Friday, 19 September 2014

Europe – finding a way out

Europe seems trapped with a sluggish economy but a way out may be close

Getting out of a hole that you have dug for yourself can be tough.  This is what Europe is struggling with as the Eurozone crisis seems to have passed only to be replaced with a slow strangling at the hands of deflation.  Infighting among politicians about the best way to deal with the economic stagnation in Europe has resulted in few reasons for hope of an escape.  Yet, this may change due to recent developments such as a flagging German economy and the rise of reform-minded governments in some countries.  Sometimes things need to get worse before a way out is possible and the situation in Europe may have finally got bad enough for positive change to occur.

An economic escape route…

An economic recovery is typically an automatic progress but may not always be easy.  Companies going bankrupt and workers losing their jobs cause considerable pain but is actually something that is good for the overall health of the economy.  A cull of weaker businesses provides more space for more successful firms to grow and prosper.  This process has the label of “creative destruction” in economic theory due to the idea of the old needing to give way for the new. 

In this way, economic growth returns after a recession as resources such as workers move to more productive uses.  The economy can grow faster as a result but a certain level of economic freedoms are needed to allow this to happen.  In this way, there is a trade-off between economic growth and the potential for instability.  It is not possible to have the former without the latter but any instability can be limited through controlling economic excesses (which often show up in the financial system).

Getting the balance right is not easy.  Companies in finance have been given too much leeway and created havoc as a result.  Yet, in other areas, businesses have been burdened with too many rules.  One example is regulation which makes it difficult for firms to fire workers.  This may seem like a good way of keeping people in jobs but such regulation has an adverse effect in that companies will not want to take on new workers if their employment is almost permanent.

… and the politics to make it happen

Many countries in Europe are in desperate need of policies to free up business from such regulation but implementation is often tricky.  At a time of rapid change, voters often crave stability of bygone eras that are no longer viable.  This does not stop populist parties making false promises to turn back time and dismissing the need for reforms.  It is heartening for the outlook in Europe that some countries such as Spain have made progress with its reforms.  Others such as France and Italy also have governments that are making the right noises in terms of reforms even if not actually putting new policies in place.

The lack of reforms has been preventing the recovery in Europe in other ways.  Germany, who has a firm grip on the reins of power in Europe, has stubbornly refused to offer much help to struggling European countries.  The reasoning behind this is that offering an easy way out would mean that these countries would not deal with the problems within their own economies.  The flip side is that, once reforms begin, Germany may be more accommodating in providing support. 

This opens up the possibility of a grand bargain, such as reforms as a trade for looser monetary policy and less focus on austerity.  More action from the central bank seems likely as the German economy is beginning to falter and genuine fears about deflation in Europe grow.  Its own weak economic growth and low inflation will highlight to the Germans that the problems are plaguing Europe as a whole rather than just individual problem countries.

Your Neighbourhood Economist penned this posting with comments from readers in mind.  Europe and the euro was seen as a lost cause by one reader while others have been annoyed that this blog always had to be so pessimistic.  Hopefully, this post will hopefully prove them wrong (but in a good way).


  1. If the German economy falters at this level of the EUR then what hope is there? Most economist reckon that the EUR is valued too low for Germany and too high for the others.

    There needs to be a fundamental rethink about what are important metrics for an economy. GDP has a very bad correlation to the wealth of the middle classes. And it is the middle classes who are the most important, as they spend into the economy a large proportion of what they earn.

    I have a serious issue with the anti-deflation argument. For 200 years or so we have been striving to improve productivity and REDUCE the price of stuff and at the same time INCREASE the amount of stuff available.

    So why is it now the focus to ensure that the price of stuff always goes UP?

    Yes, I can follow the argument that if prices go UP then wages should also go UP and make it easier to pay the debts.I do not agree with this policy. Why are people borrowing from tomorrow and expect to pay back less than the cost of the goods in real terms?

    I see the real problem today being the massive increase in rent seeking activities in the economy. Rising property prices, rising rents and the finance industry seeking a rent in every corner of each financial transaction.

    So what would I employ as a metric?

    How about the number of people fully employed, with no government subsidies able to support themselves at a decent standard?

    And a big step in that direction would be to cut out the rentier class totally.

  2. Thanks for your comments.

    In this blog, I have argued both that deflation comes with positives and is not something to fear as well as that inflation would be good to help pay off debt. While I understand your argument about borrowers needing to pay back the full amount, excessive debt creates wider problems that goes beyond just the borrowers themselves. Lower consumer spending will affect job creation and make it difficult for people to find work. Individuals stuck with large mortgages are likely to remain in less suitable jobs to ensure that they have money to make their monthly repayments. With money and people stuck in unproductive uses, the overall economy will suffer.

    I do agree with your statements about rent seeking. Too much attention is paid to making money from sectors such as real estate or finance when these resources could be put to better use. The only problem is that there seems to be few options available to invest money in the actual economy. This means that more and more people are working in jobs that are not making the most of their skills. People can support themselves but they could (and often want to) strive for more. There are no easy answers to these questions and they are not even discussed much by people in power. I often get accused of being too pessimistic in this blog, but sometimes it is hard not to be.