Sunday, November 9, 2014

The false rhetoric of (Euro) victims and offenders

Hans-Werner Sinn has written a new book with an analysis of the causes and potential solutions of the Euro crisis: "The Euro Trap: on Bursting Bubbles, Budgets and Beliefs". I have not read the book yet but I just went through a video of the presentation he made about a month ago at the Peterson Institute for International Economics. The video of the presentation as well as a transcript are available at the PIIE web site.

For those who have followed the writings of Hans-Werner Sinn there should be no surprise in the presentation. His views are very consistent and they put most of the emphasis on the price imbalances that were built prior to the crisis (the periphery becoming uncompetitive, interest rates being too low). These imbalances partly supported unsustainable growth that hid the need for structural reforms that were badly needed. His analysis of the crisis years is very similar: bailouts from the ECB and others, not enough austerity have also supported governments in their actions to avoid  reform.

After Sinn's presentation, Fred Bergsten provides some insightful comments. He gives credit to the book as it highlights some of the weaknesses among Euro countries (it is hard to disagree with the view that reforms move very slow in Europe and that government will find any excuse to slow them even further). But Bergsten also provides very critical comments about Sinn's view of the crisis and its solutions. I like in particular Bergsten's emphasis on the economic benefits that Germany has derived of the creation of the Euro area. He goes as far as saying that Germany is possibly the only country that has so far benefitted from the Euro (going against the German conventional wisdom of who are the winners and the losers of EMU).

One of the issues that Bergsten does not bring up enough is the misplaced (in my view) emphasis that Sinn puts on relative prices and competitiveness. The idea that in periphery countries the cost of production became too high and unsustainable and that it now requires deflation in the periphery (and some inflation in Germany) is a constant argument in Sinn's presentations. But the data does not fully support his views. It is not that relative prices do not matter, but they do not matter as much as he claims and I would go as far as saying that they are not a central part of the pre-crisis or post-crisis experience of Euro members.

Here is a quick chart to support my views. This is the value of goods exports (data originally in in billions of US dollars, from the OECD) for Germany, France and Spain since the Euro was launched. Data is rebased so that it equals 100 in 1999Q1.

It is hard to see in this chart the story of the periphery (Spain) high prices reducing growth via lack of competitiveness (before or after the crisis). Even compared to Germany where we know that there was a significant internal devaluation via very low nominal wage growth, exports in Spain grew at a similar speed before the crisis and faster than in Germany. Yes, the current account in Spain was on an unsustainable trajectory but it was caused by capital flows supporting excessive imports.

Then, why the insistence on prices? Because it fits well the rhetoric of misbehavior that led to the crisis. Under this view, countries belong to one of two groups: the victims and the offenders. And it explains everything: the differences between the savers and the borrowers, the ones who reform and the ones who never do, the ones who control debt and the ones that just let it increase, the ones where workers are reasonable and they accept lower living standards and the ones where they are not and want to live beyond its means. Reality is more complex than that, countries do not always belong to the same side of these imbalances, some imbalances are not central to explain the crisis and all imbalances have two sides to them.

Antonio Fatás