IFI governance


Is the European recovery finally under way?

13 October 2013 | Minutes

IMF/World Bank annual meetings 2013, Civil Society Forum

Saturday 12th October 2013



Mark Weisbrot, Center for Economic and Policy Research

Prakash Loungani, IMF Research Department

Chair: Aldo Caliari, Rethinking Bretton Woods Project

Copies of the presentations are available from the CEPR site.



Mark Weisbrot

The prolonged destructive impact of macroeconomic policy in Europe: Economic and Political Agendas

Europe remains biggest threat to the world economy, despite US issues

The IMF’s Article IV consultation with the Euro Area reveals a pessimistic view, and they appear to accept that austerity is a problem, and a pattern is of fizzling out where recoveries had appeared. This is also true of employment.

Inflation remains very low, its importance is in terms of the potential for expansion or even quantitative easing as has occurred in the US.

The only source of growth in the last couple of years is net exports, which is principally due to shrinking imports related to austerity.

This is important because the theory of the austerity is to achieve internal devaluation as countries within the Eurozone cannot devalue their currencies, they are basically forcing wages down via massive unemployment as has occurred in some countries, such as Spain, Greece and Portugal.

The attempt to force wages down hasn’t gone according to plan however — there hasn’t been a reallocation of resources from non-tradable to tradable industries, e.g. an export-led growth recovery.

The authors of the fiscal consolidation continues to promise recovery around the corner. The Fund appears to understand is reducing growth and employment.  They show that the output gap (difference between GDP and potential GDP)  and growth slowdown are  correlated fiscal tightening.

The IMF now projects in its latest World Economic Outlook -0.4% growth for the Euro area, and 0 for Europe; meanwhile the world’s growth projections from the Fund have been downgraded repeatedly.

The ILO estimates a record 202 million people could be unemployed by 2013. The IMF projections have been generally over-optimistic, especially true for Greece, and which has gotten progressively worse in terms of forecasting errors.

The decision-making is still not well understood, as the data is well known and not disputed. Austerity is not often defended, but the media is often complicit in representing austerity as being the result of no other possible choice. This choice is being made and is leading to millions of people not getting jobs.

What is really going on?

It is political, not the result of financial markets or debt dynamics, but rather a decision by decision makers in the Troika.

How do we know this is occurring deliberately? An important example: in summer 2012 Mario Draghi the head of the European Central Bank, following repeated crises, he said “we’ll do whatever it takes” and as a result he indicated a willingness to protect the Spanish and Italian bond markets. That’s all he had to do, and the acute part of the crisis ended after his commitment. Why didn’t he do that earlier?

Because the crisis was used to force through changes that people would never vote for.

A few quotations reveal this: “recoveries from economic crisis often serve as an opportunity for reform” taken from Spain’s Article IV consultation with the IMF in 2013. This is what they are doing. A member of the ECB Executive Board said a similar thing in September 2012, who insisted that it is “crucial to ensure that ECB decisions do not reduce pressure”.

They have now put an end to the recurring acute crises, but the austerity continues to inhibit recovery.

CEPR analysed 67 Article IV consultations with European Union states, and this agenda is evident in IMF documents even if they are the most dovish of the Troika lenders.

The pattern is about reducing spending and shrinking the size of government. Other policy issues tend to reduce social protections, reduce labour share of national income, which is probably part of the connection between austerity and income distribution found by Prakash Loungani in his research.

Fiscal consolidation was recommended to all EU countries, with a preference for cuts rather than tax increases. Despite increasing unemployment there were still reforms that would increase labour supply and downward pressure on wages regardless of whether the country had very high labour force participation rates.

Social Policy

Dividing into low-debt and high-debt states there was not much difference in policy recommendations, such as to cut pensions, reduce health care, education, benefits and so on.

In every single case pension spending was sought to be reduced, irrespective of life expectancy.


There is a political and ideological agenda that drives the Troika’s agenda in Europe, and has led to prolonged recession, stagnation, and high unemployment.

There are of course structural problems in the Eurozone that have been there from the beginning, given countries had different productivity levels and productivity growth rates and a common currency, as well as bubbles, which led to the crisis.  But that is not what has caused this prolonged economic crisis; nor has pressure from financial markets, which the ECB has shown that it can easily overwhelm.  Rather it has been the Troika’s strategy of using the crisis to force “reforms,” and the The U.S. was at the epicenter of the world economic crisis, but here the recession lasted only 18 months. That’s because unlike in Eurozone, there is some accountability for policy makers, the Fed (unlike the ECB) did its job, and politicians here would never be able to get away with the austerity imposed by the Troika.

This problem is political, a group of unaccountable officials, unelected and making decisions which people never voted for. Had Romney been elected or someone even more right wing, they would never attempt Eurozone policies as they would desire reelection. In Europe about 20 governments fell before Draghi committed to put an end to the threat of meltdown. This is a very slow-motion form of democracy, where the most important economic decisions are removed from the decision making of the voters.

