Divergence of the European Monetary Union’s Monetary Policy from Member-States’ Fiscal Policies as a Structural Deficiency in the Eurozone Crisis

By Sheldon Birkett

The European Monetary Union’s (EMU) reforms, following the 2009 Eurozone crisis, proved to have mixed results on the future stability of European economic integration. For example, the stabilization of the European economies through macroeconomic fiscal consolidation policies, and the subsequent polarization of political parties across EU member-states, has proven that the EMU’s response to the crisis has been inadequate. This paper will show that the Eurozone crisis was perpetuated by the structural deficiencies present within the EMU since its establishment by the Treaty of the European Union (TEU). The principal structural deficiency within the EMU was the divergence of perspectives between EU supranational institutions and member-states involvement in monetary and fiscal policy. It is argued that the EMU mistakenly made the assumption that a singular monetary policy would inevitably lead to systematic fiscal policy coordination between member-states through “spillover” effects. On the other hand, member-states assumed that the EMU would inevitably bail them out in times of economic difficulties. The inevitability of the EMU as a “lender-of-last-resort” is due to the intergovernmental dependence of each member-state on one another under a singular monetary policy. This paper will firstly introduce the structure and organization of the EMU followed by an analysis of the main structural deficiencies within the EMU, which perpetuated the Eurozone crisis. Next, the paper will highlight three EMU reforms, and the implications of those reforms within the EU, in response to the Eurozone crisis. Lastly, there will be a short discussion of the EMU’s trade-off between supranational and intergovernmental policy coordination when it comes to ensuring the EMU’s democratic governance.
STRUCTURE OF THE EUROPEAN MONETARY UNION (EMU)
The European Monetary Union (EMU) is responsible for establishing sustainable economic development balanced on growth and price stability (Art. 3, TEU). The European Monetary Union (EMU) consists of the “Eurosystem” and the European System of Central Banks (ESCB). The Eurosystem is comprised of the European Central Bank (ECB) and the member-states’ National Central Banks (NCBs). The Eurosystem member-states also hold the euro as their official currency making them part of the Eurozone (ECB, 2011, 13). The European System of Central Banks (ESCB) is comprised of the ECB and NCBs of all member-states not in the Eurozone, in which they do not participate in European monetary policy (ECB, 2011, 13). Other than balanced economic growth and price stability, at the heart of the “institutional set-up” of the EMU, is the idea that it is possible to have “one monetary policy and many fiscal policies” by having a strong coordination amongst fiscal policies to achieve a sort of “fiscal federalism.” Fiscal federalism refers to how fiscal responsibilities of taxation and expenditure are divided up between different levels of government (Baldwin & Wyplosz, 2015, 427). In the case of the European Union, fiscal federalism is referring to how fiscal competencies should be allocated between national governments and supranational (EU) institutions. Along with establishing monetary policy, and (indirectly) coordinating sound fiscal policy, the EMU is responsible for a flexible exchange rate regime, converging long-term interest rates, maintaining independence from political influence, and European Supervisory Authorities (ESAs) in areas of banking, insurance, and securities to secure adequate intervention when economic difficulties arise (ECB, 2011, 18).
In accordance to Article 130 in the Treaty on the Functioning of the European Union (TFEU) the central bank shall remain politically independent from “Union institutions, bodies, offices or agencies and the governments of the Member States… and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks” (Art. 130, TFEU). The strong principle of monetary independence, where there was a lack of coordination with member-states’ fiscal policies, resulted in macroeconomic divergence between the EU’s monetary and fiscal policies. Macroeconomic divergence in the EMU was a prominent contributing factor to the Eurozone crisis. However, it was not only the deficiencies within the EMU structure that lead to the Eurozone crisis, but the fact that such challenges are inevitable in being part of the European integration process. As Mario Draghi, the President of the ECB, stated in 2014 this was the “Achilles Heel” of European integration (Jones, Keleman, Meunier, 2016, 1011).

CORE STRUCTURAL DEFIENCIES OF THE EUROPEAN MONETARY UNION (EMU)

