07 January 2012

Structural Adjustment for Advanced Capitalism

Recently, I mentioned how Germany quietly volunteered to underwrite the entire European debt in exchange for a new fiscal order to be determined by, well, Germany.

As everyone was focused on the fiscal integration part of the equation (even though very little is known about the proposed system), with a few notable exceptions (all quoted in my original post), no one noticed the dramatic shift from "no bailout with German taxpayer money" to "hey, what's a few trillion euros among friends."

Since I never buy the idea of stupid politicians making stupid mistakes, I said that I have some contrarian ideas to explain this silently received about face.

Here they are...

Do You Remember Structural Adjustment Programs?

Those of you who are at a certain age (and of a certain political predisposition) might still remember the glorious days of structural adjustment programs (SAP). These were special set of rules imposed by the IMF and World Bank whenever poor countries found themselves in financial dire straits. In fact, these were pretty much the precondition for providing bailout loans.

These SAPs were invariably introduced with a a tut tut attitude from stern IMF officials condescendingly chastising these periphery governments "for living beyond their means." Their reports showed how widespread the corruption was, how no one paid any taxes and how publicly owned corporations were filled with lazy cronies of the ruling party.

These measures consisted of drastic cuts in state expenditures (a.k.a. austerity measures), privatization of publicly owned companies, removal of subsidies and price controls and a general deregulation and lowering of trade barriers.

Not surprisingly, in all cases, these measures increased poverty, created much larger income disparities, led to a worsening of trade balance and forced these countries to sell their major assets for a song.

That's because these measures were not designed to help the local economies. They made a lot more sense for the needs of foreign corporations operating in those places and their local counterparts: they reduced the labor cost of manufacturing, they made imported goods cheaper with lower tariffs and the forced privatization under dire economic conditions gave these companies the opportunity to buy local assets cheaply. SAPs also helped local business classes greatly as they became the beneficiary of this unequal income re-distribution.

Interestingly, people forget that it was the shock therapy of massive privatization and deregulation recommended by the recently redeemed Jeffrey Sachs that led Russia to go bankrupt and default on its debt in 1998. (The irony of Communist China's highly regulated and, at the time, hardly privatized economy performing much better than Russia escaped most observers). The same policy was also the direct cause of the emergence of the so-called oligarch class, i.e., those people with access to capital and government power who acquired massive economic assets for peanuts in the name of privatization.

In most Third World countries SAPs had two serious consequences. One was the new class configuration: The middle classes collapsed under the weight of austerity measures. And a large portion of the working classes joined under classes, as trade unions were unable to hold on to social gains in a crisis setting. With state expenditures sharply reduced, even their rudimentary social safety nets disappeared. With high unemployment caused by a contracting economy, people had to accept all work and any wage with no possibility of bargaining.

The second was the rise of authoritarian rule as democratic governments were unable to implement those measure without forsaking re-election and they were also unable to contain popular unrest (see the section entitled "Global Protests Up To Early 2000s") triggered by increased poverty levels.

Yet, in those days, you couldn't utter a critical word about these theories (and their plainly disastrous consequences) without getting dismissed by the Very Serious People. They knew what they were doing and they kept telling you that short term pain was necessary for long term gains.

Structural Adjustment for Advanced Capitalism

Somehow what is happening in Europe and the US right now reminds me of those bright and bountiful days of SAPs.

Let's look at the parallels.

First off, we have the same tut tut attitude with all corporate media outlets telling us that in Europe, those lazy southerners were living beyond their means. (In the US, it is states vs other states, or as Michael Lewis quotes an analyst “Indiana is going to be like, ‘N.F.W. I’m bailing out New Jersey.’ ”).

We all heard of Greeks who retired at a ridiculously young age with full benefits and who never paid a cent in taxes all their lives. Or Spaniards, or Italians, or Portuguese, or [insert a nation here] taking advantage of their corrupt system. The fact that these exaggerated snapshots hardly reflect reality is besides the point. Just like the housing bubble and the 2008 financial crisis was blamed not on banksters who pushed money on anyone with a pulse but on poor people living beyond their means, this crisis was placed not on Goldman Sachs that pushed money on politicians but on the frail shoulders of a few lucky and lazy southerners.

Secondly, just like SAPs made no sense for their local economies, the proposed austerity measures make no economic sense for the indebted European countries. They will only push them into deeper recession and will remove any possibility of debt repayment. Don't take my word for it, take the word of this Nobel Laureate or this Nobel Laureate.

