Rising inequality in a declining country

Italy is no doubt a rich country. It is probably among the richest economies in the world, mostly concentrated in North America and the core Europe. But Italy is a country where exists a large part of the population living in poverty conditions, not only in the southern part as well as intolerable disparities in individual incomes and wealth.

The main feature is that there is no social mobility between the rich, upper classes and the poor, low income groups. The wealth produced by the economy is not redistributed, flows in the system and feeds the perverse logic of making the richest even richer. Over the last decade, the Gini coefficient - a measure of income inequality- rose from 0.29 in 1990 to 0.35 in 2005, following the rising trend in OECD countries. According to ISTAT, the national statistical office, relative poverty rose to 10,9% of the population in 2009 and absolute poverty to 4.7%; the respective figures for the Mezzogiorno- where more than two thirds of the poor live- are 22,7% and 7,7%. Furthermore, it notes a worsening of economic conditions among the blue collars and the elderly.

Fig.1: Growth of GDP in Italy 2000-2011

The main difference with other rich nations is that Italy has performed poorly over the last two decades (see Fig.1). Growth has remained sluggish from 2001 until now, with a dramatic drop in GDP in 2009 due to the global crisis. Yet, low growth does not allow any durable narrowing of income gaps, also given the magnitude of public debt.

Policies inspired by values of social justice should be pursued in order to dismantle the perverse logic of enriching the rich and to restore a virtuous circle in the distribution of income. The thrust is to act quickly through tax reforms which should benefit primarily the low and middle classes. But, it requires, above all, an effective partnership between the government and social parties as it was the case in 1993 under the Ciampi government.

The false debate on austerity

The debate on austerity has brought a harsh confrontation between keynesians and anti-keynesians. This has been going on for sometime in the US with the 'deficit hawks' who claim that the US fiscal stimulus plans will lead to an unsustainable path of public finance . As Krugman argued, they just mess up with numbers; the US economy can cope with the federal debt burden- which is just above 60% of US GDP- which is exactly what the Maastricht criteria set as a limit for debt sustainability - thanks to low interest rates. Furthermore, it is rather obvious that ending the fiscal stimulus - or even tightening fiscal policy would just put the economy and jobs in peril.

Now, Niall Ferguson, a British historian, claims that keynesians haven't learnt anything from the 30s (FT July 20) . It is true that the world has changed since the 30s; we are much wealthier than at that time, although that wealth has led to greater inequalities among people. It is therefore difficult to compare deficits in the 30s with the fiscal situation today. In 1930, governments did not use monetary and fiscal policy to offset the contraction of economic activity as they did in 2008-2009.

In replying to Ferguson's anti-keynesian argument, Lord Skidelsky, author of a voluminous biography of Keynes, points out that ... expansionary fiscal policy (in the UK and the US) was ruled out by adherence to the doctrine of balanced budget; in the US, a large part of the banking system was allowed to collapse. Public policy, that is, was not used to counteract the fall in private spending. In 2008-09 all the tools available to government were broght into play - bail-out of banks, open market operations, fiscal stimulus. the reason for the different response was the change of theory associated with the name of Keynes" (FT July 22).

Another point made by Skidelsky is on the economics which underpins the anti-keynesian argument. There is, in fact, some analogy with the supporters of the 'Treasury view' which keynes fought vigorously and which argue that 'bond financed government spending was bound to "crowd out" private sector spending". The other well known argument is that multipliers are quite small because of the openness of the economies and therefore the demand effect leaks out to other economies. Recently, the Congressional Budget Office estimated that each dollar spent to assist the unemployed brought about $1.90 dollars in additional economic output.

Fiscal conservatism is not the solution to reduce uncertainty and restore confidence among private investors. Governments have allowed banks to act as they wanted, being aware of the risks of a financial meltdown. As a result of the banking crisis, millions of people lost their homes and savings and were left without any protection.

The debate is less between austerity and fiscal stimulus; it is about a fundamental choice in favour of policies which create jobs and provide decent incomes for those most in need.

Are Europeans going conservative?

The FT (12 July) reports the results of its survey* which indicates an overwhelming support - from citizens in the largest five EU countries and the US -for the spending cuts made by European governments led by conservative governments, with the exception of Spain. It also highlights that aid to developing countries and defence - adding unemployment benefits in the UK- should bear the bulk of the cuts, but on the other hand, there was barely no support for cutting public expenditure on police, healthcare and education.

This 'fiscal conservatism' is largely influenced by the debt crisis which resulted in a rescue plan for Greece and a resolution crisis mechanism for any other euro area countries in default. This also reflects a fear from middle class citizens- who already lost a fraction of their real incomes over the last decade- for any further taxes which might result from a rise in public deficits. This appears to be a natural reaction to protect their incomes and savings as the crisis deepens.