At the heart of the deficiencies of the EMU (which perpetuated the Eurozone crisis) was consistent conflation between an intergovernmentalist fiscal policy and a supranationalist monetary policy, whereas EU bureaucrats were promoting a supranational “fiscal federalism” even though fiscal policy was primarily intergovernmental in nature. Instead, the ECB assumed that neo-functionalist integration in the EU’s monetary policy would create a “spillover” effect into a seamless coordinated “intergovernmental” fiscal policy between member-states, however, this did not come to fruition (Jones, Kelemen, Meunier, 2016, 1016). On the other hand, member-states assumed that the ECB would inevitably have to offer a bailout package if a member-state did not maintain sound fiscal policy. Although the promise of a bailout package was not the case in the TFEU, the implicit assumption of bailout remained true as the failure of one member-state would mean the failure of the EMU. Therefore, the ECB would be “forced” to bailout the member-states to serve their own interest of achieving macroeconomic stability. At the creation of the EMU in 1999 these two perspectives of implicit coordination of fiscal policy, as a form of “fiscal federalism,” and the assumption by member-states that the ECB would inevitably bail them out in times of extreme economic difficulty created a lack of coordination between fiscal and monetary policy which exacerbated the Eurozone debt crisis.
In economics, coordination of fiscal and monetary policy is critical in an optimum currency area because monetary policy affects the ability for governments to finance budget deficits while fiscal policy coordinates taxation and expenditure (Laurens & Piedra, 1998, 3). Therefore, if a state decides to have a large fiscal deficit but does not adjust the interest rate this can result in asymmetric currency shocks. Due to asymmetric currency shocks the state would have to devalue its currency or become fiscally insolvent (Laurens & Piedra, 1998, 5). Since all “Eurosystem” member-states share the euro it would be difficult to devalue the euro currency accordingly. Similarly, the EU as an optimum currency area (OCA) is subject to asymmetric shocks because the Mundell-Fleming model predicts that when capital markets are open EU member-states must choose between exchange rate stability or domestic policy autonomy (Copelovitch, Frieden, Walter, 2016, 824). The “Mundell-Fleming trilemma,” or the “impossible trinity principle,” implied that member-states of the European Union had to reluctantly give up domestic monetary policy autonomy to achieve exchange rate stability (Copelovitch, Frieden, Walter, 2016, 824).
Member-states of the Eurozone that gave up their monetary autonomy reflected the EU historic trend of moving from an intergovernmentalist to a supranationalist approach of EU policy-making (Tommel, 2018, 90). However, policy-makers during the formation of the EMU did take the difficulties of monetary and fiscal policy coordination into consideration; although, individual member-states were too reluctant to give up fiscal policy competencies to a supranational institution (i.e. ECB). For example, at the time of formation, the EMU knew of the risks associated with discoordinated monetary and fiscal policy, but they did not establish an effective method for regulating fiscal policy because the costs of giving up fiscal policy were too high for member-states wishing to maintain national sovereignty (Copelovitch, Frieden, Walter, 2016, 825). As a result of the endogenous constraints from the member-states’ reluctance to give up fiscal competencies, in favour of an intergovernmentalist approach to European integration, a revision of the EMU was inevitable since its establishment in 1999. As on the eve of the launch of the euro currency European Commission President, Romano Prodi, stated that “I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But someday there will be a crisis and new instruments will be created.” (Jones, Kelemen, Meunier, 2016, 1018).
The Eurozone crisis had to be dealt with separately from the United States’ subprime mortgage crisis, even though the catalyst for the Eurozone crisis was the collapse of Lehman Brothers in 2008. The United States’ subprime mortgage crisis and the Eurozone crisis must be dealt with separately because there were structural problems within the EMU that perpetuated moral hazards in fiscally adverse EU states, such as the PIIGS countries (i.e. Portugal, Ireland, Italy, Greece, and Spain) (Shure & Verdun, 2018, 137). The principal structural deficiencies in the EMU that perpetuated the Eurozone crisis were: 1) a lack of a “mutual-recognition” approach that facilitated macroeconomic divergence; 2) a lack of fiscal policy coordination between member-states, and with the ECB’s monetary policy; 3) weak financial regulation, most notably the Stability and Growth Pact (SGP); and, 4) the lack of credibility behind the no bail-out commitment (Art. 125, TFEU) meant that sovereign default risk was not taken into consideration when financial market risk increased in 2008 (Bernoth & Erdogan, 2012, 651). These four factors contributed to a divergence of expectations between EU institutions and member-states. The core structural deficiency being the ECB’s assumption of “spillover convergence” of fiscal policies and the member-states assumption that the ECB would have to bail out insolvent member-states. Next, I will provide an assessment of how the four deficiencies developed within the EMU. This will be followed by an assessment of the key reforms and their implications since the start of the Eurozone crisis.
There was a lack of “mutual recognition” of the structural trade relationships between northern and southern European countries leading up to the Eurozone crisis. For example, between 1998 and 2007 German inflation averaged 1.5 percent per year while in Spain inflation averaged 3.5 percent per year (EuroStat, 2018). As a result of the differences in inflation, labour costs increased by 30.4 percent in Spain while in Germany labour costs fell by 3.9 percent between 1998 and 2007 (Copelovitch, Frieden, Walter, 2016, 818). Irrespective of the differences in inflation rates between Spain and Germany the EMU followed the optimum currency area (OCA) theory. Following OCA theory, the ECB targeted the interest rate between EU member-states inflation differentials to best serve all EMU member-states at around 3 percent inflation (Copelovitch, Frieden, Walter, 2016, 818). However, this implied negative real interest rates for southern European member-states, after factoring in high inflation, and slightly positive interest rates for low-inflation northern member-states. As a result, negative real interest rates in high-inflation member-states induced large amounts of private borrowing (Johnston, Hacke, Pant, 2014, 1772). With the exception of Greece, a “wage price-level effect” induced domestic inflation that