The European North-South Conflict

«The Taboo – Are Southern European Societies Finally Dysfunctional?»

Speech by Beat Kappeler (in German)

Swiss economist, publicist and author

The Euro as a common currency fell into crisis in 2010 after just 11 years, due to the stark differences in competitiveness between the northern member countries on one hand, and the southern countries and France on the other. This situation led to trade balance deficits and corresponding debt in these countries. For a while, this was obscured by the only convergence in the Eurozone after its creation, namely the fall of interest rates in Latin countries, Ireland, and Greece to German levels.

The politicians of the Eurozone were first confronted with Greece’s mountain of debt and falsified statistics, and then with the insolvency of the rest. They responded in three stages:

First, they denied the fundamental problem (“it’s speculation,” said Eurogroup President Juncker), then they believed they could solve it with hastily made financial transfers, and third, they realized that structural problems were at play and made plans for fiscal union and banking union, disciplining the debtors accordingly. This worked in the case of Ireland and its real estate crisis, but not for the southern debtors and France.

Here, we propose a fourth stage of response: societies of Latin culture have significant deficits compared to the model of globally competitive Western and Asian market orientation and modern Max Weberian rationality of the public sphere. Whether this remains “permanent,” as suggested in the title, only means that it cannot be corrected quickly enough to save the Euro in its current form or to allow these countries to maintain the consumption standard of advanced industrial nations.

Since the voting rights in the fiscal union, the European Stability Mechanism (ESM), and the European Central Bank (ECB) allow the heavily indebted countries of the Eurozone to block reforms and sanctions, this question is significant.

The dysfunctionality manifests in the following ways:

• No separation between office and officeholder
• Parties as tribal structures with feudal loyalty and favors
• Unions with zero-sum thinking instead of win-win thinking, reflected in labor market regulations
• Poor PISA results, limited English or IT skills, weak universities
• Small businesses outside global value chains
• People there don’t travel and don’t know the world
• No respect for written commitments, but rather situational arrangements (“promises only bind those who believe them”): the problem of “collective action” according to Public Choice theory.

Now in detail:

Interest in Office and the Officeholder

Max Weber’s rationality regarding the separation of interests plays no role in Latin countries and Greece. This has been known for decades, and since the Euro crisis, some legal processes have been initiated, highlighting the enormous failures (Berlusconi, Bossi, “appalti,” Spanish ministers, Rajoy, and mayors, regional governments in Spain and Italy, legal cases in France, and earlier Craxi offenses, tens of thousands of campaign workers made civil servants after every election in Greece, etc.). Additionally, the privileges and salaries of political personnel in the South are much higher than in the North. In Italy, criticism of “parentopoli,” the enormous family ties among professors at the universities of Messina, Palermo, Bari, Sapienza-Rome, etc. (Nino Luca, “Parentopoli…” 2009), has been rising for some years.

The fashionable trend of regionalization, with an additional level of government and administration, has led to massive expenditures on projects and personnel in Italy, Spain, and France, according to spending competencies that are not backed by equally high revenue responsibilities. The resulting over-indebtedness and deficits are covered or guaranteed by central governments to avoid risking the nation’s overall ratings (Italy, Spain, France). A chain of extortion runs from Dezabank, Sicily, and Catalonia to Paris, Rome, and Madrid, and from there to Berlin, Brussels, and the ECB.

Parties with Tribal Structures

The parties in these countries are less ideologically connected and more held together by personal networks, dependencies, and funding. Rivalries among leading figures are the norm and often constitute the main focus of national political and media debates (Renzi-Letta, Alfano-Berlusconi, Copé-Fillon, “currents” in the Socialist Party and “Clubs” on the French Right). The selection of parliamentary candidates often follows “parachutage” from the party headquarters, a co-optive, oligarchic process. Reform parties are often no better – the M5S and its members receive their instructions via Beppo Grillo’s blog.

Labor Market Seen as a Zero-Sum Game

The discourse of unions and parties, even far into the conservative middle, revolves around a stark opposition between capital and labor. Often, it seems that any harm done to companies is considered a gain for workers. In any case, a “lump-sum theory of work” prevails, suggesting that more work for some takes away work from others. Hence, “job redistribution” through shorter workweeks (and the massive increase in labor costs and regulation), hence job security that prevents hiring. Labor disputes are taken up by politics, “solved,” or drag on for years in court. With short weekly, yearly, and lifetime work hours, the employment rate of active age groups is far lower than in northern countries (especially Switzerland and Norway). Globalization is seen as a threat from outside to be resisted through national protectionism. Industrial policy is viewed as a government task, leading to enormous sums being misallocated or private manufacturers being outcompeted (also in housing construction). All these policy fields are strongly path-dependent, following political correctness, and are difficult to reverse. No government in these countries has been re-elected since the Euro crisis.

