IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
It is summertime and everyone is happy to take a brake from what has been a terribly tormented spring. Many of our European politicians and policy advisers (IMF) feel satisfied—or at least claim to be—that they have done the right thing and kept the boat afloat. Now, they say, we just have to consolidate the job to make sure that a new big financial crisis, spurred by disastrous public finance in many EU countries, will not blow in our faces.
The “stress test” imposed to the largest banks in the EU is part of that consolidation. It is also part of a new myth rapidly spreading: the market can’t value correctly the balance sheet of a company and, following an initiative of our politicians, we will finally know which banks are in good health (84 out of 91 tested) and which ones need—let’s bet that this will be the conclusion—a hand from the Member States in order to avoid the risk of a new “systemic” crisis.
If we are suspicious of the conclusions provided by those “stress tests”, we must however congratulate our politicians for indirectly admitting that the situation is stressing! For the bail out plans set up in the spring are far from solving the problems and, indeed, it is stressing to live with such a sword of Damocles over our heads. What will happen if the situation in Greece, Portugal, Spain, Italy and now Hungary is not improving fast? Difficult, even for the market, to predict what the issue could be. And I doubt that the experts who run the “stress test” know much more than the individuals who will potentially lose all their wealth in a new crisis.
So, instead of running dubious “stress tests”, we should be asking ourselves whether the emergency plan decided in May and June should not be supplemented by—or replaced with—a true change of policy that would place Greece and the EU on a more promising route.
In a recent piece publish in the Wall Street Journal Europe, the economist, Steve Hanke from The Johns Hopkins University and Cato Institute suggests that Greece follow the route taken by New Zealand in the eighties.
In 1984, a labour government was elected in New Zealand to succeed a National Party that had piled up disastrous and ruinous policies. What Roger Douglas and his team did then was not to impose an austerity plan à la Papandreou but a radical change; a supply-side “big bang”.
Greece could do the same and Steve Hanke presents what could be the main pillars of a Greek Big Bang. First, reschedule the debt. Second, eliminate employers’ contribution to the payroll taxes (currently 28% of wages). Third, eliminate the two preferential VAT rates to keep only the “normal” one that could be slightly lowered from its actual 23% level. As a result, Greece competitiveness will be greatly increased; savings will increase, and if consumption will drop, so will the debt.
Being a renown specialist in monetary policy, Steve Hanke also points out that such a policy would be much more effective than getting out of the Euro and devaluating the Greek currency. This last scenario is likely to be, unfortunately, the second best scenario of many political leaders.
So, as they are about to enjoy what they take to be well deserved vacations, our leaders should not be hypnotised by the result of the “stress tests” that tell us that most European banks are safe. They should instead reflect on the policies that enable countries such as New Zealand or Ireland to avoid bankruptcy in the past by introducing pro-market reforms. Those experiences teach us that austerity, if sometimes necessary, is not the panacea. What needs to be done is to stimulate wealth creation with a stable money, lower tax rates and more open markets.