eroded export competitiveness, which led to a surge in the current account deficit (i.e. net import surplus) (Johnston, Hacke, Pant, 2014, 1794). Therefore, Portugal, Italy, Ireland, and Spain’s involvement in the optimum currency area (Eurozone) resulted in an overvaluation of the euro relative to the domestic strength of their economies. The overvaluation of the euro induced heavy private sector borrowing in high-inflation member-states (e.g. Spain) and heavy private sector lending in low-inflation member-states (e.g. Germany). This meant that capital was following north to south in the EMU because of interest rate arbitrage in the financial/private sector. Interest rate arbitrage in the financial sector implied that the sovereign debt crisis was not the result of reckless fiscal spending but was the result of private sector mismanagement, which turned into a sovereign debt crisis once the financial institutions were “bailed-out” (Johnston, Hacke, Pant, 2014, 1794). Failure of the EMU to adequately consider the effects of asymmetric supply shocks in an optimum currency union, which would increase the inflation rate under a targeted exchange rate, has been a core structural deficiency within the EMU (Roisland & Torvik, 2003, 113).
There was also a lack of effective fiscal policy coordination due to structural deficiencies within the EMU’s Stability and Growth Pact (SGP). The Stability and Growth Pact (SGP) was established in 1999 to “speed up and to clarify the excessive deficit procedure set out (Art. 126, TFEU) in order to deter excessive general government deficits” (Council Regulation, 1997, No. 1467/97). The main role of the Stability and Growth Pact (SGP) was to ensure responsible fiscal policy coordination amongst EU member-states. However, a 2010 European Commission paper from the Directorate General of Economic and Financial Affairs found out that there were two “critical elements” overlooked in the SGP.
Firstly, it was found that rules and procedures for national fiscal policy making were “entrusted” to the member-states to decide on what was in common EU interests, which was an inevitable result of a “lowest common denominator solution” (Copelovitch, Frieden, Walter, 2016, 831). The key failure of this mechanism was that there was no institutional framework to enforce the SGP mechanism other than “peer pressure” from the no bailout clause in the ECB and “moral persuasion” from other EU member-states (Jonung, Noord, Larch, 2010, 5).
Secondly, the original SGP did not implement a proper escape clause because they did not factor in that even the most complicated SGP system would be unable to account for all potential financial situations or “contingencies” in the EU (Jonung, Noord, Larch, 2010, 5). A lack of foresight by SGP policy-makers and the fact that fiscal deficits did not show up on the public deficit figures, because they were private deficits, increased the financial risk of the EMU leading up the Eurozone crisis (Copelovitch, Frieden, Walter, 2016, 820).
Lastly, there was a lack of commitment behind the no bailout clause (Art. 125 TFEU) because EU member-states’ self-interest appealed to intergovernmentalist thinking in which integration efforts only “intermittently spilled over into related sectors and policies.” (Moravcsik, 1993, 476). For example, Article 105 (6) within the TEU (Maastricht Treaty) contained a provision that allowed member-states to “confer on the ECB a leading role in financial supervision” (Jones, Kelemen, Meunier, 2016, 1019). However, the Council of the European Union rejected the idea of a regulatory authority as “a step too far towards regulatory integration” (Jones, Kelemen, Meunier, 2016, 1019). Similarly, in response to the no bailout clause ECB President Mario Draghi stated he promised to do “whatever it takes” to protect the euro in 2014. The Outright Monetary Transactions (OMT) was his solution to the constitutional limitation of the ECB to act as a “lender-of-last-resort” when faced with the no bailout clause in Article 125 of the TFEU. The Outright Monetary Transactions (OMT) was a secondary bond market outside of the ECB placed under sovereign bond prices. The OMT made “unlimited purchases of obligations” with short-term maturities with governments that participated in fiscal consolidation (Jones, Kelemen, Meunier, 2016, 1025). Although the OMT saved the euro it implied strict “fiscal consolidation” policies that had stringent conditionalities similar to the IMF’s structural adjustment programs.
In Greece, the OMT conditionalities under the European Stability Mechanism (ESM) implemented “austerity programs” which had strong contractionary effects on the Greek economy from 2010 to 2014. For example, the Greek GDP (Purchasing Power Parity 2009 adjusted) declined by 22 percent in less four years, unemployment rate increased from 7 percent in 2008 to more than 28 percent in 2014, final consumption expenditure decreased by 30 billion euros, and monthly minimum wages saw a real decline of 23.2 percent before income tax and social security contributions between 2008 and 2014 (Panagiotis, 2017, 43). As a result of “austerity reforms” the Greek economy’s debt-to-GDP ratio still remains high at 179 percent in 2016 (Shure & Verdun, 2018, 141). The Greek’s debt-to-GDP ratio is quite high considering Canada’s debt-to-GDP ratio was only 92.3 percent in 2016 (Trading Economics, 2018). Despite the stabilization of the major European economies after 2014 the implications of “austerity” policies have created an environment for political polarization, with the rise of political parties such as SYRIZA in Greece, PODEMOS in Spain, and the Five Star Movement in Italy (Mavrozacharakis, Kotroyannos, and Stylianos, 2017, 39). In Greece SYRIZA led by Alexis Tsipras came to power in 2015 after George Papandreou of PASKO implemented austerity policies to manage the economic crisis (Mavrozacharakis, Kotroyannos, and Stylianos, 2017, 41). However, SYRIZA both wanted to leave the EU and stay within the Eurozone. Since Greece could not have it both ways the Tsipras government was forced to implemented further austerity policies in return for the chance to stay in power (Mavrozacharakis, Kotroyannos, Tzagkarakis, 2017, 40). SYRIZA presents an interesting case where decades of “spillover” integration of the Greek economy with the European Union limited Greece’s sovereign ability to engage in intergovernmental bargaining with the EMU. The EMU’s supranationalist authority over the Greek economy stands in direct contrast to the predominantly intergovernmental SGP program, where a lack of an effective enforcement mechanism gave rise to discoordinated fiscal policies. However, the success of Mario Draghi’s OMT policy is debatable, as on the one hand it protected the euro and possibly the EU from disintegration; but, on the other hand it established strict austerity policies which has presented a challenge towards the democratic-sovereignty of EMU member-states.

