16/5/2013: Euro Area 'Austerity' in One Chart

Frankly, folks, there is nothing like making a factual argument across emotive subject lines... I have put up two posts on Euro area 'austerity' - here and here - and the readers want more numbers, usually in hope of finding a hole in my arguments.

Here is, perhaps a better, summary of the Euro area Austerity in its own numbers - in levels of nominal expenditure and revenues:

I hope this settles the issue:

1. Euro area austerity has meant revenues collected by the governments are up
2. Euro area austerity has meant that Government spending is up

Tell me if this is a 'savage cuts' story or a 'tax burden rising' story...

12/5/2013: Much austerity? Not really... & not of the kind we needed

A week ago I published a blogpost exploring IMF data on austerity in Europe, based on a sample of 20 EU countries with advanced levels of economic development (excluding Luxembourg). You can read that post here. The broad conclusions of that post were:

1. There is basically no austerity in Europe, traceable to either changes in deficits, changes in Government spending or changes in debt. If anything, the European fiscal policies can be characterised by a varying degree of fiscal expansionism during the current crisis, relative to the pre-crisis 2003-2007 period.
2. This, of course, does not account for transfers between one set of expenditures (e.g. public investment reductions) and other lines of spending (e.g. banking sector measures).
3. The only area of fiscal policy where austerity is evident is on taxation burden side, which rose in the majority of sampled economies.

The numbers got me worried and in this post I am looking solely on deficits side of Government spending. If there is savage austerity in EU27, so savage it is killing European economies, surely it would show up in General Government deficit numbers. As before all data reported is based on averages and comparatives computed by me from IMF's WEO data as reported in April 2013 edition of the database.

Let's take a closer look.

Only 2 countries out of 20 have recorded a reduction in average deficits during the crisis period (2008-2012) compared to the pre-crisis average (2003-2007). These were Germany, where annual average deficits declined by 0.95 percentage points (pretty significant) and Malta, where annual average deficits fell 0.79 percentage points (also pretty sizeable drop).

On average, EU20 sample annual deficits have increased by a massive 3.44 percentage points over the pre-crisis period. In  non-Euro area states, the average increase was 3.16 percentage points. But in 'savagely austerian' Euro area, the increases averaged 3.51 percentage points.

So far, the Euro area analysts' rhetoric opposing austerity has been focused on 2012 as the year of highest - to-date - cuts. Was this so? Not really:

Again, as above, there is scantly any evidence of deficit reductions, and plenty of evidence that deficits are getting worse and worse. Again, the comparative is not to the absurd levels of spending during peak spending years of the crisis, but to pre-crisis averages. After all, stimulus is not measured by an ever-escalating public spending, but by increase in spending during the recession compared to pre-recession.

The same conclusion can be reached if we look at 2007 deficit compared to 2012 deficit.

In other words, folks, Europe has had, so far, only 3 measurable forms of austerity, none comfortable to the arguments we keep hearing from European Left:

1. Tax increases (remember, we want to soak the rich even more, right?)
2. Revenue re-allocations to banks measures (remember, no one on Europe's official Left has come out with a proposition that banks should not be bailed out) and to social welfare (clearly, the Left would have liked to spend even more on this)
3. Germany

Note: we must recognise the simple fact that social welfare spending will rise in a recession for a good reason. The argument here is not that it should not (that's a different matter for different debate), but that when it does increase, the resulting increase is a form of Government consumption stimulus.

So let's make the following argument: Euro area did not experience 'austerity' in any pure form in the reductions in deficits. Instead, it experienced a 'stimulus' that was simply wasted on programmes and policies that had nothing to do with growth stimulus (e.g. banks supports). Here are two charts to illustrate:

What the charts above clearly show is that Euro area can be divided into three types of member states:

• Type 1: states where cumulated 5 year surpluses over pre-crisis period gave way to cumulated 5 year deficits. These are: Estonia, Finland, Spain and Ireland.
• Type 2: states where cumulated 5 year deficits over the pre-crisis period were replaced by more benign deficits over the crisis period period. These are Germany and Malta.
• Type 3: all other euro area states where cumulated 5 year deficits over pre-crisis period were replaced by even deeper cumulated deficits over the 5 years of the crisis.