One indicative fact shows the long-term damage in Spain.

The IMF is projecting 25.3 percent unemployment in Spain in 2018 but with very little output gap, e.g. Spain’s full employment level will be close to 25 per cent. This is their projection, an example of the long-term damage, which may not occur given the political un-palatability of these processes.

Some recovery may occur, as is evident from the numbers, which will be dependent on net exports and it will be determined by the world economy in the immediate future. Beyond that it will be political, as people have been pushed in some countries to the limit, e.g. Greece and Spain suffering huge political changes. Given the political difficulty of leaving the Euro, as Greece shows where even Syriza will not talk about leaving the Euro, despite possibly it being the case that they would be better off.

The former IMF economist Subramaniam has argued that the reason that the European authorities don’t want Greece to leave the euro, is that they are afraid that it would recover so quickly that other countries would want to leave.  We are at a political point, where it is very difficult to contemplate or say that leaving the Euro, not because many love the Euro though in specific contexts people conflate the Euro with the European Union, where the latter was more of an integration based on progressive inclusion. The Eurozone was different, it was from the beginning a neoliberal project and it was initially voted down in some countries. The severely regressive and anti-democratic nature of the Eurozone  was masked by the bubble growth prior to 2007, but now we see that it is in fact deadly for the majority, e.g. much like the gold standard

It is difficult for any politician to suggest leaving the Euro, since that may risk capital flight before ever being elected.

As a matter of economics, they’re going to have to either elect governments which refuse these conditions, or they’re going to have to elect governments which more slowly force the changes in the Troika. If the former, they would nevertheless be unlikely to be expelled from the Euro.

Without either of those approaches, there will be wasted lives and prolonged unemployment. There remain limits to the ability of the Troika to dismantle welfare state, but more regressive changes will result until you see a real removal of these conditions.

Given the focus on the IMF – though they are not the main actor – they are a significant influence, and there are evidently people within it who do not believe in what is occurring. However the European executive directors’ have dominant influence on European policy matters at the Fund.

Note the leaks documented by the Wall Street Journal last week, of the 2009 meeting, which decided to proceed along this path. The Swiss director indicated doubts, Brazilian director noted that risks are immense and that it would bailout Greece’s bankers and not the people.

Very marginal and limited success has occurred in altering the IMF’s voting structure, however that’s not enough. The WTO shows that this is not the only dimension, given the prejudice against interests of developing countries. Here developed states are receiving this treatment.

The reality is that blocs of countries have fought for their interests within the WTO, and successfully blocked many policies harmful to them. What will have to happen in the IMF is more of these fights, but they are going to have to be public as occurs in the WTO and blocs of governments, who do not wish to see the damage to the world economy that is caused by IMF policy.


Prakash Loungani

Three points to make.

The first is that fingers-crossed the recovery has arrived

Secondly, why it took so long via comparison of Europe to the Asian recovery from the Asian 1990s crisis, and this current global recovery to past global recessions

Third how to ensure the recovery keeps going.

What we have seen from the most recent data is a fragile recovery occurring in Europe, after nearly 2 years of recession, there is one quarter of growth and forecasts for next year is for positive growth. One quarter is not a recovery but at least it’s not negative.

Despite the real GDP turnaround, the labour market situation remains pretty dire and is coming down pretty slowly. Current projected growth will not do much to reduce growth. The human cost of unemployment is not just on people’s immediate earnings but also over lifetimes.

Unemployment impacts children’s economic attainment and health. The recovery should be judged not just on whether real GDP recovers but also if there is a dent in historically high unemployment.

The work I’ve done on growth and labour market developments does indicate hope for a little more optimism today than 6 months ago.

Why did it take so long?

When comparing how Sian crisis countries recovered, e.g. Thailand, Indonesia, Malaysia compared to European crisis countries including Greece, Portugal and Spain, two things jump out.

Firstly the Asian crisis countries had better fiscal positions. There was more fiscal space available for Asian crisis countries.

Secondly many European crisis countries have chosen to belong to a currency union so they do not have the option of currency devaluation. The reliance on internal devaluation has been painful and had mixed results.

Hence the fiscal position and the desire to belong to a currency union, but an unfortunate cost of wanting to be in a currency union is limiting the options when seeking to carry out adjustments.

Another way to consider the slowness of Europe’s recovery is to look at past recessions. The story is again of fiscal options being limited. Past global recessions and the period immediately after shows that fiscal policy remained accommodative through the period of the recovery.

Fiscal policy in this case initially appears to suggest that it was accommodative until 2010.

The pattern of what emerging versus advanced economies did, in emerging states the fiscal stimulus was maintained, probably as they had more room this time thanks to better policy actions prior to the crisis to build up buffers.