THE EUROPEAN MONETARY UNION’S (EMU) REFORMS AND IMPACT

As a result of the Eurozone crisis there have been a number of EU programs established to manage the economic fall-out and potential recurrence of the Eurozone crisis. These policy programs can be characterized under fiscal policy reform, financial sector reform, and crisis resolution reform (Buti & Carnot, 2012, 906). In response to the lack of coordinated “macro-prudential” approach in the management of fiscal and monetary policy, it was critical that the Stability and Growth Pact (SGP) be revised to implement more stringent enforcement mechanisms. The European Commission revised the SGP into the 2011 “Six Pack” reforms that established quantitative fiscal rules for member-states to meet including an “operationalization of debt criterion” (Buti & Carnot, 2012, 907). The operationalization of debt criterion stated where public debt exceeded 60 percent of GDP member-states would have to reduce the excess debt by 5 percent per year over an average of three years (Buti & Carnot, 2012, 907). Otherwise, member-states would have to implement an excessive deficit procedure (EDP). The EDP is an action by the European Commission that would follow a set of financial procedures resulting in the imposition of strong financial sanctions against a EU member-state (EuroStat, 2016). Thus, the “Six Pack” reforms would enforce responsible fiscal policies amongst Eurozone member-states by increasing the severity of repercussions against states facing a sovereign debt crisis.
In the financial sector, the Basel III agreement increased capital requirements for credit institutions and investment firms. Increasing the capital reserve requirement for national and commercial banks reduced the risk of financial insolvency, which also improved transparency, accountability, and regulation of the banking system. These EU regulations and directives were based of the Basel Committee on Banking Supervision (BCBS) regulation (Regulation EU, No. 575/2013). Alongside the Basel reforms, the EU reformed the European financial supervision framework into the European Systemic Risk Board (ESRB) that monitored excessive risk-taking and deficit leveraging (Buti & Carnot, 2012, 908). However, the reforms in the financial sector have proved difficult to enforce because of the close relationship between governments and national banks (Buti & Carnot, 2012, 909).
Lastly, the EMU’s crisis resolution reform established the European Financial Stability Facility (EFSF), later superseded by the European Stability Mechanism (ESM), which restructured monetary policy in Greece, Portugal, Ireland, Spain, and Cyprus through intervention in secondary bond markets (Buti & Carnot, 2012, 909). As proposed by the ECB President, Mario Draghi, the EFSF did stabilize the insolvent EU member-states. However, the imposition of harsh fiscal consolidation “austerity” policies on insolvent member-states contracted recipient countries’ economies (Mavrozacharakis, Kotroyannos, and Stylianos, 2017, 39). In fact, it has been found that merely belong to the EMU would “increase the vulnerability of sovereign issuers relative to non-Eurozone countries” as private financial markets can “force” default on a state despite sound fiscal policies (Buti & Carnot, 2012, 909). Although the ESM system provided an effective curtailment of the Eurozone crisis the contractionary effects on recipient economies, and the political fallout (e.g. Greece), has hindered ESM policies as a politically attractive stabilization mechanism.

TRADE-OFF BETWEEN SUPRANATIONALISM AND INTERGOVERNMENTALISM?

Given the complexity of the EMU structure, and Eurozone crisis, establishing viable policy solutions to aid the structural deficiencies present has proven difficult. However, the approach taken to aid the Eurozone debt crisis has presented new challenges that question the democratic nature of the EMU. Questions revolving around the democratic legitimacy of the EMU’s policies can be attributed to the macroeconomic divergence of monetary and fiscal policies in the EMU. Furthermore, the discoordination of monetary and fiscal policies can be attributed to the divergence of perspectives between member-states that assumed the ECB would act as a “lender-of-last-resort,” and the ECB’s assumption under a centralized monetary policy fiscal policy coordination would be inevitable.
Dani Rodrik’s trilemma between deep economic integration, national sovereignty, and mass politics implies that only two out of the three components can be maintained at a single point in time. For example, due to the separation between monetary and fiscal policy in the currency union mass politics was sacrificed to maintain national sovereignty of the member-states and EMU price stability (Snell, 2016, 178). The transfer of mass politics to EU institutions, at the expense of national sovereignty, can prove to be a viable solution in establishing a democratic and stable EMU. However, the complete transfer of democratic politics to EU institutions is unlikely given the reluctance of member-states to give up fiscal policy autonomy (Snell, 2016, 179). Rodrik’s trilemma shows that the EMU’s response to the Eurozone financial (and sovereign debt) crisis has proven to be an ad-hoc arrangement with mixed implications for EMU member-states. Overall, divergence of expectations between supranationalist institutions (e.g. EMU) and intergovernmentalist member-states has proven to be a fundamental deficiency within the EMU’s architecture regardless of the EMU’s reforms.

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Citations
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Trade Politics, a Politics of Illusion

By Sheldon Birkett

On December 18, 2017, Canadian and British governments materialized in front of a U.S. trade tribunal arguing against Trump’s aggressive countervailing duties on Bombardier’s C-series jet. [i] The Canadian Ambassador to the United States, David MacNaughton, said the imposition of up to a 300 percent countervailing duty is illegitimate speculation premised on pure conjecture. [ii] This is one of the latest developments in the pro-protectionist populist backlash against the historic trend of global economic liberalization (circa. 1945).

