Europe: Debt's death grip causes 'double-dip' recession

Sunday, December 9, 2012

The latest economic data for the European Union, released on December 6, confirms that the region has officially entered a “double-dip” recession. Over the year to September, Gross Domestic Product fell by 0.4% in the 27-state European Union (EU27) and by 0.6% in the 17-state eurozone.

On the same day, the European Central Bank revised its September forecast of 0.5% growth in the eurozone in 2013 down to -0.3%.

A year ago, only seven national economies in Europe, and only the Netherlands in the northern European “core”, were in recession. Now the figure is 13 and growth is slowing across the whole EU.

Leading the disaster and almost in a category of its own is Greece, whose economy contracted 7.2% in the year to September. At the end of the year, the Greek economy ― alone in never coming out of the 2008-09 “Great Recession” ― is at least 20% smaller than when the crisis originally broke.

Next worst figures are for Portugal, Slovenia, Italy, Cyprus, and then Spain and Hungary.

Reality has turned out to be worse than all official forecasts. In February, the EU’s interim growth forecast for the 27 EU states was 0%, down from its autumn 2011 forecast of 0.6%. For Spain the forecast was -1%, down from 0.7%. Now the final figures for the EU27 and Spain for 2012 will be even lower, at least -0.4% and -1.6% respectively.

All signs are that unless there is serious action to lift public spending and introduce debt relief, this second “dip” will be longer and more destructive than the first.

Origins

This new recession has its origins in the way the European economic-powers-that-be responded to the 2008-09 recession.

As soon as recovery of some sort was on the horizon, they turned their attention to forcing rapid and deep cuts in the government budget deficits that had ballooned as a result of the slump. This was especially so in countries such as Ireland, Spain and Portugal, where public funds “had to be found” for bank bailouts.

The combination of slumping tax revenue and nationalisation of private bank debt had seen deficits skyrocket in the eurozone “periphery” in 2009 and 2010. It reached 30.9% of GDP in Ireland, 15.6% in Greece, 11.2% in Spain, and 10.2% in Portugal.

The supply of public debt on offer to markets then ballooned, where it met suspicious and cautious financial institutions burnt by the 2008 crash. The interest rates that “peripheral” governments had to offer to get their debt sold then leapt.

The ECB could have intervened in debt markets to counter this. But it did so only minimally to keep up the pressure on peripheral governments for “reforms” ― chiefly labour market deregulation, privatisation and wage and welfare cuts.

These led to attacks on public services, living standards and employment that have created the past two years of mass protest across southern Europe. But now it is becoming clear that could also generate an intractable recession, capable of pulling greater areas of the “periphery” down into the icy misery that grips Greece.

Debt dynamics

How? In a November 2012 paper for the European Credit Research Institute, researcher Alex Chmelar described two vicious circles that could interact to produce this result.

Chmelar said households, especially those of the more stable parts of the working class, can survive short periods of unemployment and maintain their spending levels by cutting back on consumer credit, digging into savings and borrowing against assets.

However, “if recovery does not come in time to help such households cope with their debt burdens, the second dip of a recession can trigger a potentially more dangerous wave of defaults, which would increasingly concern long-term housing loans”.

The second vicious circle described by Chmelar starts with austerity and rising unemployment driving total household consumption lower.
The latest data confirm that this process is under way.

Next, as profit opportunities dry up, the slump in consumption feeds into a decline in private investment. And, just as an investment slump heralded the 2008-2009 recession, so investment has been declining since the first quarter of 2012 ― by 4.6% across the eurozone and by 3.4% in the whole EU.

Again, the most disastrous decline is in Greece (-19.4% in the year to June), then Ireland (-18.2%), Portugal (-16.7%), Spain (-10.4% in year to September) and Italy (-9.5%).

In a normal downturn, this combined slump in consumption and private investment would be offset by increased public spending. However, the pressure to reduce ballooning public sector debt means government spending has also been falling in the eurozone (by -0.2% to September) and barely rising in the EU27 (0.5%).

