skip to main | skip to sidebar
Global Labour Column Archive
  • HOME
    • ABOUT US
    • GLC ANTHOLOGIES
  • LINKS
    • RECOMMENDED SITES
    • DISCLAIMER
  • AUTHORS
  • GLOBAL BOARD
  • CONTACT
  • GLU
  • ICDD
  • Follow Us on Twitter
  • Wednesday, June 23, 2010

    Why the Stability and Growth Pact does not work

    Till van Treeck
    The current crisis of the Eurozone clearly shows that the European Stability and Growth Pact (SGP) does not work. A European “rescue plan” was finally agreed upon by the member states on May 9th 2010 after a long period of hesitation, especially in Germany. It has, for the time being, prevented the breakdown of the monetary union, as it could potentially grant up to €750 billion of credit to Euro countries with financing problems. But this rescue plan has merely bought time. The structural flaws of the SGP are still to be addressed.
    The main problem with the SGP is that it focuses on the financial position of only one sector of the economy, namely the state. According to the SGP, no state should ever run a government deficit of more than 3% of GDP, with the further stipulation being a balanced budget over the medium term. Moreover, public debt shall not exceed 60% of GDP. The only legally binding constraint for any government is the excessive deficit procedure which will set in as the government deficit exceeds 3% of GDP. The two other important sectors of the economy, that is, the private and the foreign sectors, are ignored by the SGP.
    Yet, it simply does not make sense to argue that a higher than 3% government deficit is unsustainable without looking at the financial balances of the private and foreign sectors of the economy. Remember that the financial balances of the three sectors necessarily sum to zero. This means that when one sector is running a deficit, then the remaining two sectors of the economy are running a joint surplus of exactly the same magnitude. If, for instance, the state runs a deficit of 2% of GDP and the private sector (households and companies combined) has a deficit of 10%, then the current account deficit of this country will be 12% (the financial balance of the rest of the world vis-à-vis this country will be 12%). Yet, such a scenario, which could hardly be considered sustainable, would not give rise to any sanctions within the current framework of the SGP. If, on the other hand, the private sector has a surplus of, say, 10% of GDP but the government runs a deficit of 3.5% (implying that the country has a current account surplus of 6.5%), then the government deficit will be considered too large and the country will face sanctions as defined by the excessive deficit procedure.
    These scenarios are not merely hypothetical but of concrete empirical importance, as the following examples illustrate:
    • Spain has never violated the 3% criterion of the SGP between 1999 and 2007. The public debt-to-GDP ratio decreased from 62% to 36%. The government even achieved surpluses in 2005-2007 of up to 2% of GDP. At the same time, the private sector was running huge and persistent deficits of up to 12% of GDP. As an implication of this, Spain was systematically running current account deficits of up to 10% of GDP.
    • In Ireland the situation was quite similar. The public debt-to-GDP ratio decreased from 49% of GDP to 25% from 1999 to 2007, and the government almost always achieved surpluses (of up to 5% of GDP). At the same time, the financial balance of the private sector was systematically negative (up to -7% of GDP).
    • By contrast, in Germany the government was in deficit from 2001 to 2006, and the 3% limit was violated during 2002-2005. From 1999 to 2007, the public debt-to-GDP ratio increased from 61 to 65%. At the same time, however, the private sector was persistently running surpluses, which always exceeded the government deficit, and at times were as large as 9% of GDP. This implies that Germany was persistently running a current account surplus, which increased up to almost 8% of GDP in 2007.
    What do we learn from these examples? From 1999 (the year when the Euro was introduced) to 2007 (the year before the global crisis started), it seemed that public finances were more “solid” in Spain and Ireland than in Germany. Yet, in the course of the global economic crisis and the crisis of the Eurozone more specifically, Spain and Ireland were soon counted amongst the infamous “PI(I)GS” countries which have become the focus of speculative attacks in the financial markets (Portugal, Ireland, sometimes Italy, Greece and Spain have been called the “PI(I)GS”). In fact, public debt rapidly increased in those countries as soon as the private spending and credit booms that had driven those economies before the crisis came to an end. (In Greece and Portugal both the government and (to a larger extent) the private sector had been in deficit even before the crisis.)
    The important lesson to learn from the current crisis is that when the private sector financial balance is unsustainable, then the financial balance of the government will also be unsustainable, irrespective of whether it is in deficit or surplus. More specifically, the combined balance of the government and the private sector are a much better indicator of whether a country is prone to speculative attacks than merely the government deficit or the public debt. This partly explains, for instance, why Germany is considered as highly “creditworthy” by the financial markets, although public debt is much higher than in, say, Spain or Ireland and the 3% criterion of the SGP has been repeatedly violated since the introduction of the Euro. As a consequence, the focus of a new and better stability pact should be on current account imbalances.
    How can we explain the large current account imbalances in the Eurozone? One important factor is the increasing divergence in unit labour costs. In a monetary union, changes in international price competitiveness can no longer be corrected through changes in nominal exchange rates. Rather, when changes in unit labour costs (which are closely related to national inflation rates) differ among member countries, then some countries persistently gain competitiveness relative to others. Now, between 1999 and 2007, unit labour costs have increased by less than 2% in Germany but by 28% to 31% in Greece, Ireland, Portugal and Spain. This means not only that all other countries have lost in terms of price competitiveness vis-à-vis Germany, but also that as a result of lower price inflation real interest rates have been higher in Germany. This contributed to the weakness of domestic demand, which was corroborated by an exceptional increase in income inequality and poverty (which depressed private consumption) and the retrenchment of the welfare state and public spending more generally (which increased precautionary personal saving and depressed the growth contribution of government expenditure). A lot of policy mistakes have certainly been made in the deficit countries as well. But a monetary union cannot survive in the longer term when its largest member country (Germany accounts for more than a quarter of the GDP of the Eurozone) hardly contributes to aggregate demand but follows an essentially neo-mercantilist growth strategy.
    A new stability pact would therefore have to oblige countries with large current account deficits to take measures that reduce nominal unit labour costs growth and, in the final instance, to conduct a more restrictive fiscal policy. At the same time, when a country has an excessive current account surplus, fiscal policy needs to be more expansionary and wage moderation needs to be stopped. This is also true for the current situation, where the old SGP imposes fiscal consolidation plans on all countries simultaneously. While this implies a serious threat to growth for the Eurozone as a whole, a more sensible approach would be for the surplus countries to allow for an expansionary fiscal stance, as long as private demand remains fragile and current account imbalances remain large.