Hence, the summary of why the crisis is prolonged is ‘It’s mostly fiscal’, as the fiscal space was restrained, and exacerbated by there participation in a currency union.

How to keep recovery going?

The (overloaded) policy agenda includes:

  • Banking union (urged by the IMF) – such as the US represents domestically
  • Macro policies
    • Fiscal
    • Monetary
    • Labour market and structural policies

On fiscal policy the IMF was one of the first institutions to urge a stimulus, which may have staved off the next great depression. So why did in 2010 the environment change, and why did countries turn to more of a cautionary fiscal stance, and why did they move to austerity?

There are a variety of reasons, but several people examined debt levels and considered them excessively high. There were different views, within the IMF and within governments and other institutions. There was no conspiracy in 2010 to drive people to priorities addressing debt levels.

With hindsight, perhaps if the decisions had changed then there was the possibility that it would have played out better, but there was no conspiracy. The UK government is an example of a transparent commitment to address debt, which won the day electorally.

Many feel obviously that perhaps there could have been more stimulus, e.g. Paul Krugman, while others disagree, e.g. such as Ken Rogoff even disregarding the Rogoff & Reinhart work.

What the IMF has done, given its past record, is pretty commendable. Regarding fiscal consolidation, there has been no demand to be hasty in taking on a fiscal consolidation, except where there is no alternative. ‘The IMF has now begun to analyse the impact of austerity on inequality outcomes.

IMF advice on fiscal remains to not front-load fiscal consolidation and always to keep an eye on what occurs to growth. The Fund has been saying that fiscal consolidation lowers growth, its’ a simple question of multipliers.

On monetary policy, we agree with Mark and Draghi’s statement clearly changed the environment in markets. More could be done, e.g. the ECB providing more forward guidance, e.g. US-style statements relating to commitments to support the economy relating to unemployment levels, or indeed monetary easing.

A complication is that European monetary policy is influenced by what the US chooses to do, as we saw when Bernanke made that tapering statement in May the yields in Europe on bonds also rose. Europe is somewhat dependent on the US making the right moves, and the forward guidance remains central.

Monetary policy is one example, the other that relates to Europe’s recovery is the potential for net exports to increase. Their hope going forward is for an export rebound, but a slowdown in emerging markets – as the IMF and others are projecting – that would also take away some of the growth that Europe’s growth was counting on.

Getting macro right will help labour markets.

Perhaps labour market flexibility has been considered a solution to all problems, but we have gone beyond this to make two points.

Labour markets require macro policy to be right, including banking union and monetary policy. Some changes in the labour market will be necessary, and we’ve thought about what flexibility is needed?

Micro-flexibility – the ability to move labour across sectors – is needed, but how? Not by giving all power to firms, nor indeed all power to workers. A system is needed to permit reallocation of workers while protecting them. This requires employment protection and insurance, combining them to enable micro-flexibility.

By and large Europe has gotten this right; a huge change is not needed in the structure of institutions, however they appear to have gone somewhat too far in terms of protection, as is the case in Portugal. We recommended a cut in employment insurance to bring about reallocation.

The other flexibility is macro, e.g. the ability to respond to shocks such as occurred with oil prices historically.

Here we began recommending that wage or employment changes should be conducted through social pacts, to determine who the burden should be shared between wages or employment costs.

Where there has not been an existing social pact, the Fund has recommended changes usually as temporary fixes, such as the op-tout clauses advocated by the Fund in Greece.

Will this all restore growth? Let’s hope so.

Response by Mark Weisbrot

Is the recovery here? Given further fiscal consolidation is to occur, though possible it really depends on what happens in the world economy, since austerity will keep domestic demand weak, so Eurozone recovery is really dependent on external demand.

The comparison to the Asian crisis and past recessions regarding policy space is wrong.  In fact, the opposite is true:  it is the emerging market countries that are constrained.  They have serious balance of payments constraints, since they can’t come too close to running out of hard currency reserves.  The ECB has a hard currency and could have created all the fiscal space they wanted through quantitative easing, as the Fed did.  They just didn’t want to do it, for political reasons.  Even though the  Congress and executive did not take full advantage of the Fed’s QE to spend more money, they could have done much more, but they still did not engage in the kind of austerity that we saw in the Eurozone.


Regarding labour market policies – the IMF has according to its article IV consultations advocated uniformly reducing labour market protections.

Prakash Loungani, Response

The ideas that the recovery is hostage to the rest of the world is not the most important thing, as recovery could be driven by domestic decisions. On monetary policy we are perhaps in agreement, the ECB statement could have come earlier.

The main issue is whether there was fiscal space, without repeating the arguments, perhaps not everybody had the courage of the convictions.

On labour market policies the CEPR paper is the kind of scrutiny the IMF should get, and we are now scrutinizing your paper. Our view is that our recommendations were not always so one-sided, including raising minimum wages or extending employment insurance. We are doing the same analysis that you are, by checking our positions against the article IVs.