Economic Interests

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Archive for the month “February, 2013”

The Myth of Successful Eurozone Austerity: Estonia

People seeking to rebut stimulus proposals often point to the example of small Baltic republic Estonia. This is the only Eurozone country to have deleveraged significantly enough to be called “Austerian”. Estonian Government Debt went from 7.2 percent to 6 percent of GDP, a remarkably high decrease. It also has a growth rate of 8%, not only one of the highest in the Eurozone, but also unique in the world.

Austerity Advocates also seem to have their private-sector oriented rationale vindicated. Estonia is a strong producer of entrepreneurs, notably including the creation of the worldwide internet calling sensation, Skype. They are also unhindered by government bureaucracy, red tape, etc. Therefore,this should surely be an example which indicates the efficacy and the desirability of austerity policies.

However, there are several chinks in the armor of that explanation. Firstly, Estonia made significant use of EU Structural Funds, borrowing 3.4 billion Euros (approximately 20% of Estonian GDP in 2011) during the years 2007-13. Now, in whichever way the government uses this money, it is effectively a Keynesian demand-side solution. In the Estonian case, however, the funds are supposed to be used to create more jobs in the entrepreneurial sector.This would therefore increase real incomes, therefore increasing consumer spending, pushing the economy forward.

Now, there are people who argue that Government spending does not push the Economy Forward. In the case of Estonia, however, it undoubtedly did do so. Historically, from 1995 until 2012, Estonia GDP Growth Rate averaged 11.6%, reaching an all time high of 4.80 Percent in March of 2000 and a record low of -5.90 Percent in December of 2008. The Estonian Economy began recovering at the start of 2009. Funnily enough, Government Spending began to kick in at the end of 2008, a month or two around the trough of the recession. Considering that Government initatives have a month or two to take effect, Estonia’s boom is more coordinated with a rise in Government Spending.

Second of all, Estonia is more export driven than any other Eurozone Economy, with 98% of it’s 2011 GDP coming from Exports of Goods and Services.This naturally means it is more dependent on foreign demand than any other of its European neighbors. One can conclude that largest catalyst that made these austerity measures work, was Estonian’s willingness to take on the hard measures needed to adopt these “belt-tightening” policies. For example, civil servants in Estonia took a 10% pay cut and ministers aswell saw 20% of their income cut. Pension age was raised, benefits cut, and job protection reduced, which points out that Estonia has unanimously accepted that times of lavish spending has finished, even the finance minister of Estonia has said that the people “understood they had to give up something”.

By Amogh Sahu & Frederick Jordaan at


Was the Euro Doomed from the Start? (Essay from my graduation year of university last year)

The European Union (EU), an economic union between 27 member states in Europe, has recently suffered its first serious setback since its creation, termed as the “Euro Crisis”. Various members of the eurozone have been found to have serious debt problems which have affected the rest of the EU as they all share a single currency, the euro. But as Verhofstadt (2011), the former Belgian prime minister said “A state can exist without a currency, but a currency cannot exist without a state”. In this essay, I will discuss whether the euro was in fact doomed from the start from structural and unforeseen problems. First a short history of the euro will fill in any background information for this essay. Then the problems that will be considered are; the monetary policy problems, fiscal policy problems, a lack of preparation for any crisis, the lack of a real political union and a lack of equality throughout the EU. I will also explain reasons why the EU has been beneficial to its members including; the growth experienced before the crisis and the safety net the EU provided for the now failing economies in eurozone. The Mundell Fleming model will also be used to help show the different effects of both fiscal and monetary policies.

The euro first came into existence in 1999, though the physical representation of the money wasn’t fully circulated until 2002. Important institutions for the EU are; the European Commission, the European Council, the Court of Justice of the EU and the European Central Bank which decide important decisions within the EU like legislation, European law and interest rates for the eurozone. Entry into the EU was regulated by the Maastricht treaty which stated any nation that wished to enter must pass certain fiscal criteria; inflation must not be 1.5% higher than the average of the three best performers, the budget deficit must not exceed 3% of GDP, government debt to GDP ratio must not rise above 60%, long term interest rates could not be 2% higher than the three lowest members and the applicant should have mirrored the domestic currency to the euro for two years without devaluating currency. Greece famously did not originally meet these criteria and weren’t allowed to join until later on, while the UK and Denmark decided against adopting the euro currency. In 2004, the eurozone expanded to include smaller nations like Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia and then in 2007 Bulgaria and Romania. Out of these nations only Slovenia, Cyprus, Malta, Slovakia and Estonia adopted the euro currency, while the other nations faced difficulties adjusting. Then in 2007/2008 there was a global financial crisis that pushed the eurozone into its first official recession in the third quarter of 2008, experiencing negative growth in the second, third and fourth quarters of 2008 and then into the first quarter of 2009. Greece suffered a crisis in confidence as international creditors started to doubt their ability to repay the huge debts they had acquired; with the debt to GDP ratio at a staggering 159% of GDP. This meant the eurozone countries along with the IMF had to bail out the country for the first time in May 2010, totalling €110 billion. This was followed by a second bailout this year of another €130 billion to help the country finance itself, while other countries like Ireland have also had to be bailed out. This has lead to a new European Fiscal Compact to be created that enforces nations to adhere to fiscal stability. This states that national budgets must either be in balance or surplus, otherwise punishments of fines of 0.1% of GDP and the loss of some of the countries fiscal sovereignty can be used.