Dysfunctional Education System

The PISA results of these countries are poor, with France not faring much better. Functional illiteracy is widespread (45% of the population in Italy, three times higher than in Germany, four times higher than in Denmark). English and IT skills are poor in these countries. According to the OECD-PISA study on adults (October 2013), adults with a secondary education in Japan and the Netherlands have better reading and math skills than university graduates in Italy and Spain. France is also performing poorly. None of these countries have vocational training systems like those in Germany, Switzerland, Austria, and Scandinavia. From personal observation, formal texts in Italian newspapers, books, and laws are very highbrow and elitist, while TV shows are lowbrow – an enormous contrast. According to various surveys, internet use and PC density in schools are significantly lower across the South compared to the North and the USA.

Teachers’ unions in all these countries are very strong and militant; they are the vanguard against any type of reform.

Small Firms Without Global Competence

The Latin countries have some large corporations, state-owned infrastructure companies, but few medium-sized or smaller companies that export, research, or innovate – compared to northern Europe or some regions in Anglo-Saxon countries, and certainly compared to Asia. A lack of familiarity with IT, lack of English skills, and limited travel abroad (statistically confirmed) restrict entry into global value chains, whether for purchasing or selling. Moreover, labor market regulations, which become stricter depending on firm size, punish companies for expanding.

Occasional Respect for Contracts

This cannot be supported by statistics like the previous points, but a lack of contractual reliability in many places results from all the points mentioned above. However, capitalism relies strictly on contractual reliability, on the enforceability of contracts in court, and on trust and good faith. The often formal hurdles to accessing courts, their slowness, hinder the rule of law and lead to self-help or clientelism, exacerbating social inequality. The legal profession is highly developed (one lawyer for every 80 residents in Palermo, one for every 100 in Rome and Milan, one for every 180 in Turin). In the political sphere, most actors operate “with a knife in the back,” as Machiavelli might have said. This political dysfunctionality stems from all the discussed points, especially the character of parties and internal party rivalries. At the state level, Public Choice theory sees the “collective action” and “rent-seeking” of rational individual pressures, with their cross-compromises at the expense of the state treasury, as a reason for the downfall. At the level of Euroland: within a few years, all contracts were broken in favor of short-term “solutions” for the South and France: ECB statutes, Maastricht criteria, the prohibition of bailouts in Article 125 of the Lisbon Treaty, and even by the highest courts (European Court of Justice and Federal Constitutional Court).

Conclusion

David Gilmour shows in The Pursuit of Italy (Allen Lane, 2011) how the integration of southern Italy into the monetary and political union of the dominant (Piedmontese-French) north brought impoverishment and political harshness. Dysfunctionality infects what works, not the other way around. These problems of the “new South” within the entire continent this time cannot be solved within 20 years, and as already shown, will infect the North and leave the South impoverished in the grip of adjustment measures. In Euroland, in order to obscure both trends, legal violations and ECB money floods due to the state financing problems of the South, as promised by the ECB a year ago, are leading to the general infection of the North with inflation, inefficiency, and misallocation of resources.

Lorenzo Bini Smaghi, in his latest book on Italy (Morire di austerità, 2013), lists all conceivable “solutions” but concludes that none are practicable.

«Germany – Island of the Blessed, Last Bastion of Economic Reason or Subtle Parasite of Europe?»

Speech by Karen Horn (in German)

Professor of the History of Economic Ideas and Business Journalism, University of Erfurt

Dear Ladies and Gentlemen,

The Progress Foundation has identified a conflict—unfortunately, and rightly so. A conflict between Northern and Southern Europe. A conflict is a collision. We know this from driving. If you’re lucky, the collision is mild enough that you’re only slightly shaken, and at most, there are a few scratches on the bumper. But it doesn’t always end so nicely. If a lot is broken in the collision, it becomes difficult to pick up all the pieces, heal the wounds, and mend the cracks. There can also be total damage. Are we in Europe facing total damage? A breakdown not only of the Eurozone but possibly also of the European Union? The European peace project, which would make the situation dramatically worse? I consider none of this very likely. I cannot entirely rule it out, of course. But the larger the context, the less inevitable such damage seems to me. If the euro fails, Europe does not necessarily have to fail, nor does peace. The forecast one arrives at in these individual issues is, after all, not least a matter of temperament.