The politics of trade protectionism must not be viewed in isolation from globalization, rather, protectionism is part of globalization. Irrespective of the variants of populism, which now pierces through the frontiers of domestic politics into global politics, globalization has perpetuated horizontal and vertical socio-economic global inequalities. Globalization in its entirety is a multifaceted and illusive concept, which is ambiguous when examining it as a singular comprehensive topic. Instead it is more practical to study the elements of globalization (i.e. economic liberalization, supranationalism, populism, integrated national policies etc.) in isolation then bring such topics together under a multifactor framework of analysis. This frame of analysis is similar in going from a partial to general equilibrium analysis in economics, but rather from a multidisciplinary approach. However, a complete comprehensive assessment of globalization could not be adequately portrayed in this article for sake of brevity, for that reason I will only examine the effects of trade liberalization on the politics of trade.

Like any good trade model measuring the welfare effects of trade on the factors of production (capital, labour, land) it is necessary to start with the stolper-samuelson theorem as the theoretical backbone for the welfare analysis of trade liberalization. The stolper-samuelson theorem states that the relatively abundant factor used relatively intensively in production benefits from trade liberalization, while the relatively scarce factor used relatively non-intensively in production does not benefit from trade liberalization. [iii] In other words, an increase in the relative price of labour-intensive goods will increase the wage rate and reduce the (capital) rental rate relative to both commodity prices (i.e. labour and capital-intensive goods). The stolper-samuelson theorem works because according to the ricardian trade model the price of the good that has a comparative advantage increases, while the price of the good that does not have the comparative advantage decreases, when free trade occurs between two countries.

The simple insight that the stolper-samuelson model provides, when it comes to the welfare effects of trade, goes a long way in explaining both the recent rise in resentment and prejudice against global trade liberalization. However, the stolper-samuelson theorem in reality does not act in isolation from other macroeconomic phenomena, such as global finance. Therefore, why does trade face the brunt of accusations in the backlash against globalization? To answer this question it is necessary to steer away from the topic of economics and focus on the ethics behind why individuals – in the west – can justify financial risk adverse behaviour, which has resulted in one of the largest moral hazards in history (i.e. 2008 financial crisis), while not justify the minor economic consequences of free trade. The divergence between justifying financial risk adverse behaviour versus not justifying the negative consequences of free trade is certainly an arbitrary assessment. Professor Dani Rodrik at Harvard University’s John F. Kennedy School of Government found that individuals resisted free trade when it resulted in job losses as a result of unfair trade practices, as “It’s one thing to lose your job to someone who competes under the same rules as you do. It’s a different thing when you lose your job to someone who takes advantage of lax labor, environmental, tax, or safety standards in other countries.” [iv] Free trade under the same regulatory rules underpins the “fair trade” argument, however it is equally important to recognize that when barriers (i.e. countervailing duties, quotas, production subsidies) arise due to “unfair trade practices” they are often met with political buyins that distort the gains from trade. [v]

The politics of free trade shows that people suffer from a sense of “adiaphorization” of perception, when there is a disconnect between a person’s behaviour and the outcome (or effect) of their action. Adiaphorization is also referred to as the “disappearance of [individual] responsibility as a result of the division of labour.” [vi] This is most commonly illustrated in collective action failure problems. For example, the divergence between an individual’s action and the accumulated effects of his or her action(s) adding to the negative consequences of climate change (e.g. pollution). As such, people’s perception of free trade is heavily disconnected from the real economic implications of trade liberalization policies. In the 1990’s U.S. advocates for the North American Free Trade Agreement (NAFTA) professed the extraordinary benefits NAFTA will have for North American productivity, competitiveness, and economic growth. However, a 2003 study illustrated that NAFTA would at most contribute to 0.5 percent of GDP growth in the United States once the agreement became fully integrated. [vii] Similarly, for Canada and Mexico the NAFTA narrative is mixed.

Despite the modest economic gains attributed to NAFTA, the public perception of free trade has hit a wall. No, this is not Trump’s physical wall with Mexico, but it is an inherently ideological, populist, idiosyncratic anti-trade barrier that has been steamrolled by demagoguery political ideals.

The recent anti-NAFTA political reaction in the United States and other western liberal democracies represents a divergence between people’s perception of FTAs, filtered through ideological lenses, and the real aggregate implications FTAs have on the overall economy. In essence, this has been the crux of trade politics as a politics of illusion. Despite the divergence between perception and effects of FTAs this does not entail that citizens’ reactions against FTAs, such as NAFTA, are inherently justified. Similar to individuals support for or against FTAs justified as being fair or unfair agreements, it is possible to justify people’s perception of FTAs (for or against free trade) depending on the political alignment of the population. This is to say even if free trade has no negative welfare impact on a person’s wellbeing, perhaps can even be beneficial, individuals will still choose to support or not support FTAs based on their own political/ideological alignment. For example, anti-free trade support based on political alignment has recently been seen across most western liberal democracies with the rise in right-wing (and left-wing) political parties. Surprisingly, the most developed countries have not been immune to trade politics as a politics of illusion.