The first fundamental problem with the euro was that it was expected a single monetary policy for all the countries would work. The monetary policy, which controls the supply of money into a country by targeting interest rates, is controlled by the European Central Bank (ECB) in the eurozone. This means every country in the eurozone has to operate under the same interest rates, despite the massive differences between the economies of the central countries (Germany, France) and the periphery countries (Greece, Spain). Andre Szasz, a retired Dutch central banker, supports this argument, suggesting it was a mistake to have “a monetary policy of one size fits all” as interest rates will be “too low” for some countries and “too high” for others.  This makes sense, as a country like Germany which produces a lot would be inclined to target low interest rates while a country like Greece which doesn’t produce enough would have higher interest rates. This led to the periphery states like Spain, Portugal and Greece being able to exploit the low interest rates that would not have been possible without being part of the euro. These low interest rates meant poorer countries could borrow money easily from international investors, not a big problem by itself, but when mixed with low productivity it encouraged nations to spend more money than they were making. This has lead to these nations building up vast amounts of debt that they cannot realistically pay back and with the financial crisis making credit scarce, these countries are finding it hard to obtain the loans they once found easy, with Portugal, Ireland and Greece being given junk credit status by credit rating agencies. This mass borrowing by the periphery nations (and Ireland) was good news for the central countries, especially Germany, as it meant new possible customers for their exports financed using money loaned from the richer nations like Germany: A vicious cycle. Zemanek (2010) supports this stating “Germany has experienced rising trade surpluses against the euro area countries starting from 2002 up to the recent crisis… other countries have large current account deficits, thereby accumulating increasing stocks of international debt”.

Bayumi and Eichengreen (1992) argued that the European monetary union could not be an optimum currency union. An optimum currency union is a region where a single currency would maximise economic efficiency, satisfying the criteria of; labour mobility, capital mobility, price and wage flexibility, fiscal transfers and similar business cycles. It is argued that the eurozone does not have price and wage flexibility, fiscal transfers or labour flexibility. Issing (2000) supported the lack of this last quality, arguing “dangers can be identified relatively easily. The most obvious one is the lack of flexibility in the labour union… this poses an almost lethal threat to monetary union”. A single monetary policy also meant individual countries couldn’t de-value their currency by printing. When the financial crisis hit, countries like the UK and USA were able to devalue their currency by printing more money, this helps boost exports and stop imports and can be an important tool in restructuring a countries economy. But countries like Greece and Portugal within the EU don’t have that option and therefore the only way to restructure their economy is through internal austerity; cutting wages and spending.  The Federal Union (2011) wrote “British government borrowing grew from 29.7% of GDP in 2002 to 36.5% in 2008… Since August 2007, the pound has lost 20 percent of its value against the euro”  showing the UK was fiscally irresponsible as well, but that they had the ability to de-value their currency and boost exports and therefore not have to adhere to severe austerity policies like their EU counterparts.

The second fundamental problem of the euro was the fiscal policy of the EU. In contrast to the monetary policy of the EU, each nation has a separate fiscal policy which leaves a very mixed economic structure for the EU. The fiscal policy refers to the government expenditure (e.g. new roads) and the collection of revenue (taxes) which affects the economy of the country. White (2011) suggested that it was “impossible to completely separate fiscal policy from monetary policy as central banks can prop up government bond prices by monetising debt” meaning the central banks of countries can buy up the debt of the country (though it is illegal to directly buy the debt, it can easily be bypassed) to help increase the supply of money, therefore affecting the monetary policy.

The Mundell-Fleming model (an adaptation on the IS-LM model) helps shows the relationship between a country’s interest rates, output and nominal exchange rates. The model argues that a country cannot simultaneously achieve a fixed exchange rate, free capital movement and an independent monetary policy. The EU for example has flexible exchange rates and instead decides to target interest rates and free capital movement. The model shows; the IS curve: Output = Consumption + Investment + Government Spending + Net Exports, the LM curve: Money supply/Price = Liquidity preference (Interest rates, Output) and the Balance of Payments curve: Current accounts (Net Exports) + Capital accounts (Cash Flow). The EU uses flexible exchange rates, which means the European Central Bank allows exchange rates to be determined by market forces alone. With flexible exchanges rates, the central bank can increase the supply of money to try and boost the economy (Monetary change). This causes the LM curve to shift to the right, thereby increasing output and lowering the domestic interest rate in comparison to the global interest rate. This depreciates the local currency, making local goods more attractive and thereby increasing net exports. Increasing net exports shifts the IS curve to the right as well, up until the point where the balance of payment is equal again and the domestic exchange rate equals the global interest rate. But while this returns to normal, the GDP increases once again, meaning any increase in the money supply doesn’t have an effect on interest rates in the long term, but does increase the GDP of the country and vice versa for a decrease in the supply of money. The European Central Bank increases money supply through Quantitative easing, where it prints more euros for all the countries to help boost the economies that are underperforming. Too much quantitative easing can be bad for the economy, leading to a poorer standard of living, bad reputation with foreign markets and even the risk of hyperinflation, while the ECB has to try and balance out whether quantitative easing would benefit all the countries in the eurozone. Another option with flexible exchange rates is to increase government spending (fiscal change), this causes the IS curve shifts to the right, causing an increase in GDP and in the domestic interest rates compared to global interest rates. This leads to the currency appreciating, making foreign goods more appealing and decreasing net exports. This shifts the IS curve back to its original position where domestic interest rates are equal to global interest rates and has no impact on the LM curve. This means if there is perfect capital mobility, then an increase in government spending has no impact on GDP and vice versa with cuts in spending. This shows that both the fiscal and monetary policy are integrated and cannot just be separated like the EU have tried to do with the euro.