The only two types of fiscal policy that Euro area is missing in its entirety is the type where pre-crisis deficits gave way to crisis period cumulated surpluses (no state in the sample delivers on this) and the type where pre-crisis surpluses gave way to shallower crisis-period surpluses (only one European state - Sweden - qualifies here).

Oh, and one last bit relating to the chart above: all of the peripheral countries, save Italy, had a massive increase in deficits on cumulated basis during the crisis compared to pre-crisis period. Apparently this is the savage austerity that has been haunting their economies.


Updated:
An interesting issue raised by one of the readers:

And my response:

2/5/2013: Austerity... savagely over-hyped?..

It was May 1 yesterday and in celebration of that great socialist holiday, "In Spain, Portugal, Greece, Italy and France tens of thousands of people took to the streets to demand jobs and an end to years of belt-tightening".

Except, no one really asked them what did the mean by 'belt-tightening'. Some, correctly, meant by the term the concept of transfers from taxpayers (usually via higher taxes, rather than spending cuts) to the broken banks, but majority, undoubtedly, we decrying cuts in Government spending. You see, damned austerity is just that (or supposed to be just that): cuts in the levels of expenditure. These can mean reduction in absolute level of spending, or a reduction in spending as a proportion of GDP.

And, you see, not much of that is going on in Europe nowdays, despite all the fierce rhetoric about savage cuts.

Ok, let's do some exercises, using IMF data.

First, consider tax revenues:

In the chart above, I marked with darker columns countries where tax revenues as % of GDP have declined during the current crisis (more precisely, taking average tax revenues fior 2003-2007 pre-crisis boom days and comparing against 2012 outrun). Guess what?

• In % of GDP terms, savage austerity meant that Government revenues have declined by less than 1 percentage point in Cyprus (-0.89 ppt), Czech Republic (-0.64 ppt) and Portugal (-0.08 ppt), the revenues have fallen by between 1 and 2 percentage points in Ireland (-1.26 ppt) and the UK (-1.68 ppt) and have declined by more than 2 percentage points in Denmark (-2.50 ppt), Spain (-3.28 ppt) and Sweden (-3.15 ppt).
• All in, only 8 out of the 20 EU countries considered above (these are all advanced economies of the EU, excluding Luxembourg, where data is so dodgy, no meaningful analysis can be made) have managed to post any declines in Government revenues relative to GDP. All other countries have posted increases. Overall, sample average Government revenues as % of GDP stood at 43.04% in 2003-207 period and this has risen to 43.84% in 2012.
• Now, onto levels of revenues. The sample of countries shown above had combined annual Government revenues of EUR7,791.61 billion in 2003-2007 on average. In 2012 this number stood at a 17.96% premium or EUR9,190.96 billion.
• Of all 20 countries considered, only one - Ireland - had experienced level reduction in Government revenues, which dropped from an annual average of EUR57.896 billion in 2003-2007 period to EUR55.42 billion in 2012.
• As I said above, there is only one meaningful form of austerity in Europe today: austerity of higher tax burdens on people.

Now, let's check out expenditure side of Europe's 'savage austerity' story:

Again, chart above highlights in darker color countries where Government expenditure had declined in 2012 compared to 2003-2007 pre-crisis average in % of GDP terms. The picture hardly shows much of any 'savage cuts' anywhere in sight:

• Of the three countries that experienced reductions in Government spending as % of GDP compared to the pre-crisis period, Germany posted a decline of 1.26 percentage points (from 46.261% of GDP average for 2003-2007 period to 45.005% for 2012), Malta posted a reduction of just 0.349 ppt and Sweden posted a reduction of 1.37 ppt.
• No peripheral country - where protestes are the loudest - or France et al have posted a reduction. In France, Government spending rose 3.44 ppt on pre-crisis level as % of GDP, in Greece by 4.76 ppt, in Ireland by 7.74 ppt, in Italy by 2.773 ppt, in Portugal by 0.562 ppt, and in Spain by 8.0 ppt.
• Average Government spending in the sample in the pre-crisis period run at 44.36% of GDP and in 2012 this number was 48.05% of GDP. In other words: it went up, not down.
• In level terms, things are even uglier for the 'anti-austerians'. Total (for this sample of countries) Government annual spending averaged EUR8,002 billion in 2003-2004 period and this rose to EUR9,941 billion in 2012 a rise in Government spending of whooping 24.2%.
• In level terms, not a single country in the sample of 20 advanced EU economies posted a decline in Government spending from the pre-crisis period to 2012. All posted increases in overall spending ranging between 88% for Estonia, to 7.76% for Portugal. Of all peripheral countries, not one cut a single cent on 2003-20007 average spending levels, with Cyprus hiking spending by whooping 39.8% in 2012 compared to 2003-2007 averages, France delivering a massive increase of 24.9%, Greece raising it modestly by 8.73%, Ireland by a massive 22.01%, Italy by a relatively benign 14.67%, Portugal by the sample lowest rate of 7.76% and Spain by a jaw-dropping 38.67%.
• All in, there is no 'savage austerity' in spending levels or as % of GDP.

So what is going on, folks? May be we can find austerity in deficits? Afterall, Paul Krugman & Co are telling us that we need to run deficits in the economy during recessions and this is the leitmotif to all of the anti-austerian policies proposals?

Savage austerity thesis must find at least a significantly large number of countries where there is no deficit financing going on during the crisis compared to pre-crisis activity, or at least a very large number of countries where deficits have declined compared to pre-crisis activity. Is that the case?

Sorry to say it, folks, errr... No. That is not the case.

• Only three countries in the entire sample of 20 have posted decreases in Government deficits in level and as 5 of GDP terms.
• In level terms, deficits declined in Germany, Italy and Malta. They rose in all other countries. Overall level of deficits in 20 countries analysed rose from EUR40.07 billion in 2003-2007 (annual averages) to EUR127.79 billion in 2012. In other words, during 'savage austerity' deficits tripled, not shrunk.
• In terms of relative weight to GDP, deficits also declined only in three countries - the same three countries as above. 
• Savage austerity meant that deficits increased in all peripheral states save Italy and that across 20 economies, whereas average deficit stood at -1.315% of GDP in 2003-2007 period, that rose to -4.215% of GDP in 2012.

 

As I said above, there are really two reasons for protesting in Europe today against what can very loosely be termed 'austerity':

1. As taxpayers we should protest against higher taxes & charges levied against us by the States to pay for various banks rescue measures and for continued public spending inefficiencies and private sector subsidies (note: I am not saying that all public sector spending is inefficient, I am alleging that some of it remains inefficient today); and
2. As taxpayers and residents we should protest about misallocation of scarce resources (including some public spending) from necessities (e.g. social welfare and unemployment protection, health, education, etc) to rescuing insolvent banks and corporate cronies.

Aside from the above reasons, please spare yourselves the blind belief in various Social Partners-produced spin about 'savage cuts'. All they care for is to increase even more state spending on their pet projects.

25/4/2013: IMF's 'End of Austerity' Napkin Sketch Is Soggy Wet

IMF catches up with 'End Austerity' bandwagon and overtakes the EU 'policymakers' in providing a general blueprint. From today's comments by IMF First Deputy Managing Director David Lipton (emphasis is mine):

"...Europe needs to act on several fronts. Countries will need to have clear and specific commitments to medium-term fiscal consolidation, with the appropriate pace to be evaluated on a case-by-case basis. Careful consideration should also be given to the composition of fiscal measures. The European Central Bank (ECB) should maintain its very accommodative stance, he said, but noted that eliminating financial fragmentation – whereby households and companies in some countries face clogged credit channels and lending rates well above those in the core – will probably require the ECB to implement some “additional unconventional measures.”

So the Fiscal Compact of 'One Policy Target & Timeframe Fit All' is out of the window then? If timeframe (pace) were to be set on a case-by-case basis, there is hardly any real discipline left. Here's why. Suppose Italy takes slower path to deflating debt levels to the target of 60% than that mandated by the Fiscal Compact (FC) (5% adjustment per annum). France, then, can demand either a slower pace for its drawdown of debt or it can opt to demand slower reductions in deficits. Which means Spain will also have its list of requests ready, all in breach of the FC.

