Alternative economic policies in Europe Pavia, April 24-25, 2015

1. Alternative economic policies in Europe Pavia, April 24-25, 2015 Annamaria Simonazzi and Andrea Ginzburg Core periphery relations in the Eurozone: a Southern European perspective The German-South Europe divide and the changing inter-regional (but intra-European) trade * * A. Simonazzi, A. Ginzburg, The interruption of industrialization in Southern Europe: a centre-periphery perspective *see also A. Simonazzi, A. Ginzburg, G. Nocella, Economic relations between Germany and Southern Europe, CJE, May 2013

2. Outline • The debate on the crisis • A long termperspective: the interruption of industrialisation of late-comercountries • Restructuring: core vs. periphery • The medium term: change in the core country’s model • Adjustmentpolicies: • Expansion of domesticdemand in the core • internaldevaluations in the peripery • productivestructurediversification (industrial policy)

3. At the origin of the crisis • a faulty EMU construction "without prior constitution of a unified polity and a common balance of payments, there is no monetary regime, established among the potential participants in EMU, that could be regarded as irrevocable” (Pivetti 1998) • based on a faulty theory Disregard for the differences in development across Member States: Countries differ only for their inflation preferences so that one size fits-all policy (price competitiveness) can suffice • Lack of a “fiscal” (that is, industrial) policy to reduce the differences in development

4. Germany’s current accounts with the Eurozone countries (€ billion) Source: Lehndorff (2012)

5. The euro crisis: a standard BP problem? Persistent German surpluses translate into persistent deficits of the euro periphery. Two different interpretations: 1. price effects-The ‘culture of stability’: German surpluses reflect its virtuous behaviour and periphery’s deficits their profligacy • Relative prices (and wages) must adjust (downwards)– Fiscal consolidation to obtain an internal devaluation 2. income effects- Fallacy of composition implicit in the internal devaluation export led strategy. German excess of S>I imply other European countries I>S • Productivity vs. competitiveness achieved by wage restraint • “current-account surpluses are as much a reflection of the economy’s domestic weakness as of its external strength” (Whyte, 2010). • German wages and prices must adjust (upwards): German internal demand: reflationary policy

6. Beyond the short run Two questions • Is the lack of price competitiveness of the periphery vis-à-vis Germany the real problem? And will a change in relative prices be enough to restore the equilibrium? • will a German reflation be sufficient to bring about an increase in periphery’s exports large enough to re-start growth?

7. Michael Best (2013) on product led competitiveness • “Productcompetitiveness, rooted in limited production capabilities”, is much more important than price competitiveness. • “The absence of the concepts of productive structure and product led competitiveness from public discourse and academic economic analysis deflects ‘growth’ policy away from its proper focus”. • “the evidence is abundant that peripheral economies suffer from a dearth of business enterprises that meet the performance standards required to compete and grow in the Single European Market”

8. The interruption of the industrialization process in the periphery: a long term perspective Late comers vs older industrialised countries • Fuà, Problems of Lagged Development in OECD Europe. A study of six countries, 1980 • technological gap, • the demonstration effect on consumption, • the challenge of competition from more developed countries • These differences translate into strong internal productivity differentials across industries and regions (‘dualism’), serious difficulties in providing regular employment to the potential labor supply, higher propensity to price instability and public deficits, and “a peculiar fragility of the balance of payments”.

9. Per-capita GDP at constant prices

10. Share of industrial employment in total employment

11. The service transition in Southern Europe: a case of “incomplete modernization” due to pre-modern traits? • According to Sapelli (1995), in Southern Europe , obstacles to the completion of the industrialization process would derive from the prevalence of cultural values and power systems based on status and clientelism, with respect to those based on contracts “typical of societies were market economy has prevailed. The Weberian capitalistic society is the ideal example. However this model has had little success in Southern Europe”. • But why the industrialization process started in the first place, and why the arrest took place precisely in the 1970s?

12. The 70s: the importance of market saturation in the major economies.. • Production for replacement: strong differentiation of brands, vertical differentiation, shortening of products life • competition in differentiated products • Selective cost competition: delocalisation of production phases (in the peripheries); OPT, increasingly assisted by ICT • ‘Services based’ sales strategy • Strong expansion of finance services • Pressure to deregulate capital movements

13. Winners and losers in restructuring: the core • The crises of the centre (for simplicity, here, Germany), lead to internal reorganizations of its production structure • In the centre we assist to a strong drive to reorganize a wide range of manufacturing and services operations. • The centre succeeds in strengthening its ability to stay in the market in the product-led competition thanks to processes of 'creative destruction’ and reconstruction, undertaken in the crisis with the support of industrial policies.