A fiscal change with floating exchange rates graph shows what happens when government spending is increased (or taxes are decreased). A monetary expansion with floating exchange rates shows what happens when the supply of money is increased.

The EU also had to make an assumption that with interest rates fixed and a single currency, each country would be fiscally responsible. That assumption was proven badly wrong, as a lot of countries used low interest rates to borrow irresponsibly without having the output to support such loans and built up uncontrollable amounts of debt. Marian Tupy (Legatum Institute) argued that “Greece’s membership in the eurozone allowed the Greek government to borrow at lower interest rates, and thereby enabled its overspending” showing the allure the EU created for poorer nations to borrow beyond their means.  A new fiscal compact has recently been agreed between the countries in Europe (as described previously), with the UK and Czech Republic notably opting out of the treaty, which has the aim of stopping states running huge debts. This new fiscal compact shows an original problem with the structure of the EU, that regulation of fiscal activity in the eurozone was too relaxed. Dominguez (2006) came to this conclusion in her paper, writing “In 2000, one year after the euro was launched, five of the eleven countries in the eurozone were in violation of the public debt rule”, she then added “In 2005, the three largest eurozone economies – France, Germany and Italy – were out of compliance with both the budget deficit and public debt rules”.

Another fundamental problem with the euro was that it seemed totally unprepared for a crisis. As the Economist captured perfectly “the designers of the good ship euro wanted to create the greatest liner of the age. But as everybody knows, it was fit only for fair-weather sailing, with an anarchic crew and no life boats”. The European central banks main purpose was to keep inflation low, not deal with any potential credit problems which it had neither the financial nor political power to accomplish.  David Cameron (British Prime Minister) argued that successful currency unions have a lender of last resort, fiscal transfers, collective debt, economic integration and flexibility to deal with shocks, suggesting “currently it’s not that the eurozone doesn’t have all of these, it’s that it doesn’t have any of these”. Looking at the EU structure, it is easy to see what he is saying; countries are unable to transfer funds to struggling regions (e.g. Germany couldn’t transfer funds to Greece), debt is split unequally between different countries despite all using the same monetary policy, economies are kept largely separate with trade barriers still existing and there is absolutely no flexibility to deal with shocks as the financial crisis showed. Stelzer (2012) wrote ”Nor does Europe have a seamless method of transferring income from flush to stricken areas. America does: cash flows automatically to troubled states with falling tax receipts and rising welfare costs, from states doing better” which shows the one reason how America have been able to bounce back faster than the eurozone, because they have been able to transfer funds to poorer regions and have spread the debt collectively over all the states. But the most important of these factors is arguably having a lender of last resort, some sort of institution that can bail out the government if they can’t pay its debt. The USA has this in the form of the Federal Reserve, which can provide funds for any of the states if they require it. One of the main problems of the euro crisis was a lack of liquidity; this should have been the role of the European Central Bank as a lender of last resort. Instead the EU had a rule of no bail outs, relying on markets to keep a government from acting fiscally irresponsible, which has now backfired as the EU has hurriedly created a rescue fund to help solve a liquidity time bomb. The rescue fund created has little use however as it is massively underfunded, unable to bail-out a country the size of Italy for example. Without the ability to bail out countries, the EU could break up, a topic politically avoided. Ulrike Guerat of the European Council on foreign relations expresses fear in his paper that rather like the Soviet Union, the EU would go down quickly if the euro started to break up, showing a general worry that if a country like Greece (in the worst condition in the eurozone) defaults on its debt and leaves the euro, it could have a domino effect on the rest of the EU, with Portugal and Ireland very vulnerable to any shocks in the market.

