Sunday, September 27, 2015

Can Economic Policy Be Changed?

On 16 September 2015, at the Chamber of Deputies in Rome, there was a seminar on “Greece, the Euro, Alternatives for Italy”. After papers by Giulio Marcon, Mario Pianta and Marica Frangakis there were two sessions on “Can Economic Policy be Changed?” and “Can Politics be Changed?”. In the first session I took the view that European economic policy can be changed, without necessarily having to change the treaties, and presented seven specific proposals and a general proposition. The real problem is whether political forces would support such economic policy changes. 

We could (and should): 

1. Remove public investment from government deficit computation. Any constraint on the fiscal deficit, averaged over a number of years and not applied to its current level, should exclude debt-financed public investments because they do not entail an intergenerational transfer. This is widely and authoritatively recognized: ”The current fiscal stance should not be confused with the capital account… Computing the maximum deficit/GDP ratio as the sum of the current and capital accounts is misleading.” (J. H. Drèze-A. Durré, Louvain 2014). At present only the national co-financing of the so-called Juncker Investment Plan is formally excluded; the principle should be extended to all public investment.

2. Remove from the computation of government deficit any borrowing incurred to finance the payment of government arrears owed to enterprises, taxpayers, as well as the particularly scandalous arrears owed to pensioners. Such borrowing does not result in additional debt but only in a change of creditors: the loans incurred to liquidate arrears cancel out with the liquidated arrears.

Thus it should be recognized that public debt is actually higher than it looks, for it should include not just the cumulated excess of actual payments over receipts but also the accumulation of payment arrears towards enterprises, taxpayers and pensioners. But since the payment of arrears leaves unchanged the amount of total public debt, it should not be included in the government deficit which by definition should be equal to the increase in government debt.

3. Revise the calculation of a country’s structural deficit by the European Commission, which determines the maximum fiscal deficit that a government is allowed. At present this is following a particularly restrictive methodology and should be converted to standard OECD procedures, which would allow a modest but significant broadening of fiscal space.

4. Tighten the existing rule that a EU member country should not exceed a trade surplus of 6% of GDP, restricting it to 4% in line with the limit set to a country’s maximum trade deficit, and actually enforcing it, for instance imposing an equivalent minimum fiscal deficit on the trade surplus country, in place of a token fine. This would stop the surplus country (e.g. Germany at 7% of GDP) forcing its Southern partners to incur higher deficits.

5. Convert the pension system, recently reformed from a PAYE system (Pay As You Earn, i.e. re-distributive, defined benefits) to a fully funded system (capitalized, defined contributions), wholly or partly back to PAYE.

Both systems are potentially viable and capable to deal with population ageing (the capitalized system promotes financial markets but is more vulnerable to economic crises), but the transition from PAYE to a fully funded system makes a pension debt, which is conveniently hidden and buried, unnecessarily surface, equivalent to the present value of current employees’ contributions no longer available to finance current pension payments. (A country’s PAYE pension debt should only include the present value of that part of pensions – if any – which exceeds what can be financed out of pension contributions).

The reversal of such policy, as exemplified in the recent experience of Poland and Hungary, restores a country’s fiscal space to the full extent of the emerged pension debt.

6. Insure member countries against the risk of growth under-performance with respect to the average
J. H. Drèze and A. Durré (Louvain, 2014) suggest an ingenious scheme whereby a European Agency like the ECB could costlessly provide such an insurance. Eurozone governments would issue bonds indexed to the growth rate of their country’s GDP. The ECB would purchase a balanced stock of such bonds, thus earning a total rate of return equal by definition to Eurozone average growth. Thus the ECB could compensate below-average growth countries for their under-performance, out of the extra-interest earned from countries that record growth faster-than-average. No cross-subsidization among member countries (Transfer Union) would be involved. (Warning: this scheme would work on condition that no member country defaults on such bonds).

7. Mobilize the present value of the ECB Seigniorage – estimated by Willem Buiter to be of the order of €3,400 bn (sic!) – to gradually withdraw government bonds issued by ECB shareholder countries in proportion to their shares, thus avoiding a transfer Union. Again, no Transfer Union would be involved. 

See P. Paris and C. Wyplosz (2013 and 2014), on their P.A.D.R.E. (Politically Acceptable Debt Reduction for the Eurozone) scheme: the ECB would use seigniorage to pay interest on perpetual bonds issued to replace and retire outstanding Eurozone debt. 

I proposed a similar scheme (on my blog Transition), envisaging Eurozone bonds retirement directly financed by the ECB by securitizing future seigniorage. 

8. A general proposition. Finally, and more generally, economic policy changes require the recovery of quantitative instruments of economic policy, in place of dubious, possibly counterproductive, so-called structural reforms (a euphemism for the destruction of the Welfare State). We need to recover

- monetary policy, which first was delegated to an independent national central banker, then transferred to the ECB in Frankfurt; 

- fiscal policy, i.e. the level and structure of taxation and public expenditure, now constrained by the recessionary straightjacket of EU fiscal austerity rules (Maastricht, the Growth and Stability Pact, the Fiscal Compact);

- the price and investment policy of state enterprises, now largely privatized or in the process of privatization; and even

- direct controls, now abandoned in favour of market forces.

The instruments are there and we know how best to use them. The problem is the lack of political will.