"As we see it, countries that can afford to support the economy need to do so—but in ways that encourage the private sector to invest and boost demand..."

Ok, but what does it mean? AAA countries borrowing to stimulate? Suppose they succeed. What happens to growth rates and income levels in Euro area? Right - divergence will be amplified and with it, mismatch of monetary and FX policies too. 

Per paying attention to the composition of fiscal measures: it is a fine objective. Except in the case of European leaders, this means, usually, hiking taxes even more instead of cutting spending. IMF knows that this is counterproductive, but whilst correctly arguing that policies should be reflective of heterogeneity between member states' economies, IMF is incorrectly ignoring the political reality of Europe, where more spending = good, lower taxes = bad.

More: "Another country responsibility is better structural policies. Countries should press on to tackle long-standing rigidities in order to raise medium-term growth prospects. Southern Europe, and even some of the core, needs to increase its competitiveness in the tradeable goods sector, especially through labor and product market reforms. So far, much of the reduction in current account deficits has come because demand is sluggish.  For a stronger, sustained improvement -- enough to boost exports that will create jobs for the unemployed -- countries need a broader and more durable improvement in competitiveness, based on structural reform. In Northern Europe, even where national competitiveness is not the issue, reforms could help generate a more vibrant services sector."

Again, usual tool kit deployed by the IMF: structural reforms are needed (no real innovation as to what these might be) and exports must be increased (who will be buying these exports in the world where every country is being told by the IMF to increase its exports?).

I wonder why would Mr Lipton label ECB current stance as being accommodative. ECB interest rate is above G7 average and ECB's 'panacea' of OMT is yet to make any real purchases. ECB has attempted to sterilise all past 'accommodative' interventions and is now pleased with winding up LTROs. In brief, setting aside war-time rhetoric from the ECB, Frankfurt is accommodating very little.

One has to agree with the need to eliminate financial fragmentation, but IMF is fully aware that European system will have to continue deleveraging. There is too much debt in the pipeline to de-clog it by simply pushing through more credit at lower cost.

"...the Single Supervisory Mechanism [is] “a key step” and ...the IMF supports a market-based bail-in approach as being considered in the European Union Directive on Bank Recovery and Resolution, which would require banks to hold a minimum amount of securities with features that permit them to be written-off or converted to equity if capital buffers fall too low..."

So getting Cyprused is  the future for Europe, then.

Mr Lipton is dead on right, saying that "In our preoccupation with sovereign debt, we tend to overlook the huge overhang of private debt in some countries that could be a deadweight on demand and bank balance sheets for a long time. We’ve already seen the hit that households have taken in the periphery economies because of the sharp correction in home prices (e.g. Ireland). This could only worsen without renewed growth (e.g. Spain, Belgium and the Netherlands)." And more: "On the corporate side, we know how much the level of debt has increased over the past decade, particularly in the periphery. We elaborated on this development in our recent Global Financial Stability Report.  ...Measured on a debt-to-equity basis, a portion of Italy's corporate sector is rising into stressed levels. In the event of a prolonged stagnation, corporate profits would slacken further, putting pressure on companies to deleverage and increasing the risk of debt distress. Corporates are not being helped by bank retrenchment back into home markets. This is most pronounced from the periphery; French and German banks reduced their exposures to these markets by some 30-40 percent between mid 2011 and the third quarter of last year."

Conclusion (relevant to 'being Cyprused' above): "None of this bodes well for banks in a stagnation scenario. They are already weak. But higher levels of corporate and household defaults and credit losses would threaten a second round of bank balance sheet deterioration."

Net result: IMF has no new ideas on what to do if 'austerity' path were to be altered. There's a good reason as to why they don't - borrowing cash to burn it on Government spending (traditional European way) is out of question, given the risk of raising costs of borrowing, slow growth and higher interest bills that await. And using monetary policy to full extent is infeasible because IMF has no hope for ECB in its current state.

'Austerity' might be overdone, but 'Not Austerity' is unlikely to be any different...