An additional structural problem with the euro was that there wasn’t a political union. George Soros (2011) stated “the euro is a flawed construct “by which he meant the euro needed a stronger political union behind it. He then went on to suggest a single-pan European Union welfare state would allow for the creation of one fiscal and monetary policy for all of Europe. The EU faces constant bickering from different members over different policies, and struggles to achieve a united front at times. One such example was with foreign policy, where the UK and France agreed to intervene in the conflict in Libya, while Germany decided against joining in, showing that a conflict in interests can divide the eurozone. The United States of America is a good body to compare the European Union to as it shows the difference of being united politically. The Economist supports this argument, stating “America created political union followed by a fiscal union. But Europe is doing things backwards, creating the euro in hope of fostering political union”. EU policy has long been seen as being dominated by the central nations, with Germany suggested as having a lot of sway in the decision making process. This has stemmed from EU policy benefitting Germany before the crisis; as a weak currency meant they could export their goods more easily and low inflation was suggested to be focused on strongly because of German fear of hyperinflation, indeed the European Central Bank’s main policy is to control inflation.  This has been resented by the periphery nations which feel they are not represented in EU policies. The EU parliament has long been an institution with little power, with the economist describing it well, suggesting they measure “themselves against America’s congress without having its means” meaning that unlike Congress, they have little sway in uniting different countries inside the eurozone and although it can decide how to spend the EU money, it cannot dictate how it is raised. The EU parliament gained mores powers in 2009 after the Lisbon Treaty to monitor national budgets but any decisions have to be debated between two other bodies; the European Commission and the Council of Ministers while all the major topics like education and health are decided by national governments. This sort of system keeps the different nations separate and makes decision making a long and tedious process. The German Chancellor, Angela Merkel, has spoken of a potential “political union” for the EU with a strong parliament, showing the lack of one originally has been realised as a mistake by the leading figures of the EU.

The final structural problem found with the euro was the lack of equality throughout the EU. There is a vast difference between the economies of the central nations and the economies of the periphery nations. Germany has been a highly competitive saving nation since the euro’s creation whiles the “PIIGS” countries (Portugal, Italy, Ireland, Greece and Spain) were the complete opposite; uncompetitive in production and too reliant on credit to finance themselves. This meant the capital flowing into these countries created a wage boom which saw wage growth rise above productivity growth, while Germany’s wage growth remained moderate meaning they could remain competitive over their rivals. A rigid labour market meant that when the financial crisis hit, real wages couldn’t adjust quickly enough in the periphery states, which coupled with an inability to devalue their currency led to a deep recession for these countries. Rogoff (2012) argued that the lack of labour mobility in the euro was a big problem, suggesting “if intra-eurozone mobility were anything like Mundell’s ideal, today we would not be seeing 25% unemployment in Spain while Germany’s unemployment rate is below 7%” meaning the eurozone is not one of Mundell’s optimal currency areas. Zemanek (2010) produced some facts, saying “while Germany and Austria broadly kept unit labour costs at the level of 1999. In Iceland, Portugal, Spain, Greece, Italy and the Netherlands unit labour costs have increased significantly – by up to 30% compared with 1999” showing how competitive Germany had become compared with most other countries. This inequality throughout the eurozone has destabilised the EU, leading to hugely contrasting current accounts; with Germany having a big surplus and Greece having a large deficit.

We can use the idea of an optimal allocation to show the problems with inequality in the eurozone. An allocation (consumption of an individual in an economy) is only an optimal allocation if it is both efficient and equitable. We can judge efficiency by using the idea of Pareto efficiency: that no-one can be better off without making another individual worse off. A lot of allocations can be pareto efficient but still be unfair however, for example if one person has 7 apples and another 3 this would be considered pareto efficient. To make the allocation equitable, it needs to maximise social welfare (benefit society). A good model to show this is the Utilitarian model, which shows an economy of two individuals, where a UPF curve shows the pareto efficient utilities of both consumers and the social welfare function curve shows the point on the previous curve where the allocation is both pareto efficient and equitable. In the case of the EU, the redistribution of endowments in the market is the responsibility of the EU government and they haven’t done this effectively, as the imbalances between different countries shows. Germany is highly productive, export more than they import and have high employment, this is in contrast with Greece where they import more than they export, have high unemployment and have low productivity. The EU needs to fix these sorts of problems, where jobs are available in some areas of the eurozone and non-existent in others. They could do this by producing more public sector jobs in areas that have low unemployment or improving infrastructure to attract private industry, but this will be hard as countries in the eurozone still have individual governments (not in the EU’s power) and political mistrust between countries will interfere in the sharing of resources e.g. Germany are unlikely to agree with strengthening their rivals in the market. A more unified European Union, as discussed in earlier points, in the shape of a real political union could help different countries become more equal in the EU.

Map showing the different debt to GDP ratios of the countries in the eurozone. This shows the contrasting levels of debt in the eurozone; with Greece, Italy, Portugal and Ireland in much worse positions than France and Germany. This inequality is bad for the EU and a collective measure of the debt would help sort out these issues. (Economist, 2011).