This survey is in fact biased as questions were not addressed to a representative sample of the population in those countries. It depends who are the respondents : if you ask public servants affected by wage cuts, the answer would not be the same. In fact, we don't know who are the citizens who answered to the survey. But, more importantly, it is difficult to draw a conclusion that there is support for a review of Europe's social model, except perhaps the UK . We know that the majority of the population in France and Germany are reluctant to any cuts in healthcare and pensions.

In its last issue (17 July) , the Economist is even more contemptuous: "the ideal of progress has been a myth for longer than Europeans may care to admit". The argument is that social progress in Europe was just an illusion and that European countries were living beyond their means by financing their welfare State with hefty debts. It continues: 'Europe has put its values before growth'' [...] the euro-zone crisis has exposed such hypocrisy". And it concludes: " "It may still take time before Europeans conclude that they must compromise their ideals in order to secure the growth needed to preserve what they can of their lifestyles".

The European social model is often associated with social reforms, especially in France, such as retirement at 60 and the 35 hour working week agreed under a socialist government. Why is this not a mark of progress? In most European countries, labour is heavily taxed compared to capital and land. The scandal is to rescue banks which have made gigantic profits with derivatives and other speculative instruments to the detriment of entrepreneurs and workers. The issue here is again about social justice. No government should restore a situation just to continue rewarding greed instead of protecting their citizens. This message should be understood by European citizens.

* The FT/Harris poll was conducted on line among 6.164 adults aged 16 to 64 in France, Germany, Spain, the UK and the US, and adults between 18 and 64 in Italy between June 22 and July 1.

The high costs of austerity

As the economic crisis deepens, European economies are focusing on austerity measures to (supposedly) restore confidence for international investors and to continue borrowing on financial markets. It started two years ago with Ireland* which cut public spending and raised taxes. Then came the Greek debt crisis and other countries at risk of default. Consequently, governments of countries in crisis have taken drastic measures to reduce deficits.

But rather than being rewarded for their actions, these countries are being penalised with a rise in bond yields. The economic downturn has been even sharper than if the governments would have spent on stimulus to keep people in their jobs. As a result, the economies of these countries shrunk dramatically ( more than 20% of GDP loss in Latvia and Lithuania) and remain in recession. Wages in the public sector have fallen by 20-30% in several countries. In the meantime, joblessness has risen to two digit reaching almost 20% in Spain!

Austerity prompts strikes and slowdowns which in turn shrink the domestic market, investment and tax revenues. As unemployment spreads and wages fall, mortgage arrears and defaults soar. Property prices have plunged in some countries. Some business owners are even escaping their debts and emigrate.

For States in crisis, austerity is not the only option. It has huge economic and social costs. It does not make countries more competitive: it uses unemployment to lower wages and imports and therefore depresses domestic demand. There is a second option for non euro-area countries which is currency devaluation but it is not pursued as it would delay their planned integration into the euro area as their currencies are pegged to the euro. It would also raise the price of energy and other essential imports, aggravating the trade deficit.

But there is another option which is worth being pursued and would yield better results. In some of these States in (fiscal) crisis, there is high taxation on labour and capital and land are under-taxed. Lowering taxes on wages would reduce the cost of unemployment and increase demand.

The main issue in European countries, notably in the eastern part, over the coming years will be whether economies can cope with heavily taxed wages and inflated housing prices while avoiding an overdose of needless austerity.

* See http://www.nytimes.com/2010/06/29/business/global/29austerity.html

The divisive Toronto Agenda

The G-8 and G-20 meetings in Toronto have a long agenda of complex issues on which rich and developing countries seek a common approach to set out new governance rules. Topics include banking levies, financial regulation, currency controls and many others.

From Toronto, bad news: there will not be at the G 20 an agreement on the levy on financial transactions. The reason is quite interesting: rich countries like US, UK, France and Germany want it but there is a strong resistance from the banking sector; other countries such as Canada, India and China, much less affected by excessive speculation- due to their relatively more traditional and stable banking sector, do not see any reason to penalise their own banks.

On financial reform, the US administration will pursue a 'unilateral' approach. Just before the meetings, the Senate approved a package of financial reform, including a tax on banks worth 19 billion $ to prevent future financial crisis. It includes a list measures including tougher powers for the Federal reserve to oversee 'too big to fail' banks, registration of hedge funds and the creation of a consumer agency to regulate mortgages.

The second issue of contention concerned fiscal policy opposing fiscal consolidation to reduce debt to GDP ratios and the pursuit of fiscal stimulus to sustain recovery. The final statement reflects this compromise: 'Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016' . But Obama - supported (only) by India- warned the eurozone and Germany in particular that early cuts to public spending might undermine the signs of recovery. It is also significant that the final statement stated that Germany and China should contribute to growth in global demand : 'Surplus economies will undertake reforms to reduce their reliance on external demand and focus more on domestic sources of growth'.