In considering trade politics not just as the politics of utility maximization, but as a politics of illusion filtered through ideology, much of the economic models used to understand the welfare effects of trade liberalization have become obsolete. Much to the same degree how protectionism must be viewed as part of the tension of the globalization process, and not as globalization’s antithesis, a multidisciplinary approach is inherent in the study of globalization. In terms of trade politics, a multifactor approach spanning across both political science, economics, literary and cultural studies is essential. In this regard, trade politics as a politics of illusion is an exemplar of such an approach.

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Citations

i. Adrian Morrow & Nicolas Van Praet, “Boeing, Bombardier battle up in final U.S. hearing,” The Globe and Mail, December 18, 2017, https://www.theglobeandmail.com/report-on-business/canada-and-uk-take-on-boeing-at-us-trade-tribunal/article37367245/.
ii. Ibid.
iii. W. Stolper & P. Samuelson, “Protection and Real Wages,” The Review of Economic Studies, 9, no. 1, (1941): 58-73, http://www.jstor.org.proxy.library.carleton.ca/stable/2967638.
iv. Dani Rodrik, “Populism and the Economics of Globalization,” John F. Kennedy School of Government Harvard University, August 2017, page. 15, https://drodrik.scholar.harvard.edu/files/dani-rodrik/files/populism_and_the_economics_of_globalization.pdf.
v. Ibid, 16.
vi. Harald Welzer, “Climate Wars: Why People Will Be Killed in the 21st Century,” Polity Press, page. 16.
vii. M. Angeles Villarreal & Ian F. Fergusson, “The North American Free Trade Agreement (NAFTA),” Congressional Research Service, page. 16, https://fas.org/sgp/crs/row/R42965.pdf.

 

Ontario Increase in Minimum Wage: A Phillips Curve Analysis

By Sheldon Birkett

Preached by business associates, CEO’s, and the wealthy elite, is often stated that an increase in the minimum wage increases long term unemployment, costing the working class. Ontario’s initiative to increase the minimum wage to $15 per hour is a sign that the realities of precarious working conditions, and the adverse effects of globalization are finally starting to be understood by policymakers.

The neoclassical rational expectations model of contemporary economics is still widely believed in as a macroeconomic “law” when it comes to the minimum wage. When people talk about minimum wage increases, individuals fail to consider the fundamental negative relationship between inflation and unemployment: the Phillips Curve. Popularized by Paul Samuelson and Robert Solow as a menu of policy options, the Phillips curve is highly regard as a foundational principal of macroeconomics. Economists such as Edmund Phelps and Milton Friedman, took the idea of the Phillips curve, and used the Phillips curve to further promote the centralized importance of monetary policy and the rational expectations model of macroeconomics. Many say that the direct correlations between inflation and unemployment are not as coherent as one may expect them to be, often characterized as an argument against Freidman’s rational expectations model. Despite the naysayers of the rational expectations model, it can very well be considered that a rational expectations theory can be utilized to justify increases in the minimum wage; implying, a minimum wage increase would hold unemployment constant to the long-run trend with a low sacrifice adjustment ratio.

Phillips Curve image

The explicit reasoning of applying a rational expectations model to justify increases in the minimum wage, is due to the neutrality of the unemployment rate around the “natural rate of unemployment.” The “natural rate of unemployment,” is more accurately defined as the “nonaccelerating inflation rate of unemployment,” (NAIRU).[1] The NAIRU is often assumed to be “fixed” or constant in nature, though such an assumption about the macro-economy can be misleading. The NAIRU is determined by real factors affecting the supply and demand for labour, such as demographics, technology, unionization, labour regulation etc. Any variation experienced in the real factors will affect variation in the NAIRU, though the exact deviation of NAIRU variation from the mean NAIRU, is often unknown. The World Economic Forum reported that the difference between British inflation rates and Ireland inflation rates was only 0.05 percent, though the standard deviation between the measures was excess of 2.5 percentage points, which implied (with a 95 percent confidence interval) inflation between Ireland and Britain was 10 percentage points wide.[2] Given the ambiguity in variation of the NAIRU measure, it is difficult to determine the long-term “real” affect an increase in the minimum wage would have on unemployment.

It is true the initial impact of a spike in minimum wage, such as to $15, will increase unemployment; though, it is often overlooked that an increase in the minimum wage will also enhance labour productivity. The mixed results of an immediate minimum wage increase often leads policy officials to reconsider minimum wage increases. If the minimum wage increase is projected on a long-run trend, it is possible to see that an increase in minimum wage will effectively increase inflation, though, the negative externalities inflicted on employment will not persists. At first, the wage increase will increase aggregate demand, increase workers bargaining power, and eventually increase consumer prices, raising the consumer price index (CPI) and inflation. As projected time and time again, there will initially be a decrease in unemployment, advent of experiencing greater aggregate demand. This trend of lower unemployment will eventually return to the natural rate of unemployment (NAIRU) once consumer expectations are adjusted. The time horizon it takes for peoples expectations, to adjust back to the long run trend is debatable. It is certain that an increase in the minimum wage will not increase unemployment in the long run, but in affect, result in lower unemployment rate in the short run. The relational concept of inflation and unemployment rates to increases in the minimum wage is widely misunderstood and overlooked. The importance of the Phillips Curve relationship should not be underestimate in macroeconomics, when considering increases to the minimum wage.

