|Spencer Gore - The Cinder Path (from the Tate Collection)|
And (as they say in Texas) it ain't pretty! But rather than dwell on events that change by the day, hour and sometimes the minute, I thought I would reflect on what could have been done and what really matters in Europe now.
I remember when the euro was first launched that I was sceptical - I wrote a few papers using cluster analysis (still available on my website) that showed that the peripheral EU countries did not display the same macroeconomic dynamics as the "core" countries in the centre of Europe. Underlying this view in economics is something called the optimal currency area theory which basically says that if your cycles are different from a bunch of other countries, then you shouldn't be using the same money. And just to make the point here, when I say "cycles" I mean all cycles, not just the business cycle. Of course we all know what happened - the euro area happened and the criteria for joining the euro had virtually nothing to do with the optimal currency area criteria. At first I thought that the euro area wouldn't last, as not only was it not an optimum currency area but also the legal underpinnings did not appear to be in place to support the single currency. Well I was proven wrong on that one and indeed the euro lasted through it's 10th birthday in 2009 to much fanfare, but after 2009 things have started to fall apart, and not at the point that you'd expect - after a severe recession. If you look at the growth dynamic of countries emerging from a recession the dynamics are usually extremely aligned - I've also done some research on this using a technique from physics called "recurrence plots". The difference though here is the debt problem that Greece faces, the fact that the debt was much higher than it should have been on entering the euro area and also their inability now to do much about it as their economy is mired in a downward growth spiral caused by the cutbacks and tax increases necessary to put them on a "sustainable path".
The problem is not just that the peripheral European countries shouldn't have been in the euro, the problem is that even with the low interest rates that the ECB is now delivering ( - now even lower after Draghi's surprise decision to lower rates last week) the peripheral euro area member states are just not growing, and the best way to get the debt to GDP ratio down is to have growth to lower the ratio as the UK is now also finding out.
So how do you stimulate growth? There are two approaches - spend and lower taxes ( - which is usually the favored route in the US) - or go for structural reforms which change the economy or its external relations in such a way that it gives businesses new incentives which jolts the economy into growth. It was heartwarming the other day to hear that that is exactly what is happening (and what I predicted) right now in Japan after the Tsunami. Just listed to this and you'll see what I mean. European member states cannot initiate more government spending or tax cuts, so structural reforms (so most economists say) are what is needed. But these are going to be hard - noone likes to lose job security in a high unemployment environment, and noone likes to have government programs reformed to give people less benefits (as has happened with teachers in the UK, Greece and it's on the tables in Italy as well).
But there is a solution that would help, and rather surprisingly the politicians who meet at the G20 summit in Cannes, France this week did not seem to get it. Indeed this was rather surprising given the motto of the summit in french read "New World, New Ideas" ( - sorry I know, I'm being sarcastic!) - in fact the lack of new ideas was enough to make anyone following all this to get out the St. John Wort tablets. This idea I had is not new, it's just that noone seems to have thought about it in the context of trying to solve the current global growth problems. At a roundtable of Consuls General from France, Germany and Italy in Houston lately, I asked it as a question and I seemed to get a bemused response from the participants. The Italian Consul General even said "it's just too complicated so it is never really considered an option", and the other Consuls General appeared to agree with this view.
So what am I talking about? In short, a TAFTA - which stands for a TransAtlantic Free Trade Agreement. Of course this is not technically correct as a TransAtlantic trade agreement should really include Canada....but wait, the Canadians are soon going to conclude their OWN trade agreement with the EU called the CETA (Comprehensive Economic and Trade Agreement) and the Mexicans already have agreements with the EU in place. I guess I would call what might emerge a EUSAFTA (- an EU-USA FTA).
But why now? First, the US Congress passed and President Obama recently signed and recently lauded new trade deals with both South Korea, Columbia and Panama. So although the US government is "broken", lawmakers on this side of the Atlantic seem to still be able to get their act together when it comes to trade deals, so there is at least a glimmer of hope there. Second, the trade flows that we're talking about are the largest in the world when you add up all the European Union member states - and yet these trade flows have not been liberalized (as anyone shopping for European cheeses knows only too well). But more to the point, the structural change (and hopefully "net boost") to the economies on both sides of the Atlantic would be significant, leading to an acceleration in growth, and indeed given how big both entities are, global growth. And third, as part of the G20 communique, leaders called for a study to be done on how to get an "early harvest" on some of the gains that could be culled from the failed "Doha round" of GATT talks which were held under the auspices of the WTO - well, hmmmm, let's think what caused the GATT talks to collapse in the first place - yes, you got it, the EU and the USA not being able to agree on agriculture! So getting them to push their heads together and negotiate something (even if you leave agriculture out) would get the diplomatic channels opened up further, and might allow a deal to also be done on agriculture which could allow the Doha round to be restarted.
Clearly getting agreement on a EUSATA would not be easy, but the potential payoff is just too great to ignore right now. We all know that just getting the trade representatives to sit down and talk will boost economic growth as businesspeople will become more optimistic about the fact that something is being done by our governments to try and boost growth. In my opinion it is the best way to get the economies on both sides of the Atlantic out of their current economic policy quagmires.