However, it cannot be said that the euro was all bad. Most of the countries that joined the EU experienced big growth in the period up to the crisis. Yannos Papantoniou (2011) found that in the years 1999-2008 compared to 1989-1998, the eurozone countries experienced; 1% lower unemployment, 1.1% lower inflation and GDP growth of at least 5% each year (excluding 2003). The periphery nations like Spain and Greece experienced big economic growth (with Greece growing larger than the eurozone in 2003) which has seen their standard of living for their people improve greatly. During this period life was good for those nations, despite it being financed by debt, and their business sectors and infrastructure were upgraded in the process.  Having the same currency also meant countries could trade with each other much easier without the need for different exchange rates. The euro has benefited businesses in Germany and France (whose main customers were in Europe) and tourism for countries like Greece and Spain (whose economies rely on this sector) as there were no longer any transaction costs for each country and made prices in each country relatively equal and transparent. Also it is comparable to look at Iceland who possesses a single currency and has had troubles with volatile exchange rates due to changes in the market. This shows the problems that each country could still be facing if they hadn’t been part of the euro; highly vulnerable to any changes in the world market like rises in oil prices or commodity prices. Papantoniou (2011) supports this stating “the growth of output seems to have been stabilised in the euro area since the end of the 1990’s. Although the eurozone has not been the only area enjoying this decline in volatility of output growth, the convergence of economic policies of the eurozone countries coupled with a steady monetary policy of the ECB in its response to major events, such as the global economic downturn in the early 2000’s”. By employing data over 1982-2002, De Sousa and Lochard (2005) found that the euro has raised flows of foreign direct investment within the euro area by 62%.

Another benefit of the euro has been the safety net that each nation in the eurozone now possesses. Since the euro crisis, Greece and Ireland have had to be bailed out by the EU and IMF, this wouldn’t have happened had they not been part of this union that they can fall back on. The EU can’t afford to let any nation default as it could trigger a domino effect, so all the countries in the eurozone will continue to help bailout any countries in need to stop another crisis. Also, though countries like the UK do have the option of de-valuing their currency that members of the euro don’t have, it does have negative effects. The Federal Union website supports this stating “devaluation leads to reduced living standards, higher inflation and creditors deprived of full repayments abroad” with the last factor leading to countries losing their credible reputation with foreign investors. White (2011) reiterated this stating “For the citizens of an open economy who want to enjoy cross-border trade and investment, and want to have a trustworthy currency, the option of their central bank to devalue carries a near zero or even negative value, while the benefits of membership in a common currency area are important and positive”. He went on to suggest “The euro has so far held its value better than the drachma or the lira or the peseta used to” meaning the countries in the eurozone could have been much worse off had they not shared a currency and seen their economies lose their value. Tilford (2012) suggests that the EU compares favourably with its rivals, stating “Eurozone members as a whole … have a lower budget deficit than the US and the United Kingdom, and a similar level of public debt. Unlike the US and the UK, the eurozone in aggregate is running a current-account surplus” though the problem is whether to perceive the EU as a single organism or a host of multiple countries. The economist also found that “Prior to the crisis, Italy’s government was running a primary surplus and bringing down its debt-to-GDP ratio. So long as markets were prepared to finance Italy’s old debt at low rates, it was in good shape. Now, of course, markets aren’t prepared to do that” showing not all the nations now in trouble were spending outrageously, it’s just that once markets were spooked it effected some fragile economies in the eurozone like Italy. The European Central Bank also managed to keep its inflation rates at low levels throughout the euro (at around 2%), an important step in making sure a problem of hyperinflation didn’t spread through the eurozone.

In conclusion, the euro has some fundamental problems that need to be solved if it is to survive. The first two problems are interlinked, as the EU cannot have one monetary policy and multiple fiscal policies. The EU will need to either centralise the fiscal policy of the eurozone, giving more power to the EU parliament over taxes/government spending or give up some of its power over monetary policy and allow countries to print their own euros with some sort of maximum limit in place. The first choice seems the most likely as the EU continues along a current path of greater unification (bailing out countries to keep the EU in existence) and this could result in Eurobonds, as a way of reducing borrowing costs for each country and creating a safer asset for the EU. The current structure of the EU has political fractures between different governments, as countries fight for their own interests, this will need to be sorted by giving more power to the EU parliament and getting rid of current trade barriers between nations. The vast inequality will need to be treated too, as contrasting statistics between central and periphery states (budget deficits, current accounts) will continue to split the EU. A solution could be to have a system like that in USA where the richer states can transfer funds to the poorer states; this is basically in use now in the eurozone as countries like Germany and France are being forced to bail-out their neighbours. The last fundamental problem of having no preparation for a crisis is already being resolved, as the recent Euro Crisis has caused countries to stop either living fiscally irresponsibly (Greece) or to stop relying on certain  markets (Spain too reliant on construction market). There is also more regulation over fiscal activity and bank credit, which was badly missing from the original set up and encouraged nations to live beyond their means. The euro did allow growth in poorer regions of Europe, but this was financed by easy debt. While the safety net it now provides relies on the belief that the countries footing the bill will continue to decide the costs of bail outs outweigh the costs of a breakup of the euro. Instead there should already be a lender of last resort set up, the European Central Bank for instance, which can help out any country and already have been financed by years of savings from each country. These points add up to suggest the euro was in fact doomed from the start due to innate problems in its structure and the only way it can survive in its current form will be through reforms in its monetary and fiscal policy and its political unity.

An Old Italian Joke

Italy is set to hold an election that could prove pivotal to the rest of Europe. The current Prime Minister Mario Monti, while a very respectable figure, was always an unelected official, which never sat right in a democratic country. His painful reforming of the country over the last year, while very much needed, has eaten into his popularity, leaving him lagging in the polls. It is almost certain a new leader will be elected (though many hope Mario Monti could keep some sort of position in the next parliament, depending on who wins), so it will be a split race between the right, the left and the radical Five Star movement lead by a comedian.

