Catching Up: Could We Have More Growth?

In 2017 the demolition of the Eurozone is quite possible, but not yet probable.

Modern man stands to democracy as his ancestors were standing to God two hundred years ago. He wants to be considered a decent man, and also a rational one. Sometimes, however, he disagrees with himself as a democrat and with how democracy, an ambiguous word, really works.

In 2016 democrats in three very important countries, Great Britain, the United States, and Italy, have been offered the chance to exercise the democratic rule of “one man, one vote” and the majority decides.

In Great Britain the electorate chose to leave the European Union, a choice which was to make it undoubtedly poorer but also to give it the illusion of being able to close its frontiers to more than a trickle of immigrants. The country in 2016 held its frontiers fairly open to 600,000 growth and 330,000 net immigrants, and then demanded a limit of only 10,000 in the future, a limit which no government was able to respect as a matter of practical politics. The illusion of making Britain reserved for the British will cost them a reduction in their standard of living, but no one can pretend to call this an irrational choice.

The Italian economy, rich in talent and energy, has had practically no growth in the last generation. The direct culprit is the “anti-fascist ” and eminently democratic constitution and a long series of short lived governments that have done little to prevent the economy from continuing its bad habits of no competition and inefficient labour relations. The 2016 referendum offered the choice of a radically different constitution capable of long lived decisions in the interest of modern liberal markets. This choice was rejected by an overwhelming majority, more in order to punish the politicians who had governed under the old constitution than for any desire for a new one. Using a democratic alternative, the Italian electorate has punished itself.

American electors envisaged government as a man and his followers who want to turn the clock back, while also promising more investment and fewer taxes, a program which is very audacious but perhaps a little too short on credibility. The voters were divided by two measures. In one, while all were benefiting from free trade as consumers, some producers were losing in competition with the Chinese, the Mexicans, and other foreigners whose imports were regarded as “unfair competition” in the domestic market; never mind the gains that U.S. exporters earned in foreign markets. The other measure which separated losers from gainers was the secular trend in which industrial products took a progressively smaller and services a greater share of the national income. Some of the service providers were in the high income classes, others at the bottom of the scale, while industrial workers earned income between that of service aristocrats and the service proletariat, being envious about one and fearing to descend into the other. By both measures, the industrial middle class felt badly done by. The end result, at least by using hindsight, was obvious in the employment statistics and again does not contradict democratic rationality.

In the European program for 2017 there are two or three electoral tests that democracy may have to stand. There is an election in the Netherlands and one in France, both of them with a “populist” party almost, but not quite, having a chance to win. Both would probably leave the European Union and the common currency area if given the chance. If there is an election in Italy as well, which may happen in the second half of the year, there may be a further candidate for exit. After Brexit, a further two or three dissident countries would suffice for the European Union to dissolve, an outcome which today looks very improbable but hardly impossible. The Brussels Commission is hardly unaware of this danger to its existence. The French member of the Commission, Mr. Moscovici, has actually proposed that three members of the Union with stronger financial positions, Germany, the Netherlands, and Luxembourg, should be invited to conduct a softer budget which would make the growth prospects of the other members a little less uncomfortable, but the proposal was for the moment rejected by these three countries which were supposed to act as volunteers.

The Brussels Commission has good reason to fear the future and its own survival. The Euro zone has suffered a miserable rate of growth since about 2008 and is hardly expected to have more than 1.2 or 1.3 percent both for this year and the next. On the other side of the Atlantic, the American economy showed some fatigue in the first half of 2016, but accelerated again and is likely to increase to as much as 4 percent by about year’s end. The President-elect during his primary campaign promised to double the rate of economic growth, although he did not say what the present rate was which he promises to double. At all events and with some scepticism about American growth, Europe is falling further behind and its capacity to catch up with the United States looks to be more and more distant.

The Powerful Number 3 

Economic science, with no little generosity, has accepted the Optimal Currency Area as a theorem. During the last third of the last century, when everything starting with the word Euro was treated with enthusiasm, the brain trust of politicians and economists who were busy founding new European institutions found no reason why Europe would not become an Optimal Currency Area as well. Expert opinion held that having the Maastricht Treaty would increase the rate of growth of the area in question by 0.5 per cent per annum, a forecast that today we can only contemplate either with humour or sadness.

The Maastricht Treaty of 1992 obliged the contracting countries to use the Euro and to hold their annual budget deficits at 3 percent or less of GDP with excesses above the 3 percent limit attracting a penalty of 0.25 percent of GDP, and increasing to double that sum when the excess deficit is repeated. This penalty was not enforceable and was always forgiven.

The brain trust that acted as the godfather of the Euro saw it not only as an instrument of economic growth, but primarily as a means to force the contracting parties to ever closer union. It was understood that the 3 rule obliged each member to obey the rule and thus would help create a unified economic zone with a single monetary and fiscal policy. Each member was governed by its own democratic government obeying its own democratic electorate, but its freedom in this respect was constrained by the 3 per cent rule. By virtue of that rule, the member countries of the Euro zone were supposed to be transformed into members of a close economic federation, which in turn would almost involuntarily transform itself into a political federation. Such an automatic result could not be achieved by conscious effort with the Maastricht treaty members, but only as an unconscious by-product. From where we now stand, we can only wonder at the optimism by which the sponsors of the treaty regarded its future.

Imagine our Maastricht Treaty contract country as having a national debt equal to 75 per cent of GDP, giving it an average interest yield of 4 percent, with long-term bonds at higher yields putting much greater weight in the balance than low yielding short term bills. Under this percentage of the national debt and its average yield, the interest charge on the all will be 3 percent of GDP and to our pleasant surprise the interest charge of the national debt will work out at 3 percent, which is exactly what the Maastricht treaty will allow. Obviously, if the national debt rises to 90 percent or 95 percent of GDP, which is what many Maastricht treaty countries have achieved in the two decades since the treaty was concluded, the 3 percent limit would be impossible to respect unless the debtor countries made super human efforts at austerity—super human efforts at which their respect for the treaty would weigh more than the pressure to which the government would be exposed by the discontent of its own domestic democratic electorate. The Maastricht treaty would be increasingly menaced. The treaty is designed to be anti-economic, almost as if anti-economists wanted it to fail. Economists will call it an example of “unstable equilibrium” where any departure from the equilibrium, sets in motion forces that make the lack of equilibrium progressively more impossible to cure. At that point, we have arrived in Greece.

Under the treaty, countries that are pressured by the 3 percent limit are forced to make adjustments to their budget, defending administration and welfare expenditures because cutting investment loses them fewer democratic votes in the next election than cutting consumption.

Europe is now getting so far behind America than the idea of catching up looks utopian. It looks a little less utopian without the Maastricht treaty than with it. However, with or without it, the road to catching up will be invisible from where we stand now. All that we have to say about it with some certainty is that there is a road because there is a prospect of catching up, a permanent cleavage between this two continents is just historically unlikely.