
On a positive note, the report outlines measures that can be taken in addition to moving towards banking union so as to solve the solvency problem of banks and controlling finance. In particular, it highlights the possibility of a jobs-centred recovery strategy that will also redress the current account imbalances within the eurozone. In surplus countries, a rise in wages in line with productivity growth is important to provide a source of demand and to encourage rebalancing. In deficit countries, on average, half of the relative increase in unit labour costs since the introduction of the euro has been reversed since 2008 through wage cuts and labour productivity improvements. But prices have adjusted only slightly, reflecting internal distribution issues between labour and capital that need to be addressed. In fact, price differences between European countries have continued to grow and do not really reflect differences in unit labour costs.
The report proposes active labour market policies to support jobs, especially for youth, and fiscally neutral expansions in public spending on employment-intensive activities with high multiplier effects. This can be achieved by measures such as broadening of the tax base on property or certain types of financial transactions.Swedens example
One interesting contribution of the report is the information it provides on the positive example of Sweden in the early 1990s, which can provide several lessons for the present even if the situation is not identical. Sweden at that time faced a major financial crisis with similar origins and trajectory as many of the current crisis countries in Europe: the bursting of a real estate bubble that had been fed by financial deregulation, deterioration in banks balance sheets and a dramatic fall in economic activity. Gross domestic product (GDP) decreased by around 5 per cent, the employment rate fell by 10 per cent and unemployment increased by five times.
Some of the financial measures undertaken by the Swedish government deserve to be noted. The first need was to reassure depositors and consolidate financial institutions. An unlimited government guarantee on all depositors and counterparties had the effect of reassuring private depositors and re-establishing credit lines with foreign banks. The rescue of banks was accompanied by stricter monitoring: banks requesting public support had to provide full disclosure of their financial positions and open their books to full scrutiny so that the state could decide to support only those institutions that were assessed as worth rescuing. Bank shareholders were not covered by the government guarantee and were exposed to the risk of capital losses to the same degree as the government. Unlike the bank rescues we have seen in the period from 2008 onwards, these measures limited the risk of moral hazard and also reduced the total cost of the rescue.
Also unlike the present, fiscal policy was countercyclical and employment programmes were developed to reduce the risk of long-term unemployment and labour market exclusion. The focus on active labour market programmes also included a youth employment guarantee. The national welfare system was maintained and not reduced. All this occurred in the context of a continuing social dialogue. The coordination of wage bargaining at the national level was not abandoned. This allowed the setting of wage increases in line with the need to secure international competitiveness of the manufacturing industry.
Overall, the combined result of all these policies meant a relatively quick real economic recovery in Sweden with much less impact on jobs and living conditions, and an overall cost to the state exchequer of only around 3-4 per cent of GDP. This is in sharp contrast to the current situation in Europe where the cost of support to beleaguered financial institutions is mounting and leading to fiscal cuts in other areas that affect not only employment but also citizens hard-earned social and economic rights.
The report notes that the policies implemented in Sweden in the 1990s could be used as a source of inspiration to address the eurozone crisis. Of course, it is true that unlike current eurozone countries, Sweden could benefit from exchange rate devaluation to support its recovery. Exports as a share of GDP doubled between 1992 and 2008. This instrument is not available for deficit European countries as long as countries stay in the eurozone, but the case for that may be overplayed. The impact of exchange rate devaluation is not always as immediate or as positive as could be expected: consider the case of the United Kingdom, whose currency depreciated sharply after 2008, but is still in the grip of double-dip recession exacerbated by government retrenchment strategies.
It is also true that in the early 1990s, Sweden could benefit from a more dynamic external environment than is the case now. But here, too, the problem is that globally not enough countries are engaging in recovery strategies that expand employment and wage incomes, and instead expect the source of growth to come from outside the economy.
Overall, the report argues, correctly, that given the current socio-political and economic pressures, a jobs pact is absolutely vital for the stability of the eurozone as a common currency area. For this to occur, there must be greater coordination between countries, which clearly involves also more trust and cooperation than is currently evident. It may be argued that the political conditions for this to happen are absent in Europe just now but then it is the dissemination of reasoned arguments like these and social mobilisation around them that can help shift the political balance. And, of course, if such ideas can spread beyond the eurozone, the outlook of the world economy will also be that much brighter.