Well I say a new leader, but somehow Mr Berlusconi has managed to veer his big ego into this election. That is despite Italy showing nearly no growth during his long terms in power, his controversial resignation in 2011 when facing criminal allegations (of which he will stand trial for after these elections) and the more recent press release stating he wouldn’t stand in this election (a decision he almost instantly reversed). He is campaigning on tax cuts and against the much maligned austerity, despite Italy holding one of the largest public debt to GDP ratio’s in Europe at nearly 130%. He is also using his considerable resources and dominance over private TV channels to grab votes from an undecided public. Even with this however, he retains only an outside chances of winning this election, with the Italians luckily holding a long memory. But even if he doesn’t win, his presence will certainly upset the balance and could stop a stable government from winning a majority.

Only Greece can boast a high Debt to GDP ratio than Italy in Europe. 

The favourite in the polls is Mr Bersani, leader of the left leaning Democratic Party. He has suggested he will keep to the same economic policies as Mr Monti, though pressures from the trade unions that support his party could lead to more frustrating postponements of reforms. His parties lead in the polls is also less than their percentage of the vote in the last election in which they lost, showing both the precarious position he holds and the split in the vote to smaller parties.

Mr Bersani looks likely to win. 

One party that has taken advantage of this is the Five Star Movement. Their anti-establishment message has a hit a cord with the voters and has seen them rise to third in the polls, with many seeing them as a dark horse. Their lack of experience holds them back however, with many doubting whether they will have the heads to handle one of the biggest economic crises’s to hit Europe in recent memory.

Beppe Grillo (a comedian) is winning support for his Five Star Movement party. 

The likely outcome is that Mr Bersani will gain enough votes to win the lower house, but could however be left lacking in the upper house (the senate), which he needs to properly govern the country. In theory, he then could form a coalition with Mr Monti’s party, the Civic Choice, which would help him gain control of the upper house and have the esteemed figure Mr Monti as part of his government, maybe as the finance minister or as “The Economist” has suggested a super-minister overseeing the economy. This would be a favourable solution to Mr Berlusconi getting back into power, who instead of providing the reforms needed during his time in office, actually changed the laws to benefit himself e.g. de-criminalising false accounting.

Whoever wins however faces a lot of tough decisions. Mr Monti did a lot of good work while in office, but has arguably ran out of time in making the biggest changes. Reforms that his government had been working on will probably not be completed, for example a much heralded constitutional requirement to balance the government budget.

The country is in recession and suffering from high unemployment of over 11%. The public sector is over bloated, with Italian MP’s some of the highest paid in the world and the parliament one of the biggest in the world. The private sector on the other hand faces stifling restrictions, with the firing of workers famously difficult due to the red tape, making it hard for new workers to break into the job market.

TOPIC RANKINGS DB 2013 Rank DB 2012 Rank Change in Rank
Starting a Business 84 76 up -8
Dealing with Construction Permits 103 100 up -3
Getting Electricity 107 109 up 2
Registering Property 39 47 up 8
Getting Credit 104 97 up -7
Protecting Investors 49 46 up -3
Paying Taxes 131 133 up 2
Trading Across Borders 55 59 up 4
Enforcing Contracts 160 160 No change
Resolving Insolvency 31 32 up 1

Italy’s ranking in “Doing Business”, found on

Unit labour costs (the combination of productivity and labour wage costs) have continually risen in the last decade, even while its neighbours have managed to lowers theirs since the financial crisis. This can be described as the real effective exchange rate and has seen Italian exports become extremely uncompetitive in the global market, decreasing Italy’s ability to create growth in their economy. Corruption is rife, with tax evasion one of the biggest issues in a country where public debt is soaring, but personal wealth is one of the highest in Europe. All in all this helps make Italy an unattractive country to invest in, with the FDI to GDP ratio nearly a third of the EU average from the period 2005-2010, vastly trailing the other European powerhouses.|unitedkingdom&src=heatmap (this table shows the difference in corruption between Italy and the UK/USA)

There are still more twists and turns in this election to come I’m sure, but that aptly reflects the economy right now in Italy; unstable.

Chaos in North Africa

North Africa is in chaos as internal unrest spreads through the region. Egypt saw the kind of mass protests that started the revolution against Hosni Mubarak, Mali is playing host to a battle between the French and the Jihadists that had taken over north Mali, Libya was recently warned off visiting by the British government while the whole world watched on as an Algerian gas plant was taking hostage by Islamist extremists. Even Tunisia, seen as one of the more stable nations was rocked this week by the assignation of an opposition leader.

