Vallenzi, implementation of the neoliberal German model or immediate and brave reforms?

, by Andrea Zorzetto

Vallenzi, implementation of the neoliberal German model or immediate and brave reforms?

The Left in Paris was born in July 1789 and there reached it peak in May 1968. Now it seems that what remained of it, at least in the Western world, died in Paris last August, when Hollande reshuffled his government to expel those ministers that opposed austerity and supply-side economic reforms.

Many believe that finally the ruling centre-left parties in Italy first and then France, led by Matteo Renzi and Manuel Valls, will adopt a pro-business stance that is paramount to lift their countries out of the crisis. According to this line of argument, social democratic parties in the United States, Britain and Germany went through this process long ago – respectively with Clinton in the 90s, Blair since 1997 and Schroder since 2003; indeed these countries have shrunk the government’s economic role and have thus been able to endure the Great Recession a great deal better than bureaucratic France and Italy. The Vallenzi’s reforms, if successfully implemented, are supposed to save the Eurozone by boosting its second and third biggest economies.

However, the issue is by far more complicated. The structural reforms that Berlin and Brussels call for every other day are of a particular strand of neoliberalism, which we might call the German model. In brief, the main idea is to rein in deficit spending on the part of the government to reduce domestic demand and make the labour market more flexible to keep down wage costs, with the target of achieving an export-driven growth. In the last decade, Germany has indeed grown thanks to huge current account surpluses. And now Schäuble recommends this “winning” strategy to other Eurozone countries.

But if there is something economists agree on, is that this strategy is not sustainable in the long run. On a global level, if some countries run trade balance surpluses, others have to run offsetting deficits. Until we colonize Mars, we cannot all export. What is more, the latest economic data unequivocally show the importance of domestic demand. Of all the other major economies, the US, Japan and China have stimulated the economy through a fiscal expansion, while Britain has reduced its program of austerity (its government deficit is greater than those of Germany, France, Italy and the Netherlands). In addition, the Fed, the Bank of England and the Bank of Japan have embarked on massive programs of quantitative easing (unconventional monetary expansion), something that Draghi would have started long ago if it wasn’t for the Bundesbank’s staunch opposition. The result? China has kept its outstanding rate of growth while the US, Britain and Japan are recovering. Instead the Eurozone is still in a deep recession, and now even the German engine appears to have stopped: German growth for the second quarter was equal to zero last June, private investment is at its lowest level in decades and according to a recent study one out of six Germans is below the poverty line. And what has been Merkel’s government response? Aiming to deliver a balance budget (Schwarz null), the first one since 1969!

What the Eurozone needs is demand-side policies to boost income and spending. On the one hand, this requires the ECB to follow the examples of the other major central banks and dramatically expand its balance sheet. At the same time, this will not be enough; only by putting in place massive fiscal stimuli can the deflation-recession spiral be stopped. True, Italy in particular but also France have high public debts. Though this should not be matter of concern during a recession, the fact that these countries do not have their own currency (and access to the money printing press) might trigger markets’ fears about insolvency, as the first stage of the Eurocrisis has shown. However, the European Commission has many ways to finance extraordinary actions. While Eurobonds remain unthinkable, the European Investment Bank or the funds of the European Stability Mechanism might be used, as Juncker suggested (and Schäuble ruled out). A Euro-wide investment program will be more effective because it will be bigger in size, and it could also be a unique opportunity to potentiate transportation, green energies, hi-tech and Internet infrastructures, paramount for the future of the continent. But above all, it should increase employment and households’ incomes, and thus private investment in turn, since interest rates will remain most likely low.

Though public investment is vital to improve the situation in the short run, Valls and Renzi have limited scope for intervention at home. They could alternatively try to cooperate with the SPD and convince Merkel and Schäuble to accept a different approach. So far, however, most attempts in this regard have failed. In the meantime, they should carry out structural reforms that enhance the long term prospects of France and Italy, but which could also have immediate positive effects, especially on firms’ and consumers’ confidence. These reforms would be of a different type from those of the “German model” though. Very few people would deny that France and Italy need dramatic institutional, legal and economic changes. Vallenzi should address corruption and inefficiency in the public sector, clientelism, over-bureaucratization, tax evasion, emigration of skilled workers, deindustrialization, complicated and useless red tape. At the same time, they should invest massively on renewable energies and hi-tech startups, and on helping the labour force acquire the skills that will be required in the future. In a nutshell, they should increase competitiveness by raising efficiency, instead of keeping down wages, reducing workers’ rights and cutting social spending. The other Southern European countries experience similar problems. Vallenzi could thus set the example and maybe even persuade the German government to accept growth-friendly policies. However, these reforms will not have immediate effects and imply taking on powerful vested interests. Instead of cowardly adopting a simplistic answer (free markets) to a set of complex problems, they require a great deal of forward-looking policy-making and political courage.

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