Alternatively, show me a single credible study that proves austerity leads to growth.

Yet, that is the only argument we hear these days.

Just look around to see the actual effects of these measures. In Spain, unemployment rose continuously this year with nearly half of its young people out of work. And it is expected to reach 22 percent, a record high:
In a sign of the challenge facing the new Spanish government, the number of people registered as 'out of work' hit 4.42 million at the end of December. That's the highest level since they first started collecting the figures in 1996, and will push the unemployment rate further above 22%.
In Greece the same rate is 18.4 percent and climbing. In fact, that number hides a much worse underemployment situation.
Nearly one-in-four Greek wage earners work illegally, without welfare. Nearly 10 percent of the country's 3.5 million private sector workers have taken salary cuts, and about half of the 537,000 new contracts signed from January to September were part-time or flexible, according to government figures.
In the same period, more than 42,000 full-time contracts were converted to part-time or other flexible forms of work, such as the four day week, from about 26,000 last year. (...)
Moreover, public sector wages are being cut between 20 and 30 percent. Pensions above 1,000 euros will be cut by 20 percent. Existing retirees aged under 55 will see their pension (above 1,000 euros) cut by 40 percent and now 40 years of service will be required for full pension benefits.

In Ireland, after two years of strict austerity measures, the economy continues to contract with unemployment remaining constant at around 14 percent. Of course that rate is not a reliable gauge as it hides the fact that there is a massive exodus from the Emerald Isle.
    (Incidentally, these news items about record unemployment coincided with reports from Germany that its unemployment rate fell to a record low, below seven percent.)

    Besides unemployment, manufacturing activity fell for five straight months in all Eurozone countries, signalling a general contraction. And the vast majority of leading economists predict a recession in 2012.

    Curiously, these clearly destructive austerity measures are accompanied by strict demands for wage reductions, extension of retirement age and massive rollbacks for any benefits that is part of the social safety nets. You can see the country-by-country arrangements here.

    These reductions do not make any sense either. They will almost certainly reduce consumption, shrink these economies and will push them down into a deflationary cycle. In theory, a wage reduction might be helpful in an export oriented economy, but none of these countries qualifies for that position. Everyone's favorite example, Greece illustrates this nicely.
    Some economists also question the wisdom of focusing on the minimum wage when only a fifth of Greece's 220 billion euro economy is geared toward exports, meaning the benefits of lower labor -- and therefore production -- costs may be limited.
    Collective bargaining rules, minimum wage limits and pension plans were modified in Greece, in Ireland, in Spain, in Italy and a number of other European countries.

    And no one asked why.

    Thirdly, just like the SAP's of yesteryear, these Eurozone countries are forced to sell their most prized assets. A recent newspaper article ordered that "Greece must sell off assets East-German style" and these were the items listed in that fire sale:
    • Selling stakes this year in the betting monopoly OPAP, the lender Hellenic Postbank, port operators Piraeus Port and Thessaloniki Port as well as Thessaloniki Water.
    • It has agreed to sell 10% of Hellenic Telecom to Deutsche Telekom for about 400m euros.
    • Next year, the government plans to sell stakes in Athens Water, refiner Hellenic Petroleum, electricity utility PPC, lender ATEbank as well as ports, airports, motorway concessions, state land and mining rights.
    Add to that the private sector companies I mentioned a couple of months ago, looking to buy profitable companies very cheaply by simply calling their bank credits, and you can see that Greece and the other countries caught in this dynamic are doomed.

    As I stated at the outset, the previous SAP countries all ended in poverty and their middle and working classes collapsed. And those countries that experienced these so called beneficial effects of SAPs almost always ended up with authoritarian governments.

    A New Europe?

    As Krugman explained recently, Germany's and GIIPS' economic requirements are fundamentally contradictory. For a one percent inflation in Germany, Spain has to suffer a 20 percent deflation.

    Yet, we are told that a new Europe with tighter fiscal integration based on Germany's priorities is the only way out of this crisis.

    This brings up three questions:

    One: if fiscal integration is done in a way to favor Germany's priorities, how will GIIPS survive the massive deflation this arrangement requires?

    Two: What kind of a Europe will the EU be if it is led by and modeled after a conservative Germany?

    Three: Can democratic governments survive these SAPs or will there be a major shift towards authoritarian measures to stifle the inevitable protest and dissent?

    The answers to these questions will be critical, not just for Europe but also for the US (which I could not discuss due to space constraints).

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