This decline intensifies stagnation, with Ireland leading the way, followed by Spain, Greece, Portugal and Italy.

Finally, despite swingeing cuts and hikes in taxes, public deficit cuts still fall well short of target, as sinking economic activity slashes revenue.

The public debt burden, whose reduction is the whole point of austerity policy, keeps climbing across the Eurozone periphery.

Bad ‘adjustment’

Gains from higher exports are doing little to offset the slump. For the whole Eurozone, net exports (exports minus imports) rose by only 0.9% of GDP over the year to September.

Although the current account deficits of the southern European “periphery” economies have all improved on the back of rising export competitiveness produced by falling real wages, they all remain negative.

The only success for the policy has been Ireland, which has averaged a current account surplus of 2.2% over the same period. This “win” is due to Irish capitalism’s success in raising the rate of exploitation of labour by more than its “competitors” in the EU periphery.

Irish “relative unit labour costs” (roughly, Irish workers’ share of newly produced value) has been driven down by 17% since 2008.

Yet, if the slump continues, the Irish economy’s “victory” in this race to the bottom in wage costs will be short lived because Ireland, too, will drown in the icy waters of spreading recession.

Chmelar pointed out that when business, labour and government are all trying to pay off accumulated debt and balance the books, and when credit is drying up, the resulting decline in consumption and investment throws countries “into a self-feeding spiral of persistently decreasing aggregate demand, falling consumer confidence, sluggish investment, capital flight, higher deficits, tax hikes and further budget cuts”.

A qualitative leap, reminiscent of the Great Depression, takes place once unemployment hits the more stable, older layers of the working class, increasing the rate of mortgage loan default.

This nightmare, which has so far affected only Greece, is now showing signs of taking hold in Spain and Portugal.

In Greece, the shrinking of the economy and the rise in unemployment happened far quicker than the running down of household debt, leading to a rapid rise in non-performing loans and a collapse in the asset base of the banking system.

In Spain, the main source of loan default has been doubtful loans to businesses, which have reached 25% of all loans issued. If the recession lifts defaulting home mortgages to Greek levels (19.9%), then the threat to the already shaky Spanish banking system will be deadly.

Winning the debt war

If the danger of self-reinforcing recession is so obvious, what can be done about it?

One apparently sensible suggestion comes from economist Paul de Grauwe in a November 15 commentary for the Centre for European Policy Studies (“How to avoid a double-dip recession in the eurozone”).

Instead of Europe’s peripheral debtor economies being forced to cut wages and prices relative to the creditor countries of the northern “core” (“internal devaluation”), why not have these creditor countries allow their prices and wage levels to grow slightly (“internal revaluation”)?

That would raise demand within the “core” economies for the exports of the “periphery” and raise growth across the EU.

However, de Grauwe’s proposal would come at a cost to the competitiveness of the EU’s most important component, Germany, now running a current account surplus of 7% of GDP.

For big German capital, that competitiveness has to be maintained not only within the EU, but towards the US, China and the big “emerging” economies like Brazil.

To be sure of winning market wars globally, German big capital will always be disposed to insist on “discipline” within the EU.

There is also the big issue of the peripheral zone debt held by the financial institutions of the “core”: even a moderate rise in the price level would erode the value of this hug asset on German, Dutch and Swiss bank balance sheets.

The only certain way of turning around the descent into recession is by boosting public investment (recent studies calculate that a euro spent on public investment in the present slump would translate into two euros of growth).

The funding for that investment requires lightening the burden of public debt repayment. In Spain, for example, public debt repayment has nearly doubled in four years to account for 9.3% of the national budget.

That debt has to be publicly vetted to establish how much is illegitimate, how much is to be rescheduled and how much honoured. It’s little wonder that the parties of the left in “peripheral” Europe, from the United Left Alliance in Ireland to SYRIZA in Greece, are now making a public audit of the debt a leading demand.

[Dick Nichols is the European correspondent of Green Left Weekly, based in Barcelona. A fuller version of this article, complete with references, will appear at Links International Journal of Socialist Renewal.]

From GLW issue 949