But on the whole there are positive signs from all these events. The Egyptian unrest was a predictable reaction to President Morsi’s attempt to fast track an Islamist flavoured constitution without any input from the other factions of Egypt. After being elected democratically, he has stretched the public backing he was given, by granting himself dictator like powers and taking advantage of the main lower house of parliament being dismissed on a technicality. The responsibility of selecting an assembly to write the constitution instead fell to the upper house (the Shura council), which was elected on a tiny turnout (10%), stripped of its non-Islamist members in protest and awarded immunity from the courts by Mr Morsi. The constitution was boycotted by the public when it came to voting, with a turnout of just a third of the population. Mr Morsi is now facing the consequences of his choices and clearly no long has the backing up the public. He has called for dialogue between the government and the protesters and could yet back down on some of the extreme parts of the constitution. The public meanwhile are not hungry for another rebellion; they want a voice and some fair leadership, not more death. If both sides can start negotiations, then this could be a turning point in Egypt.

Mr Morsi is losing the public support that won him the election. 

The same can be said for the rest of North Africa. The French are impressively pushing back the Jihadists that took over North Mali, Algeria moved swiftly to deal with the terrorist occupation of their gas plant, in the process sending out a signal to the rest of the world while Libya is finally embracing democracy after decades of dictatorship (if not rather clumsily).

The main problem that is emerging from this volatility is that the economies of these North African countries are grounding to a halt. This could leave many long term problems for these nations.

Growth has stagnated in the region for the last two years, which for these developing countries is extremely harmful, as growth of near 6% is ideally needed to provide jobs and drag millions out of the poverty that plagues Africa. In Mali, a poor harvest in 2011 was compounded by the coup in March last year (where the military has given back power in nothing but name). This has impacted on Mali’s agriculture where around 70%s of the population works (with the north effectively separated from the southern capital). This is a major reason for the rise in unemployment to 17% as well as the contraction in the service sector of nearly 9%. The fighting has seen many foreigners flee the country, taking their money with them, as FDI has been chased away. Aid has also been impacted, which the country heavily relies on, as Obama and Europe cut off donations to the country after news of the coup in March. This all lead to the economy contracting last year by 1.5% (a devastating blow for a country that already ranks among the poorest in the world). Since the start of 2013, France has entered the country and helped establish the authority of the government once again, while the IMF has announced a loan of $18.4 million to help the economy recover. But the political environment is still heavily unstable, and while the French can help battle off the bad guys, they can’t govern the country for Mali, which has long been a problem. The country needs an election and has to break the power triangle between the president, prime minister and the army that has lead to many squabbles. In December the prime minister was arrested and forced to resign live on TV by the army, which managed to reject the calls of another coup by keeping the president in power. Growth is expected to return this year if Mali can inject some stability into their economy, but no-one would be willing to make that bet. This all prolongs the development of the country to the point where it no longer needs to rely on aid and be able to develop its own private sector. The Jihadists might be leaving, but the destruction and instability they leave behind will set Mali back years.

President Hollande can’t fix Mali’s political problems. 

The Libyan economy is still trying to recover from the fall of the Gaddafi dictatorship in 2011, but has the helping factor of being one of the most oil rich states in Africa. Since the revolution, many large oil companies have been able to return to the country and oil production has impressively returned back to original levels, lifting Libya to third in the oil production league table in Africa. The small population and high oil earnings should help Libya recover much faster that its fellow North African economies. In fact, in 2012 the IMF estimated that Libya grew by 121%, though this was after a contraction of around 60% in 2011. This growth is majorly inflated by the mass oil production, with oil production accounting for 70% of GDP and 90% of exports. A true recovery is still years away and the current government spending on rebuilding infrastructure is too high to be sustained in the long term. More FDI is needed to help lift the service sector and the private sector off its knees, but this is unlikely when the country is still beset by social unrest. The murder of the American ambassador last year and the recent travelling alerts are big warning signs to businesses investing in the country, as internal divisions remain high.  Until this can be resolved, the country will remain reliant on a volatile oil market.

Algeria remains the only country not to experience the same sort of social problems as its neighbours, though this is mainly down to the government raising wages and deferring taxes last year. They could only afford this because of the rebounding oil market, which accounts for 97% of its exports along with gas. The country is just as reliant on oil as Libya and faces the same problems of become dependent on a volatile market without any other diversification in their economy. The increase in wages and food prices also saw inflation rise above 8% last year, weakening the growth of 2.5% for 2012 that was already downgraded from the 4.7% growth forecasted by the government. The hostage situation was dealt with swiftly by the government and perhaps reduced the chance of Islamic extremists moving into Algeria and causing the havoc that has unravelled in Mali. But a less publicised negative impact was that on the countries oil and gas sector, as the terrorists targeted a BP gas plant. If investors and energy companies become anxious that their plants are going to be targeted in the future, they might start pulling out of the country, as they did with Libya when a (albeit more dangerous) civil war broke out. The country is already ranked lower than Mali for business friendliness by the World Bank. This incident has pointed out not only the danger of growing terrorism in the North African region, but also the utter reliance of Algeria on its oil and gas sector.

Tunisia is being hit by angry protests against the Islamist government after the assignation of a secular opposition leader. Tensions have been rising for a while between the two sides, with skirmishes occurring across the country. The unrest reflects their economy that has struggled on since the toppling of its dictator at the start of 2011, registering decline of 1.8% in 2011 and 3.5% growth in 2012 that was overshadowed by increasing unemployment of nearly 20%. The lack of positive change since the revolution has helped increase tensions in the country, with the sacking of the internationally respected Mr Nabli as head of the central bank showing a lack of common sense according to critics of the government. The top aim now is for the country to create real jobs (not just artificial ones) by investing in areas that it could become market leaders in the region. Tunisia’s close integration with Europe has cost the country during the euro crisis, but with the tide perhaps turning in the continent, a chance for economic progression could arise. Tunisia surely needs some signs of economic progress if the governance is to hold off talk of upheaval.