Given the findings about the Phillips Curve, it is apparent that many of the criticisms against a minimum wage increase are inherently embedded in class politics. From a business perspective, it is self-evident that an increase the minimum wage would be cutting away at marginal profits. Individual businesses fail to analyze the return of benefits from a minimum wage increase on the collective economy, and is a classic fallacy of viewing the economy as non-cyclical in nature. Respective on minimum wage increases, it is apparent that precarious labour conditions cannot persists in a globalized economy.

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[1] Kevin Hoover, “Phillips Curve,” The Concise Encyclopedia of Economics, 2008, http://www.econlib.org/library/Enc/PhillipsCurve.html.

[2] Stefan Gerlach, “Why the Phillips curve still works for Ireland,” World Economic Forum, July, 22, 2015, https://www.weforum.org/agenda/2015/07/why-the-phillips-curve-still-works-for-ireland/.

 

Venezuela: The Inevitable Crisis?

By Sheldon Birkett 

Last Thursday the United States imposed unprecedented sanctions upon the Venezuelan Supreme Court chief judge, Maikel Moreno, for his involvement in the devolution of the opposition led Venezuelan National Assembly. Despite the actions of the U.S. supporting opposition, the devolution of the National Assembly was necessary for the stability of the Venezuelan state against an opposition-led coup. Leopoldo López, the leader of the right-wing opposition party Primero Justicia, was imprisoned in 2015 for inciting violence against Venezuelan citizens. Many supporters, including the current leader of the opposition Henrique Capriles, declare López 14-year prison sentence unconstitutional. Respective of the so-called “authoritarian dictatorial regime” of the Maduro administration, declared by many mainstream western media sources, it is necessary that the Venezuelan government maintains stability in the region: especially in defence of a democratically elected Maduro administration.

Respective of the “authoritarian” conditions imposed by the Venezuelan government, many Venezuelans still have the right to protest the government in defence of their rights. The incurring violence in the streets of Caracas is a result of opposition led forces demanding for a presidential election to occur as soon as possible, given the fact that in 2016 Maduro did not have a recall referendum on the previous presidential election. Maduro suspension of the recall referendum was granted after it was discovered many of the opposition petition signatories were fraudulent. Despite the opposition calling for an immediate presidential election, a recent public opinion poll by Hinterlaces claims that 65% (p<0.05) of the population claims to agree that the presidential election should be withheld till 2018[1].

Although the suspension of many municipal elections by the Maduro administration were democratically uncalled for, the stability of the Venezuelan state is paramount to maintain in the face of an opposition force that is not willing to negotiate a settlement with the Venezuelan government. In spite of the crumbling of Venezuelan democracy, it is important to remember that Venezuela was suspended from the MERCOSUR common market in 2016, and is currently experiencing unprecedented levels of inflation (over 480 percent as estimated by the IMF). Now the Organization of American States (OAS), spearheaded by secretary general Luis Almagro, is considering suspending Venezuela’s membership from the OAS on May 31st, 2017. Clearly, the political situation in Venezuela is reaching a tipping point, which is all compressed under a five-billion-dollar current account deficit and the inevitable outcome of economic insolvency: despite Venezuela not holding any external debt to the International Monetary Fund (IMF). If the current political-economic environment persists in Venezuela, intervention by the international community will be necessary in the name of upholding a normative internationalist framework to protect a legitimate government against an illegitimate movement advocating regime change. Venezuela in the past has proven sound fiscal and monetary economic policies, social welfare initiative (i.e. misiones), and has shown resilience against unconstitutional coup attempts. Despite the persistent violence on the streets of Caracas, the stability of the Venezuelan government must not be jeopardized at the expense of the instability of the Venezuelan state.

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Featured Image Taken From Wikimedia Commons 

[1] “65% “de acuerdo” en esperar elecciones presidenciales de 2018,” Hinterlaces, April 30, 2017, http://hinterlaces.com/65-esta-de-acuerdo-en-esperar-elecciones-presidenciales-de-2018/

The Political-Economy of Kalecki

 

By Sheldon Birkett

Would an increase in wages decrease corporate profits or increase prices? This is one of the central questions behind Michal Kalecki’s article Political Aspects of Full Employment published in 1943. Ultimately, Kalecki theorized the effects of Keynesian stagflation in the 1970’s and the rise of neoliberal “TINA” economic policy, foretelling the demise of the Bretton Woods global economy from a debtor to creditor paradise (Blyth, 2016).

Living in a time (2017) of increasing global political-economic uncertainty, in a world facing the rise of populist politics, precarious labour conditions, deregulated global financial markets, increasing intrastate inequality…etc, it is becoming increasingly paramount for the global citizen to ask “How did the state of the world end up in the present condition?”. In answering such a question, it is necessary not to ignore the role of inadequate common sense economic policy played in developing illusionary narratives of how “should” the macro-economy function. Through analysis of Michael Kalecki’s Political Aspects of Full Employment it is apparent that the majority of macroeconomic policy is prescribed through a ‘normative’ (what should be) common sense moral narrative, lacking any substantial insight into the political motives behind economic policy. By critically examining the moral assumptions behind economic thought, it is apparent that a common-sense approach to macro-economics is inadequate in finding solutions to present political turmoil.