    Download this article as pdf

    Till van Treeck is an economist at the Macroeconomic Policy Institute (IMK) in the Hans Boeckler Foundation in Duesseldorf, Germany.

    Posted in: Financial Crisis,Growth
    Email This BlogThis! Share to X Share to Facebook
    Newer Post Older Post Home

    1 Comments:

    dr kango bhalchandra says:
    June 24, 2010 at 8:29 AM Reply

    To find solution within the national economy without considering the global scenario gives false or temperary solutions. Workers of the world unite was the slogan in 19th and20th century, we need to improve on that concept to find the real solution!

    Post a Comment

    Share

    Twitter Facebook Stumbleupon Favorites More

    Subscribe to the Mailing List

    If you want to subscribe to the GLC mailing list, please click here or send an empty email to "List-GLColumn-subscribe@global-labour-university.org"

    Contribute to the GLC

    If you want to contribute to the Global Labour Column, please read here the Guidelines for Contributions

    Languages






    Donations

    More Info

    Popular Posts

      T-Shirt Economics: Labour in the Imperialist World Economy
      Chinese Construction Companies in Africa: A Challenge for Trade Unions
      Ruskin, the trade union college, is under siege

    TAGS

    Trade Unions Financial Crisis Workers' rights Globalisation Neoliberalism Labour Market Collective Bargaining Decent Work Inequality Labour Standards Wage Social Movements Europe Development Strategies Struggle Progressive alliances Strike Growth Labour Labour rights Financial Market Tax Financial Regulation Social Security Public Investment Social Democracy South Africa Economic Democracy Fiscal Space Germany Informal Economy Corporate Governance Freedom of Association ILO Minimum Wage United States Competitiveness Human Rights Labour Movements Trade Union Austerity Central Bank Environment Free Trade Free Trade Agreement Greece Labour Movement Social Protection State Funding Transnational Solidarity Unemployment Vietnam Workers’ Rights Crowd Work Domestic Workers Economic Crisis Education Employment Forced Labour France Global Warming Labour Market Flexibility Labour Statistics Migration National Minimum Wage Public Works Programmes Trade Union Divisions Workers' unity Agriculture Brexit Care Work Construction Sector Cooperatives Crisis Economic Alternatives Economic Reform Farmworkers Financialisation Globalization Indonesia Just Transition Labour Process Liberalisation Macroeconomic Policy NUM Nationalism Occupational Health Organising Outsourcing Portugal Privatisation Refugees Regulation Reserve Army of Labour Right to strike Social Dialogue Social Justice Solidarity Tax Evasion Welfare State Workers Rights Workers’ Organisations AMCU Africa Alternative Sources of Power Anti-privatisation Anti-union Violence Automobiles Brazil Business and Human Rights Capital Flight Capitalism Chinese Investment Climate Change Collectivity Colombia Community Monitoring Conference Corporate Transparency Coup Cuba Debt Restructuring Decriminalisation Demand Democracy Developed and Developing Countries Development Digitisation Disciplining of the superfluous labour force Domestic Work Economic Development Egypt Elections Entrepreneurship Eurozone Crisis Executive Compensation Factory Occupations Fair Trade Farm Workers Feminism Finance Financial Crises Financial Innovation Financial crisis. Fiscal Austerity Food Sovereignty G20 Gender Gentrification Global Health Global Multiplier Great Depression Great Recession Hawkers Health Hotel Housekeepers Human Rights due Diligence India Industrial Relations Informal Employment Institutions International Aid Policy International Framework Agreements Investment Partnership (TTIP) Investment Partnerships Iran Korean Shipbuilding Industry Kuznets Labor Labour Broking Labour Income Share Labour Markets Labour Reform Leadership Left Legislation Loi Travail Macroeconomic Performance Management Manufacturing Marshall Plan Metal Workers Migrant Domestic Workers Militarised Capitalism Mineworkers NASVI National Health Service Neolibaralism Networking New Progressive Consensus Online Campaigning Options for the Euro Area Paternalism Patriarchy Pensions Performance Standards Political Alliances Poverty Reduction Precariousness Prison Labour Prisoners Private Plantations Progressive Tax Reform Protectionism Protests Public Policy Quebec Racism Rank-and-File Member Redistribution Regulation of Labour Rent Seeking Rural Development Ruskin SEWA Securitization Sex Work Shadow Banking Shaft Stewards Social Audit Social Development Social Movement Social Transformation Solidarity Economy Spain Sportswear Industry State Stellenbosch Street Trading Street Vendors Strike Ban Strikes Structural Changes Supply Chains Swedish Model Tertiary Education Top Income Shares Tourism Trade Liberalisation Trade Misinvoicing Transatlantic Trade Transformation Transparency Transport Trump Tunsia Turkey Unfree Labour Union 4.0 Union Strategy Unions Universal Health Coverage (UHC) Voluntary Initiatives Wage Employment Wage Inequality Wage Share West Africa Wild Cat Strike Winelands Women Women’s Movement Workers` Organization Youth