The Toronto meeting reflects in fact the strategic division on the response to the crisis between the European 'doctrine' (stability and budget deficit reduction) and the US conception based on maintaining fiscal stimulus plans to sustain the recovery of their economy. The feeling is that nations are concentrating on their own economies ignoring global welfare and aid to the most vulnerable countries. Unilateralism in areas such as financial regulation and trade is unproductive. Uncoordinated financial rules may be self-defeating because of the need for regulatory arbitrage. Does it make sense that the US will pass its new financial regulation law but no agreement on the Basel III rules on bank capital requirements has been reached.

In sum, the outcome of the G-2O meeting has been deplorable, but not for failing to co-ordinate fiscal policy. This is the least of its sins; it has failed on the main issues which are decisive for better global governance.

http://g20.gc.ca/toronto-summit/summit-documents/the-g-20-toronto-summit-declaration/

The Spectre of the 30s

The lessons from the 30s seem to be forgotten. In 1937, when F.Roosevelt sought to balance the budget, the economy plunged again into a severe recession. And here in Germany, the financial orthodoxy pursued by the finance minister, Heinrich Brüning, from 1930 to 1932, led to the end of the Weimar Republic.

There are no sanctions for those- the experts who preach financial rigour and budget balance- who repeat the mistakes of the past. Since the 80s, the dominant economic view repeats the same discourse which led to the depression of the 30s. At that time, J.M. Keynes rejected vigorously what he called the 'Treasury view'. The main argument is that an economy with rising unemployment is badly managed and that mass unemployment should not be tolerated in any economy . The famous British economist made that point in the Mac Millan Committee*, putting forward a set of principles defining a full employment economy: full employment is the primary objective for economic policy; wage flexibility is not a remedy to unemployment; the currency in a country with high unemployment could not be strong unless depreciation of assets is compensated by high interest rates; the State can contribute to restore full employment via an active policy increasing public investment financed through a budget deficit; the Central Bank should help financing spending which will generate wealth in the future.

In recent times, President Barack Obama urged other G20 countries to boost domestic demand and increase exchange rate flexibility to encourage global growth and rebalance the world economy.He said in a letter : “I am concerned by weak private sector demand and continued heavy reliance on exports by some countries with already large external surpluses.”**

This warning seems to be largely ignored by the deficit hawks, which are now prevailing in Europe, Canada and other countries. The myth of 'sound finance' - which is related to a blind faith in free markets- is based on a 'classical' vision of capitalism driven by the search for more savings. As opposed to it, Keynes and other post-Keynesian economists such as Kalecki and Minsky demonstrated that the engine of capitalism is the debt which generates the 'quantum' of money necessary to finance investments.

As in the 30s, the danger of unemployment should deserve greater attention. Trade unions have understood it, not our political leaders.

* See P.Clarke, The Keynesian Revolution in the Making 1924-1936, Oxford University Press, 1988

**http://media.ft.com/cms/eca5e8a4-7acf-11df-8549-00144feabdc0.pdf

G-20: the return to economic orthodoxy

The 'hawks' are back and took over the G-20. The final declaration* of the 4-5 June meeting in Busan states: "Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions".

It seems that there has been a shifting attitude relative to the previous Washington communique issued on 23 April which insisted that demand stimulation policies" should be maintained until the recovery is firmly driven by the private sector and becomes more entrenched".

Historical experience in the 30s show that drastic cuts to public spending during a grave recession are not only ineffective in terms of reducing public deficits but also socially harmful. Restrictive fiscal policies - if not conducted wisely and gradually - may have opposite effects, as they might depress further the economy and reduce tax revenues, therefore further increasing public deficits.

So, what should be done? One possibility would be to wait that the economy recovers in order to allow central banks to use monetary policy to offset the contraction of economic activity resulting from budget austerity. But here again the 'hawks' ask for further budget cuts in the face of high unemployment and interest rates close to zero.

One might argue that the situation in Greece represents a serious warning against any further rise in public debt. But this cannot be taken as a general situation. Countries with high public debt are Spain and Greece (leaving aside the specific situation of Italian public debt being largely held by domestic financial institutions and households) ; they belong to the euro area and they have overvalued assets due to huge capital inflows in previous years. The risk is thus a prospect of deflation over coming years. However, for other countries, there is no objective reason to conduct immediately such policies. Ten year bonds in the UK yielded interests of 3,51%, in the US 3,21% and in Japan, 1,27%.

So where does this radical shift toward austerity stem from? the answer is that Finance ministers and governors of central banks of the G-20 are convinced that expenditure cuts would reassure investors. They just care about how world markets would react if the leading economies were not ready to make further sacrifices. But the idea that these sacrifices might be useful or even be harmful for large segments of the society does not count at all.

So the message is that if the leading economies will not pursue these virtuous policies along the lines of the G-20 and other organizations, it will undermine the fragile basis of economic recovery to satisfy hypothetical demands of investors for more austerity.

*http://www.g20.org/Documents/201006_Communique_Busan.pdf