IREF has asked its scientific director, prof. Enrico Colombatto (Turin) to provide a periodic update on EU regulations. Policies adopted by Brussels in 2012 did not help to surmount the crisis: what will happen in 2013?
2012 has been a crucial year for the European economic context. In retrospect, two major features stand out. First, the EU authorities have insisted on requiring austerity measures from most member countries and have been explicit about their intention to bail out financial actors – mainly banks – that might trigger a systemic crisis. Second, regulation has been identified as the long-term solution to the weaknesses revealed by the crisis that has been affecting the US and the European area for the past four years.
As a result of this mix – austerity and promises – financial markets have rebounded. Yet, although public opinion feels that the worst is behind, opinion polls do not show that the public at large basks in optimism. Let us briefly examine why.
We have mentioned that the key word in most EU troubled countries has been and continues to be austerity. This means more than meets the eye. After years of benevolent and guilty neglect towards the repeated violations of the Maastricht criteria with regard to the prescribed Government Debt/GDP and Deficit/GDP ratios, the European Commission has asked domestic policy-makers to stabilize their debt levels and bring about balanced budgets. Given the inability and the unwillingness to reduce expenditure significantly, this budgetary recommendation has de facto led to substantial increases in taxation. There is no indication that this trend is going to be reversed in 2013, a year in which the new tax laws passed in 2012 will hit most European taxpayers.
Not surprisingly, high taxation, high public expenditure and exceedingly heavy regulation have had negative effects on growth, which has been disappointing during the past year (-0.6% in the euro area) and does not seem to be much higher in 2013 (about +0.2%, according to most predictions). Put differently, and despite the fact that austerity has failed to lift Europe out of the crisis, during 2013 the euro area will still continue to focus on trying to fix the national budgets by taxing income and wealth. Perhaps the authorities will justify the extra tax pressure by pretending that the rich will be squeezed more than the poor. The truth, however, is that there are not enough rich taxpayers to hit, that the burden will be borne by the middle class, that growth is unlikely to take off without a prosperous and motivated middle class able to spend, and that the crisis will not be solved unless robust growth resumes. Bailing out governments and banks will not accomplish this.
The world stage has also witnessed the gradual weakening of the role played by the International Monetary Fund. During 2011 and 2012, the IMF was called upon to legitimize local policies, such as austerity and expansionary monetary policy in order to finance national debts. Yet, the past twelve months have made clear that most IMF members are unwilling to contribute extra resources to the agency headed by Mme. Lagarde. Perhaps the IMF could have more responsibilities in the developing world, but nobody doubts that in the past months the European Union has obtained undisputed control of European matters. Rather than an activist IMF in Europe, one may anticipate tensions within the Union: between the European Commission, which longs to acquire a more active role in regulation and budgetary policy, and the European Central Bank, which might have second thoughts about and expansionary monetary policy and come up with good reasons to stop printing money.
In other words, more emphasis will be drawn to the inflationary consequences of its past action: although the proportional increase in the general price level is still moderate (in Europe it was around 2.7% in 2012) and the European Commission predicts a slowdown to 2% in 2013 and to 1.8% in 2014, we believe that the rate of inflation might not decline at all, especially if financial markets stabilize and individuals/investors are less inclined to stay liquid. If we are right, stagflation would no longer be a remote possibility.
In the end, tensions might evaporate if the ECB tightens its grip on the banking sector (regulation and supervisions of the too-big-to-fail players should be operational as of spring 2014 and their acceptance will be a pre-condition for a bail-out guarantee), and if the Commission takes responsibility for providing budgetary “guidelines” and stultifying tax competition. Yet, the two components are interdependent and too much encroachment upon national sovereignty might stoke populist reactions and lead to additional volatility in financial markets.
The past twelve months have also been characterized by the widespread ambiguities in the banking world. The crisis has highlighted the fact that most troubled banks had been neglecting their basic role – transforming short-terms deposits into long-terms loans to productive borrowers – to the benefit of something rather different: turning short-term deposits into debt-financed government expenditure. True, 2012 has brought about growing awareness of the inadequacies of the Basel agreements and standards. Regulation is no longer regarded as a magic wand. Yet, it is unlikely that 2013 will address the fundamental issue: banks’ major business should not consist in financing government debt and more onerous capital requirements do little to change the picture. Rather, these requirements will lead to fewer funds for the world of production, an issue that has already led to revising the timing for the introduction of the new rules (mainly to the benefit of the large-size banks).
Second thoughts on banking regulation would of course be welcome, because banks should operate to meet the preferences of their clients, rather than of politician and bureaucrats; and because bureaucrats are not necessarily better than bankers. Be that as it may, second thoughts have emerged and have been widely reported in the press. Yet, their presence also shows that they can easily become the object of negotiation. This could be interpreted as a sign of weakness and does not bode well for stability, one of the mainstays of a market economy. Moreover, the idea that regulation is up to political negotiation adds to the persisting ambiguities of the present accounting practices (the so-called International Financial Reporting Standards), which have been criticized as deeply flawed and have prompted the EC to announce (tardive) investigation. Truthful accounting is of course welcome, but past experiences in this field suggest prudence. It would be regrettable if the efforts to attain greater transparency led to more intensive bureaucratic interference with the working of a market economy.