The Economy Is Not a Race

I've mentioned before the new Tory narrative - that Britain is in a race and the economic challenge can be reduced to its ability to compete. The fact that I hear the same rhetoric from different ministers convinces me that this is a coordinated message.

Of course it is nonsense. One country's economic success can benefit other countries. Stronger growth in the eurozone would generally support growth in Britain.

Samuel Brittan goes off message to demolish the narrative in today's FT, "Politicians should stop their talk of competitiveness" He points out:

for a country or area with its own currency... its competitive position is entirely a matter of its exchange rate

His point not only undermines Mr Cameron's cozy story, it also flatly contradicts the view Mrs Merkel pushes on the Eurozone. For example:

The competitiveness of countries depends on many more issues than just weighing up imports against exports.

Samuel Brittan is right, politicians who see the economy in terms of competitiveness are capable of doing great harm.

The Euro Crisis Can Be Solved

The only solution to the Euro crisis is more Europe, for example* Joschka Fischer said:

The price of the monetary union’s survival, and thus that of the European project, is more community: a banking union, fiscal union, and political union.

 There is not the political will for more Europe, and the longer the crisis goes on the more support for Europe evaporates:

Support for European economic integration is down over last year in five of the eight European Union countries surveyed by the Pew Research Center in 2013.

The only conclusion is that the long grind of austerity in the periphery will continue , or the Eurozone will fall apart.

The pessimism is congealed in this post by James Haley . There are two paths, he says, banking union or grinding internal devaluation. When I read it I thought, no there are other paths. The point of this post is to illustrate one.

The key to fixing the Eurozone crisis lie in repairing its broken banking sector. European banks have yet to recognise the losses on their dubious loans. European countries have not the funds to bail out their banks nor nor to pick up the tab for closing them down. Ireland tried and found itself in a sovereign debt trap.

On the whole, the Eurozone can afford to bailout or close down insolvent banks. That is why banking union is seen as a solution. There is enough room to raise the funds to pay for a programme to resolve and recapitalise Europe's banks.

Here is my proposal. Instead of new permanent institutions we could look to a one-off solution. The institutions for assessing the needs of banks for fresh capital or for closing down insolvent banks already exist. Bank stress tests have been conducted. They can be done again, but this time for real. The ESM has the power to invest directly in banks rather than forcing their home country to take on the debt.

The remaining problem is that this exercise will be costly. The solution is a one-off bond issue jointly guaranteed by all Eurozone countries. The EU already raises funds this way, but on a much smaller scale to support for example the European Investment Bank. Making the exercise a one-off can be used to create incentives for banks to come clean on their problems.

Let me anticipate two objections. One, why would Germany go along with this plan? Two, if it is done once it can be done again.

Germany has been reluctant to see Eurobonds, mainly because of moral hazard. This is different because it would be for a specific purpose, not directly funding individual governments but solving a Europe wide problem. Germany's own banks would benefit, both from recapitalisation and by removing the risks of default by some of their borrowers.

On the second objection. It would be necessary to follow up by making financial supervision more national. This would mean rolling back the single market for this sector so that banks which want to offer services in another Eurozone country would need to create a subsidiary which was separately capitalised and under the supervision of the host country.


*Joschka Fischer is not alone. Yesterday I picked up El Pais in a cafe and found Javier Solana, Felipe Gonzalez and Jacques Delors making the same point.

Exit By Accident

As Mr Cameron loses control of his party, the country is once again heading towards leaving the EU by accident. It is evident that Brexit is supported by a minority of the country's political class. None of the leaders of the main political parties favours the idea, nevertheless we could find ourselves on the outside before the end of the decade.

Mr Miliband has been too astute to fall into the trap of matching the Conservative pledge of a referendum. Not only would that increase the risk of exit by accident, it would legitimise the Tory right and embroil Labour in an issue which is best left to the fanatics, rather than keeping the focus on jobs and growth.

Labour needs a line on Europe that allows us to watch from the sidelines while the other lot tear themselves to pieces. The line should remain that Europe is changing and we should not make a decision until the Eurozone crisis is finally resolved.

We could add that the Euro may not survive another five years. Mr Kai Konrad, who chairs the advisory panel of the German finance ministry, recently declared that

I would only give the euro a limited chance of survival.

The break up of the Eurozone would be immensely disruptive and costly, not just to its members but also to its trading partners. At the same time it would present Britain with a new challenge to help rebuild Europe in a different form.

A European Union after the Euro would be a very different proposition from the present set up. The key lesson of the failure of the single currency would be that integration needs a more cautious and pragmatic approach.

Which is very much what Britain wants from the EU; a sharing of power where there is a clear benefit while avoiding grand schemes driven by dreams of unification for its own sake.

Now is not the time to talk of leaving the EU. It might be worth thinking about how to help the EU backtrack on its single currency.

Umm... Well... Uh... Bye then.

One in Four African Countries May Double GDP This Decade

For a change here is some good economic news. From the World Bank's latest Africa's Pulse:

About a quarter of countries in the region grew at 7 percent or better, and several African countries are among the fastest growing in the world. Medium-term growth prospects remain strong and should be supported by a pick-up in the global economy, high commodity prices, and investment in the productive capacity of the region’s economies.

Seven percent is pretty good. It is not a threshold, or a tipping point, but as a growth rate it has the neat quality that 7% is about what you need to double in size in ten  years. 

Growth alone does not guarantee development, and the report points out that poverty reduction lags behind the economic performance. This is basically good news; for many people the world is becoming an easier place to live.

Moving the Threshold

It seems that the tipping point for the decision by Fitch to downgrade the UK credit rating was their forecast that gross government debt would pass 100% of GDP. FT Alphaville reports:

Fitch now forecasts that general government gross debt (GGGD) will peak at 101% of GDP in 2015-16 (equivalent to 86% of GDP for public sector net debt, (PSND) and will only gradually decline from 2017-18. This compares with Fitch’s previous projection for GGGD peaking at 97% and declining from 2016-17 and the ‘AAA’ median of around 50%.

It looks like: 97% good, 101% bad.

It comes at the end of a week when we have been celebrating the demise of the myth of the 90% threshold for debt to GDP beyond which lay catastrophe.

A 100% the threshold doesn't make any better sense than 90%. In fact as Frances Coppola pointed out yesterday, the debt ratio is a poor way to predict the health of an economy. It is even a poor way of looking at the health of public finances. She explains it like this:

Debt/GDP is a pretty confusing metric, since it compares a stock and a flow. It would be more meaningful to compare fiscal deficit/GDP. But even that is not ideal, since GDP measures activity in the economy, not government income, and the government income figure is netted with spending to give the deficit. The reality is that governments do not have to pay all their debt off in one year - in fact most governments pay off little or no debt. What they have to do is service the debt. And their ability to service the debt is governed by two things: 1) the interest rates prevailing on outstanding debt stock and on new issues during that period: 2) revenue from taxation and other income.

What does it mean to say that national debt is 100% of a country's annual income? It means  that debt is 50% of two years income, 25% of four years income or 10% of ten years income. That is what happens when you mix a stock and a flow. I've talked before about how government's can run deficits forever, provided the economy is growing.

The reasoning behind Fitch's downgrade is flawed and we should take no notice. Unless, like Ed Balls you want to add to Mr Osborne's discomfort.