 

POLITICS OF FULL-EMPLOYMENT

Deviating from Keynesian economics Kalecki points out the inherent political problems that arise from sustaining levels of full employment. Kalecki notes that sustaining full employment will increase market demand (as everyone will be buying and spending more with their incomes), and the prices of all goods and services in a market economy will rise. The rise in prices because of an increase in income, will effectively lead to a period of inflation. For the average worker, the macroeconomic effect of full employment is wonderful, as there is a greater availability of work, greater bargaining power, less financial liabilities (as inflation will act as a natural devaluation on loans, mortgages…etc), and an overall increase in economic welfare in the short-run (Kalecki, 1943). For the corporate businessmen, a scenario of macroeconomic full employment is a nightmare as inflation over time will slowly eat away at corporate investments, despite full employment causing no decrease in corporate profits (Kalecki, 1943).

At the heart of the politics of full employment is the shift in political leverage full employment gives labour over capital interests. Apparent from the nature of full employment the business elite class will be against any full employment policy, because a full employment policy would give the working class considerable political leverage in a macro-economy. Therefore, it would be in the interest of the business elite to keep ‘discipline in the factories’ and ‘political stability’ to lower risk on investments and profits (Kalecki, 1943).

Despite the economics behind the nature of stagflation, it is clear that a Bretton Woods system of minimal risk sustaining full employment inherently causes political class conflict. In the wake of the 1975 OPEC crisis and the dismantling of the Bretton Woods economic system, the wrath of anti-inflationary policy was paramount to advancing the neoliberal agenda, as the only inevitable alternative. Reagan and Thatcher in the 1980’s solidified anti-inflationary policy by stagnating wage growth under increases in productivity, resulting in wealth accumulation towards the top 1% of the income distribution. Contractionary anti-inflationary fiscal policy was also aided by expansionary monetary policy, effectively regulating the money supply in maintaining low to negative interest rates. This new ‘neoliberal’ agenda drastically differed from the regulated Keynesian economic model, because of the political-class leverage at stake. Thus, Kalecki’s 1943 Political Aspects of Full Employment effectively foretold the rise of contractionary fiscal consolidation (austerity), in which an alliance of big business would “…induce the government to return to the orthodox policy of cutting down the budget deficit.” (Kalekci, 1943).

 

ELEPHANTS, INCOMES & WAGES

Kalecki’s theory on full employment, resulting in the subsequent rise of anti-inflationary neoliberal policies can be seen in the real changes of global income between 1988 to 2008. Economist Branko Milanovic published in a 2012 World Bank working paper, the now-famous elephant graph of the global income distribution (Figure 1.). This graph clearly highlights which part of the global income distribution are the “winners” and “losers” of economic globalization. The vertical axis measures changes in real income (measured in a 2005 baseline prices), the horizontal axis is the percentiles of the world population in income. It is apparent that the top 1% real income increased more than 60% over the past two decades, as well as the 50th to 60th percentiles had an 80% increase in real income (Milanovic, 2012). These “winners” demographically consist of the 60 million richest people, and the middle-class population of the emerging market economics (i.e. China, India, Brazil, South East Asia Nation-States…etc.). The apparent “losers” from policies of economic globalization or “neoliberalism” appear to be the lowest 5% of the income distribution with their incomes remaining relatively stagnated (Milanovic, 2012). Most interesting about the elephant graph is the portion of the income distribution between the 75th and 90th percentile, that have seen the greatest stagnation in income growth. Demographically, the 75th to 90th percentile downward portion of the elephant graph is the American middle class. This downward portion is exactly what Kalecki predicated the political effects of full employment on, and is the reason why Donald Trump is now the president of the United States. The stagnation of upper middle class incomes was a lost battle in favour of international capital investment, playing into the greater narrative of global financialization since 1975.

Figure 1. Change in real income between 1988 and 2008 at various percentiles of global income distribution (calculated in 2005 international dollars)

elephant  Milanovic, Branko. (2012). Global Income Inequality By The Numbers: In History and Now – An Overview –. World Bank’s Research Department, 1-27. Retrieved from, http://heymancenter.org/files/events/milanovic.pdf

 

BEYOND THE KALECKIAN APPROACH TO FULL EMPLOYMENT

Thinking beyond the inherent problems of stagflation, income inequality, and political populism is critical not only to advance individual’s political rights and freedoms, but also to protect humanity from existential global crises. Although, a review of Michal Kalecki’s 1943 Political Aspects of Full Employment might seem outdated in its application to the political-economy of the 21st century, the central idea of class conflict premised on political interests in Kalecki’s work is more prominent in 2017 than ever before. The fight over wage stagnation diverging from increasing economic productivity in upper middle class nation-states imposes a political challenge to center-liberal policy makers. Essentially, center-liberal governments are self-imposing a political deadlock between the special interests of capital and labour classes, while serving neither their political aspirations. In response to the center-liberal/liberal internationalist approach, upper middle class citizens around the world are increasingly growing politically disengaged, using their vote for fringe politics as backlash against the last thirty years of the neoliberal agenda.

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Citations

Blyth, Mark. (2016). Global Trumpism. Retrieved February 20, 2017, from https://www.foreignaffairs.com/articles/2016-11-15/global-trumpism

Kalecki, Michael. (1943). Political Aspects of Full Employment. Political Quarterly, 14 (4), 1-9. Retrieved from, http://delong.typepad.com/kalecki43.pdf.

Milanovic, Branko. (2012). Global Income Inequality By The Numbers: In History and Now – An Overview –. World Bank’s Research Department, 1-27. Retrieved from, http://heymancenter.org/files/events/milanovic.pdf.