It was a difficult week for the eurozone but not as disastrous as it might at first sight seem. And that has lessons for us and other developed nations.
First there was the effort to contain the Greek debt crisis, with assurances of support from France and Germany that were initially seen as a bail-out. But this was quickly countered by Angela Merkel, the German Chancellor, who suggested that Germany would not extend financial help to Greece, indeed, could not under its constitution. Quite what happens next no one knows, but it is pretty clear that Greece will have difficulty rolling over its debts unless it has a credible austerity programme in place.
You can always borrow if you are willing to pay a high enough interest rate, so the issue will be what premium the country has to pay to cover the risks involved. Greek 10-year debt is trading at close to 7 per cent. That compares with 5.6 per cent for the best 10-year UK fixed-rate mortgage. So a British home-buyer is ranked as rather less risky than the Greek government. Think about it.
The other discouraging thing last week was the poor growth number for the final quarter of last year, just 0.1 per cent quarter-on-quarter, after 0.4 per cent in the previous quarter. Of the big three, Germany was flat, France up and Italy down. German domestic demand was down and the only thing stopping the country slipping back into recession was export growth. France was the mirror-image of that, with strong demand from home consumers, while Italy was joined by Spain in having a negative final quarter. (Greece, by the way, was down 0.8 per cent. Truly glum.)
You can see the pattern in the main graph, with the year-on-year measure of GDP still negative. This is disappointing, particularly given that fiscal policy will now have to tighten across southern Europe, the worst-performing area. It is alarming that such a divergence has been allowed to grow between north and south, and this bodes ill.
But there are some chinks of light. We don't know how Greece will be supported, or on what terms. That is all to play for. I assume the rest of the EU will extend some kind of guarantee for Greek debt, but let's see. What we do know is that Greece sets a precedent. It will not be allowed to default and, as a result, other weak members of the eurozone will not be allowed to default. This is the common-sense outcome because the costs of a default to the rest of Europe would be greater than the costs of support. It is only a patch, but that is better than no patch at all, so it represents modest progress.
As for the growth figures, well, you really would not expect the eurozone economy to leap upwards right away. You would expect some sort of bounce after the pasting it took last year, but the normal pattern of recessions is that it takes a couple of years for any recovery to be secure. Have another look at the big graph, this time focusing on the 2001 downturn. As you can see, there was an initial dip in 2001, followed by a bit of growth in 2002, then a slither back to zero growth for the first part of 2003 before things cranked up again. It would be normal for there to be some flat quarters, even some negative ones this year, before the recovery gets going in 2011. If the European economy is not growing by 2011, then we should start to worry; not now.
There is a further reason for expecting the eurozone to come out of recession quite slowly: the euro remains strong. The graph on the right shows what has happened to it over the past decade, along with sterling and the dollar, on a trade-weighted basis. The dollar has been all over the place, rising initially, then plunging and now steadying at a relatively competitive level. The pound was remarkably stable until two years ago. Then it plunged. Now it seems to have stabilised but at some 20 per cent below its trade-weighted level in 2000; the euro is still close to 20 per cent above its trade-weighted level of a decade ago. Despite the evident fact that Germany has managed to carry on as a successful exporter despite the strong euro, some depreciation of the currency at a time like this would be no bad thing.
The lessons from this week? One is that a country can reach a tipping point when action is forced on it by the financial markets. Greece reached that point. I have been looking at some RBC Capital Markets work that suggests that, on fundamental grounds, the UK and France look vulnerable in that the price at which their debt is trading does not compensate for the risks associated with the stock of debt (France's particular problem) and the rate at which that debt is rising (ours). Neither country has reached such a tipping point but, as we have seen, things can go wrong very fast.
The next lesson is not to expect straight-line recovery. The Bank of England's Inflation Report last week downgraded expectations for growth next year and beyond. You may recall suggestions in these columns that it was over-optimistic. But even now it seems to be expecting a faster recovery than any recent one I can recall. Maybe it will be proved right, but much will depend on the financial sector recovering fast – and the prospects for that look uncertain at best.
There is a third, more general lesson – that events in financial markets generally take longer to happen than you would expect, but, when they do, they happen more suddenly. For years Greece has been able to borrow almost as cheaply as Germany. That was always ridiculous. But when the markets belatedly appreciated that, they reacted with undue ferocity. I am worried that the creditworthiness of all national governments is much more fragile than it appears, and that we are facing a progressive loss of confidence at some stage in the future.
As it happens, a good staff paper published by the International Monetary Fund last Friday called Rethinking Macroeconomic Policy looks closely at what we thought we knew about policy. Put crudely, this includes: how we thought we could control inflation with monetary policy; that fiscal policy was secondary; and that financial regulation was not part of macroeconomic management. Then it looks at where we were wrong: that stable inflation is necessary but insufficient; that low inflation makes it more difficult to boost the economy through low interest rates; that fiscal policy is an important counter-cyclical tool; and that regulation has macroeconomic effects (this includes the idea that deregulation of finance boosted the economy in ways that were unsustainable).
Finally, it looks at the implications for policy in the future. That needs another column, but one thought is relevant to Europe's fiscal plight. Just as fiscal deficits were vital in boosting demand in the downturn, there is a need for "creating more fiscal space in good times". Translated, that means governments have to run surpluses as soon as they can. Tell that to the Greek government, and to the next one in Britain.
Cameron should apply the principles of mosquito-net research
David Cameron was the not-so-surprise speaker at the London adjunct of California's TED conference last Wednesday. TED is a sort of mini-Davos conference, with a strong technology twist. Speeches are less self-regarding than at Davos, but the organisers are trying to make it more global, with an international version in Oxford, at which Gordon Brown spoke last year, and the event last week.
Mr Cameron was effective, making the argument that because the next government would not have any spare money it would have to use technology to do more with less. He gave three examples. The first was to provide better access to public accounts so that taxpayers could see how their money was spent. Second was to improve choice, for example by giving people access to health records to choose doctors. And the third was to improve transparency to improve services, his example being the way on-line crime maps were being used in Chicago to make police more accountable.
It was all decent stuff, but the most impressive presentation was one beamed in fromCalifornia, by Professor Esther Duflo, a French developmental economist at the Massachusetts Institute of Technology. Rather than look at the macro-economic theory of economics – questions such as whether aid is effective or destructive, she looks at micro-economic solutions. She applies medical testing techniques to development policies to see, as she put it: "What works, what doesn't, and why?"
Thus to see how to reduce malaria by distributing mosquito nets you take 100 or more African villages and give away or sell the nets at different prices. Will people value something if they get it for free? And if next year they have to pay, will that put them off? The answer is it is best to give them away; but they will still buy the nets next year. People want the nets more than the hand-outs.
If the Tories applied these principles to government, they might be more convincing. I was glad Cameron stayed for the presentation.Reuse content