The regulation adopted last year by the European Union has led to the first Alert Mechanism Report (AMR) of the European Union being published this week. The document and the legislation behind it are interesting because it runs counter to the idea that sovereign debt has caused the crisis. The European Commission was pointing out in 2009 and 2010 already that macroeconomic imbalances were the mechanism driving the crisis. Therefore, understanding this mechanism is crucial. In the following I will evaluate some issues raised by the AMR and refer back to the regulation when necessary.
First of all, it must be welcomed that the Commission understands that macroeconomic imbalances are meaningful. However, the whole concept of macroeconomic imbalances is not based on solid economic theory. Just like when the introduction of the euro was announced, politics have once again overridden economics. Having said that, it should be noted that no other country or group of countries has adopted anything like the AMR. Macroeconomic imbalances build up and subside almost everywhere. Therefore, the question must be allowed whether macroeconomic imbalances are the symptoms or the cause of the European troubles. This is where the regulation, instead of providing clear-cut concepts and economic theory, assumes the following (my highlighting):
Since the objective of this Regulation, namely the effective enforcement of the correction of excessive macroeconomic imbalances in the euro area, cannot be sufficiently achieved by the Member States because of the deep trade and financial interlinks between Member States and the spill-over effects of national economic policies on the Union and the euro area as a whole, and can therefore be better achieved at the level of the Union, the Union may adopt measures in accordance with the principle of subsidiarity, as set out in Article 5 of the Treaty on European Union. In accordance with the principle of proportionality, as set out in that Article, this Regulation does not go beyond what is necessary to achieve that objective,
To economists, it is not evident that macroeconomic imbalances should be corrected at a supra-national level. The International Monetary Fund does not do it, and the Bank for International Settlements does not do nor is any other institution in this business. Certainly, there is much talk in the financial press about sustainability of current account deficits and the like, and some of the above institutions commented on related issues, but to my knowledge the enforcement of the correction of macroeconomic imbalances was never discussed. The reason, one would think, is that it interferes with the sovereignty of a country.
So, it is up to capital owners to decide whether a country in current account deficit (like Turkey today) is in this position because
- capital inflows allow the country to increase imports over exports, as international investors are optimistic, or
- capital inflows are the result of an increase in indebtedness as firms loose international competitiveness and households struggle to uphold their consumption.
If capital flows in or out, sometimes countries do judge these capital flows to be misguided and do take action to correct the macroeconomic imbalances. Switzerland, for instance, last year fixed its exchange rate vis-a-vis the euro because speculators were betting on a strong franc, pushing up the price of Swiss exports in international markets and making imports much cheaper. The threatening collapse of Swiss industry was too much for the central bank to bear, and it intervened. Again, macroeconomic imbalances can be corrected by policy action, but until now it is the sovereign who decides what to do.
Now to understand better what the Commission plans to do, it would be interesting to look at the definition of excessive macroeconomic imbalances in art. 2:
(1) ‘imbalances’ means any trend giving rise to macroeconomic developments which are adversely affecting, or have the potential adversely to affect, the proper functioning of the economy of a Member State or of the economic and monetary union, or of the Union as a whole;
(2) ‘excessive imbalances’ means severe imbalances, including imbalances that jeopardise or risks jeopardising the proper functioning of the economic and monetary union.
This, of course, begs the question of a definition of severe imbalances. To my taste, defining something that is excessive as something that is actually only severe is a strange thing to do. Excessive is a relative term, severe an absolute term. This seems to be a play of words when conceptual clarity is needed. Also, ‘any trend’ which is (potentially) bad is meant to be an imbalance. Again, this is not very helpful. ‘Macroeconomic developments’ there are many, and they can be affected by almost anything. Even an oil price shock would be an excessive imbalance according to this definition, even though it hits every country by the same mechanism.
In the first Alert Mechanism Report, it is clear that Germany has drafted this thing in order to be allowed to continue its export-led growth model. Table 2 says that net exports of up to 6% of GDP (three year average, which puts Germany at 5.9%) are OK, while net exports of -4% of GDP are already excessive. Once again, politics wins over economics. From a balance sheet view – in this case, the balance of payments perspective – one country’s export surplus is another’s deficit. If that is so, why then blame the deficit country before blaming the surplus country?
Table 2 is full of arbitrary numbers that define what is excessive and what is not. I cannot see any justifications for choosing these numbers. It reminds one of the Stability and Growth Pact, with its 3/60 rule concerning government debt. Therefore, just like with the design of the euro, it is European politicians that are driving the economy without consulting with economists who are experts in the field. Those would probably have pointed out that current account imbalances have to be financed either by capital inflows are a rise in the amount of credit (indebtedness), and that therefore the ECB and financial market regulation are not independent from the Alert Mechanism Report. Some consultation is prescribed, but the question remains:
If the ECB cannot steer money/credit supply in the EMU member countries, can regulation against macroeconomic imbalances work effectively to balance/stabilize the European economy without harming economic growth?
If that is so, and imbalances need to be corrected, are these symptoms or causes? If they would be causes, than perhaps the EU indeed is the right institutional level for this, but if they are symptoms and the causes are largely domestic, than Europe – the Commission, the Troika, the Council, etc. – might engage into fights with national parliaments that put the two parties into prolonged political fights, where the domestic ruling partly – rightly or not – uses Brussels as a scapegoat. The euro has been a disaster exactly for this reason, and research is needed urgently to examine these questions. Otherwise, the whole project is in danger of falling apart.