Crossroads (Toward Philippine economic and social progress)
Philippine Star, 8 October 2014


Europe’s recent economic experience is a double dip-recession — a prolonged recession that continues to this day. Like that of the United States economy, developments in the European economy have an influence on world trade, investments and economic growth.

A prolonged European recession. The first recession arose from the contagion of the US recession of 2007-08. After prolonged inability to tackle the recessionary conditions, further economic decline and recession set in.

Last week, I discussed the US economy and how it has recovered and returned to growth. US unemployment rate was rising from 2007 to 2010 and then began falling consistently, thereafter, from year to year as the result of sustained 2.5 percent per capita growth rate.

At this juncture in history, part of Europe’s main problems relate to rigid labor market policies. As the home of many labor welfare policies, European labor welfare and security have kept labor secure during normal and prosperous times. During weak economic times, however, the labor market remains rigid and does not adjust.

Such inflexibility has led Mrs. Thatcher’s, as Britain’s prime minister during the 1980s, to rebalance the politics of the welfare state back toward greater economic efficiency.

She turned back many social policies that made it difficult to introduce wage flexibility and economic productivity. This led her to privatize public enterprises, to expand the private sector, and to rebalance social welfare with economic efficiency.

Success there did not spread to the rest of Europe. The tensions between rigid labor policies and economic efficiency continue to remain at the center of structural reform problems in the labor markets in continental Europe.

Wages had no downward flexibility. Those employed had a great advantage over entrants to the labor force who then could not find jobs, thus enlarging the ranks of the unemployed.

Countries in the Euro zone system became enmeshed in the recession more deeply, especially as a consequence of the Greek debt crisis that broke open by 2010. By mid-2014, unemployment climbed: for Greece, 27.2 percent; Spain, 24.5 percent; Portugal, 14.3 percent; Italy, 12.6 percent; and France, 10.3 percent, among the big countries. The Euro area unemployment rate (weighted) was 11.5 percent.

These unemployment rates reflected the recessionary changes in output in the region. Some countries have shown positive growth (for instance, United Kingdom and Germany). Weak growth of output however had been dragged down by the negative growth rates of bigger economies (Italy, Spain) between 2011 and 2013. Euro zone economies had real growth contractions close to half of one percent in these years.

Magnitude of the problem. Europe was slow to adopt measures to counter the recessionary conditions. The policy makers in the region were dominated by believers that the cure to the problem was to tighten fiscal discipline – to reduce the fiscal deficit rather than raise expenditure and introduce direct economic stimulus.

At a time when aggregate demand had fallen while unemployment rates were ring – sure indications that demand management in the macroeconomy was needed – governments in the region tightened fiscal policies. They could not effectively reform labor market policies.

Many European governments did little to strengthen the position of the banks early enough. In the US, an aggressive approach was undertaken to reform their capital structure which restored strength to the banks as a result of the financial debacle. This led to a program of raising capital of banks that were found after “stress tests” were instituted.

Then the Greek debt problem shook up the Euro currency system. European banks were highly exposed to heavily indebted countries, not only to Greece, but also to the bigger countries, like Italy, Spain and others in the zone.

ECB introduces monetary stimulus. As in the US, there was a way out – monetary policy to expand credit and liquidity in the economy. The European Central Bank followed the track to introduce non-conventional measures to ease monetary policy.

“Quantitative easing”, ECB-style, was narrower in definition than what the US Fed undertook. In the US, the Fed bought a wide range of secured private debts, including mortgage-backed debts, in order to introduce a sizable monetary and credit stimulus.

Within the near zero interest rates policy that the Fed has sustained, QE opened up a large credit channel to the private economy. Programmed QE purchases by the Fed helped to create new jobs, induce greater demand for output, and spur a rise in production. In turn, these measures also sustained a weaker dollar that made US firms more internationally competitive.

The ECB also took the same road. In the summer of 2012, the recently installed ECB president Mario Draghi, after coming out of its policy meeting, boldly announced that the regional central bank would “do whatever it takes to preserve the euro. And believe me, it will be enough.”

Unlike the case of the US Fed, ECB was, however, limited its purchases of private debt only to lower risk, asset-backed securities. ECB’s program, though bold in its target quantity of private bond buying, was much more restricted in what it could buy from the region’s banks.

ECB’s program was held back by German opposition to a bolder private debt-buying approach. German opposition was consistent with its more conservative stance regarding the measures designed to deal with the recession, which was more aligned with tighter fiscal and monetary policy.

ECB’s announced programs have been massive in quantity of offers to buy. The outcome for the moment is more modest than the US Fed’s. It could even be said that it is not succeeding in its goal of stimulating the restoration of growth.

ECB’s target has not been achieved. It has fallen short by about one-third of announced target. Apparently, banks took advantage of the scheme mainly to lend back to their governments or to boost their own balance sheets. Thus, there is still missing sufficient economic stimulus to restore the economy back to growth.

ECB’s quantitative easing did help, however, to restore calm to the European debt crisis arising from Greek, Italian, Spanish and other regional country debts. These countries have found relief in the fall of the cost of refinancing their debts.

The full test of success of ECB’s quantitative easing policies will be if they could help bring back Europe to growth and higher employment.