Tunisia fared rather badly in the aftermath of the revolution; declining in GDP and suffering from higher unemployment than its neighbours. 

Finally there is Egypt, the biggest economy in North Africa. Said economy is now collapsing, with the Egyptian pound falling in value, imports at double the rate of exports and public debt equal to over 70% of GDP (too high for a developing economy). Negotiations with the IMF over a vital loan have stalled as well, as the government refuses to cut unhealthy subsidies for gas and food. In a similar situation to Tunisia, the public are impatient over an economic situation that has only gotten worse since the revolution in 2011. High growth in the years before have been replaced by stagnation and decline, unemployment has risen and the private sector is in tatters. Stability more than anything is required to help the economy; after the revolution year of 2011, 2012 was filled with divisions between the supporters of Mr Morsi and those wary of the Muslim Brotherhood working behind the scenes. Because of this, foreign investment has significantly dropped, falling by over three quarters in the last five years. Negotiations is needed between both sides, with neither covering themselves in glory; Mr Morsi remains too radical on the Islamic changes he wishes to implement, while his opponents are too ready to charge to the streets over the smallest issues. If Egypt can achieve some sort of consistency, then an economy full of potential can start to recover, if not then another revolution is never off the cards, worryingly.

This table shows the collapse of Egypt’s currency, as the country spends billions of foreign exchange reserves to try and keep it pegged to the US Dollar. 

North Africa was once one of the leading lights of the African economy, but has since been derailed by the Arab Spring. While the immediate danger of civil wars and revolutions are not as serious as believed, a collective effort must be made to reform the economies and encourage growth. For some there needs to be some diversification in the economy away from oil and gas, while for others some stability and political leadership remain the key principles needed for growth. Otherwise the dreams of the revolutions could become a nightmare.





 Key Idea:

“To be a “master of the Market” you need to look past the immediate effects of major upheavals and fluctuations, and look at their secondary and tertiary effects.” The efficient market hypothesis says, as accepted, that the price of an asset always perfectly reflects the value of that asset.  The idea is that all the information about an asset–public and private–gets translated into market activity, which is a kind of revelation of the asset’s real value.  It’s an elegant, if contentious, theory, that in some way illustrates the intrinsic value and organic nature of the market. The efficient-market hypothesis was developed by Professor Eugene Farma at the University of Chicago Booth School of Business as an academic concept of study through his published Ph.D. thesis in the early 1960s at the same school.


When Lebron James, arguably one of the best basketball players of all times, became a free agent, his next move was one of high anticipation, and one that was obviously reflected in the world markets. It is an amusing story to hear that when it became rumored that Lebron James was going to sign with the New York Knicks, it drove up the stock price of Madison Square Garden (MSG) (New York Knicks stadium) up by 6.4%.

As we can see above it is a clear example of the Efficient Market Hypothesis.When someone finds out a secret (Lebron is signing with the Knicks), realizes the financial consequences (tens, if not hundreds, of millions more in revenue for MSG), realizes MSG stock is under-valued, and buys a bunch; other people see this and jump on the bandwagon.  At some point, the stock price levels off at its true value. As we can see in the graph above the price of MSG skyrocketed. However as Lebron signed for the Miami Heat only 3 days after, again the same principle happened, resulting in a drop in the share price of the New York Knicks Stadium.

However there have been some counter-examples:

Remember Chernobyl? When news broke that the Soviet nuclear reactor had exploded, Alexander called. Only minutes before, confirmation of the disaster had blipped across our Quotron machines, yet Alexander had already bought the equivalent of two supertankers of crude oil. The focus of investor attention was on the New York Stock Exchange, he said. In particular it was on any company involved in nuclear power. The stocks of those companies were plummeting. Never mind that, he said. He had just purchased, on behalf of his clients, oil futures. Instantly in his mind less supply of nuclear power equaled more demand for oil, and he was right. His investors made a large killing. Mine made a small killing. Minutes after I had persuaded a few clients to buy some oil, Alexander called back.

File:Chernobyl Disaster.jpg

“Buy potatoes,” he said. “Gotta hop.” Then he hung up.

Of course. A cloud of fallout would threaten European food and water supplies, including the potato crop, placing a premium on uncontaminated American substitutes. Perhaps a few folks other than potato farmers think of the price of potatoes in America minutes after the explosion of a nuclear reactor in Russia, but I have never met them.

Yet if Alexander believed in perfectly efficient markets, he would not have bothered, instead figuring that the market had beaten him to it.  So almost 50 years after the efficient capital markets hypothesis, it’s still a hypothesis.  We don’t really know what drives securities prices.  But one thing we do know: the markets are very hard to beat and as John Maynard Keynes once commented, “Markets can remain irrational far longer than you or I can remain solvent.


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