14. Winners and losers in restructuring: the periphery • Higher weight of sectors subject to stiffer competition of emerging economies (steel, shipyards, textiles). • Higher volatility of Foreign Investments • Premature liberalization • The restructuring of the core deeply affects the countries of the periphery. • Firms struggle to adapt to the new environment (dominated by deflation and quality competition) • They fall behind and, also as a consequence of their policies, implement what might be called a 'plain destruction' of their capabilities to create new products, market niches and markets.

15. The paradox of a “consumer society without a production base” (Fotopoulos, 1992) • The crisis opens a gap in aggregate demand, eventually filled with welfare and costruction expenditure: restructuring without industrialization • The 80s: welfare and debt led growth • Faced with the challenge of “expanding the development role of the state, by adopting a radical restructuring program” (Fotopoulos 1992), the governments of peripheral countries, confronted with a deep fall of private investment, withdrew, expanding instead the consumption function of the state, with the double objective to avoid a massive rise in unemployment and to reproduce the consumer society. • The ‘peripheral tertiarization’ based on construction and welfare finds increasing difficulties to reverse the hardships of a limited and dependent accumulation

16. Medium Period: three hypotheses to explain the periphery’s crisis Persistent disequilibria cannot be explained (solely) by price competition Changes in Germany’s economic model (since the mid ‘90s) • East-ward enlargement and trade diversion: the rise of trade in intermediate goods weakens the ties with Southern periphery • Quality of German foreign trade, and relation between imports and income distribution • The new German specialisation model is associated with the hollowing out of the productive fabric of the periphery industrial districts, big MNCs (Spain), but insufficient to activate links and ensure full employment and long-term sustainability Increasing skewness of the trade matrix within the euro zone

17. Restructuring of the German economic model a) labour market reforms • “core” export industries: corporative institutions • Other sectors: ‘orthodox’ labour (and welfare) policies • The result: increase in wage inequality and in working poor (higher share of low wages) • Increasing poverty rates

18. b) Changes in the direction and composition of trade: the rise of intermediate imports Delocalisation of German industry to the East: diversion of trade from the South. Low growth of the euro area did not help southern countries to diversify (contrary to the Eastern periphery)

19. Germany-Central Europe supply chains

20. Source: Stehrer, 2015

21. Spillover effects from a German expansion? • Should the core expand to help the periphery? Yes is this enough? no • Econometric results: public investment would benefit German growth, but only a much smaller effect would trickle down to peripheral countries • The pattern of growth matters: different components of demand have different spill-over effects across EU areas (e.g., exports vs. domestic demand) X-led growth favours CEEC, which are specialised in intermediate goods, much less Mediterranean countries, specialized in consumer goods a German domestic-demand expansion favours imports from a much larger geographical basis (imports of low quality Asian consumption goods)

22. Spillover effects of a German expansion It is true that more buoyant demand in Germany would help economic rebalancing in deficit countries through the direct and indirect effects but their export base is at the moment too narrow to sustain a development driven only by external demand A more fundamental objection: an export-led recovery would respond to the composition of imports (and the objectives) of the importing country, and the latters do not necessarily coincide with the ones needed for the development of the peripheral countries This policy risks to reproduce the same dependent development of the past decades

23. Quality of trade and price competitiveness • Domestic devaluations? • labour (and price) flexibility are unnecessary or counterproductive if the underlying problem stemmed not from price competitiveness but from "product competitiveness, rooted in limited production capabilities” • Ambiguity of aggregate price deflators: different price indexes lead to different measures of competitivenes (Bayoumi et al. 2011) • Price competitiveness implies homogeneity in the basket of X • Development is associated with diversification more than cost competitiveness

24. Indicators of real exchange rate: Italy 1995-2009

25. Product Complexity and Export composition Proxy for product complexity: diversification of the country’s X structure and ubiquity (an index of worldwide diffusion of the production) (Felipe and Kumar 2011) Share of world exports by complexity: Top 10 products Germany 12.24 Italy 1.40 Spain 0.23 Portugal 0.05 Greece 0.01

27. The Network of Trade in the Eurozone 1999 2008

28. “The persistent intellectual confusion between austerity and reform” (A. Sen) • Centre: industrial policy+ lower interest rates+ exchange rate devaluation • Periphery: Global Financial Crisis--Debt/Y • Austerity–(higher D/Y)lowerinvestment (private and public)hollowing out of the productivematrix--lowerresilience to the nextsystemiccrisis

29. The fiscal crisis increases the future divergence between core and periphery: the North-East/South-west divide