    PUBLICATIONS

    Click here to view more

    Blog Archive

    • ►  2020 (1)
      • ►  September (1)
    • ►  2017 (40)
      • ►  December (4)
      • ►  November (2)
      • ►  October (3)
      • ►  September (5)
      • ►  July (4)
      • ►  June (6)
      • ►  May (4)
      • ►  April (3)
      • ►  March (2)
      • ►  February (4)
      • ►  January (3)
    • ►  2016 (34)
      • ►  December (3)
      • ►  November (2)
      • ►  October (2)
      • ►  September (4)
      • ►  August (4)
      • ►  July (2)
      • ►  June (3)
      • ►  May (4)
      • ►  April (1)
      • ►  March (4)
      • ►  February (3)
      • ►  January (2)
    • ►  2015 (32)
      • ►  December (2)
      • ►  November (5)
      • ►  October (4)
      • ►  September (2)
      • ►  August (1)
      • ►  July (2)
      • ►  June (5)
      • ►  May (3)
      • ►  April (2)
      • ►  March (2)
      • ►  February (3)
      • ►  January (1)
    • ►  2014 (32)
      • ►  December (3)
      • ►  November (1)
      • ►  October (4)
      • ►  September (3)
      • ►  August (1)
      • ►  July (3)
      • ►  June (6)
      • ►  May (2)
      • ►  April (3)
      • ►  March (2)
      • ►  February (2)
      • ►  January (2)
    • ►  2013 (41)
      • ►  December (3)
      • ►  November (2)
      • ►  October (5)
      • ►  September (4)
      • ►  August (1)
      • ►  July (4)
      • ►  June (3)
      • ►  May (4)
      • ►  April (3)
      • ►  March (4)
      • ►  February (4)
      • ►  January (4)
    • ►  2012 (35)
      • ►  December (3)
      • ►  November (4)
      • ►  October (4)
      • ►  September (2)
      • ►  August (2)
      • ►  July (2)
      • ►  June (2)
      • ►  May (4)
      • ►  April (3)
      • ►  March (3)
      • ►  February (4)
      • ►  January (2)
    • ►  2011 (39)
      • ►  December (3)
      • ►  November (4)
      • ►  October (3)
      • ►  September (4)
      • ►  August (3)
      • ►  July (2)
      • ►  June (3)
      • ►  May (3)
      • ►  April (4)
      • ►  March (4)
      • ►  February (4)
      • ►  January (2)
    • ▼  2010 (39)
      • ►  December (3)
      • ►  November (5)
      • ►  October (4)
      • ►  September (2)
      • ►  August (2)
      • ►  July (3)
      • ▼  June (4)
        • Why the Stability and Growth Pact does not work
        • More pay and more jobs: how Brazil got both
        • Crisis of Distribution, not a Fiscal Crisis
        • Beyond neoliberalism?
      • ►  May (1)
      • ►  April (4)
      • ►  March (4)
      • ►  February (4)
      • ►  January (3)
    • ►  2009 (5)
      • ►  December (3)
      • ►  November (2)

     
    Copyright © 2011 Global Labour Column Archive | Powered by Blogger
    Design by Free WordPress Themes | Bloggerized by Lasantha - Premium Blogger Themes | 100 WP Themes