The collision is evident in the fact that the desired culture of stability, which was supposed to be enforced with the single currency, has long since dissolved in parts of Europe. Nowhere is it as it should be, not even in Germany, where the emerging coalition is already preparing to back away from the once-ambitious austerity goals. But the situation is particularly dramatic in the South: in Greece, Cyprus, Spain, Portugal, Italy, and unfortunately also in currently dangerously misguided, apparently deliberately and willfully undermining competitiveness, and increasingly deindustrialized France. The dividing line between the North and the South is too stark to be ignored or considered insignificant. It probably reflects misguided incentives linked with different economic policies, traditions, and mentalities. At least the latter two cannot and should not be judged, but they must be acknowledged.

The euro was, in a sense, an educational project: by taking away the ability of states to devalue their currencies artificially and thereby gain export advantages, even the less stable candidates were supposed to have an incentive to manage their economies properly and permanently in the future, and to behave in a stability-oriented manner. They were supposed to learn and practice economic reason. It was made easy for them with low interest rates, from which they benefited as a windfall profit, completely undeserved and solely thanks to their connection to the Eurozone. But the opportunity associated with it was squandered. The educational project, which contained a great deal of hope and a considerable dose of centralist arrogance, has failed.

Instead of general economic good behavior, we are now witnessing a gigantic rescue policy, of which no one has even an inkling of what it will cost whom. We don’t need to think much about it, because the rescue of countries that would normally be heading for bankruptcy is, as German Chancellor Angela Merkel proclaimed early on, “without alternative.” The only question was how this rescue, this opening of the markets, was to be carried out. The German Chancellor has earned credit for the fact that there are still no Eurobonds. Eurobonds have become a symbol in Germany for the communalization of debt in Europe and at the same time for a smoke screen. In this case, the public understands that at some point, this could affect German wallets. Merkel’s party, the Union, benefited greatly in the recent Bundestag election from its opposition to Eurobonds—after initial hesitation. The rescue architecture she supported and promoted, with its countless and unpronounceable institutions and acronyms, coupled with the monetary policy of the European Central Bank, ultimately leads no less to the communalization of debt and massive redistribution within the Eurozone, something even the political opposition does not admit. This is logical, because they wouldn’t even have a problem with Eurobonds.

At least in superficial perception, Angela Merkel has positioned herself in European policy not only as a guardian of German interests but also as a voice of economic reason. The infamous hostility that pours down on her from the South has helped her domestically. Those who appear on newspaper covers with Hitler mustaches in countries benefiting massively from German support can be sure of the sympathy of German voters at the ballot box. If the southern countries wanted to prevent Angela Merkel, they should not have taken such a tone. It was tactically unwise. There are forms of slander that the German, who will probably never be able to casually deal with his dark national past—and in my opinion, should not—cannot easily stomach.

The conflict, as has become clear, takes place on two levels: on the economic level, where not only economic policy beliefs and long-established national practices collide, and on the European political level, where claims are now being made against each other. In Germany, resentment is growing against the Greeks and the other affected southern countries that do not know how to manage their economies, have squandered the euro dividend, and are now threatening to become a bottomless pit for the German taxpayer. In Greece and the other affected southern countries, resentment is growing against the Germans, who now actually insist that support be tied to conditions, which is ultimately a monstrous interference.

The North, meaning Germany and at least England and the Netherlands, now sees the South in a stereotypical way as a haven of unsoundness and chutzpah. Old prejudices are resurfacing. The South, in turn, increasingly sees Germany as a haven of humorless, pedantic bureaucracy, as an increasingly dictatorial power, and also as a perfidious parasite. Germany and especially its export industry have profited from the euro for so long, systematically draining other European economies, that it is now high time to give something back to the partners, they say. This point will need further exploration.

So much for describing the conflict. Now to the question of how Germany actually stands in this situation. The good news: We have little to complain about. What a phrase. As if something were missing if one could not complain! Typical German. But seriously, the German economy is sailing through the crisis with a growth rate of probably no more than half a percent in 2013 and an unemployment rate of less than 7 percent. This is not as if nothing had happened, but this is mainly due to the precarious environment, to the weakness of the world economy. That is why exports are currently stagnating, with a slight improvement expected next year.

The German economy itself, however, is overall so robust that it understandably makes its European partners green with envy and even surprises the Germans themselves. Wasn’t Germany not so long ago the laggard of Europe? A real problem child? Not much of that remains today, and this is not least due to the “Agenda 2010,” with which the German Social Democrats have contributed to Germany and its competitiveness in a way they now deeply regret. Germany’s robustness is also due to the strength of German industry and the long-standing prudent restraint of the labor market parties.

In indices such as the DACH Reform Barometer or the Economic Freedom of the World ranking, Germany is moving forward. The outlook is good, and confidence is unbroken. Recently, in October 2013, the ZEW Economic Sentiment Index rose for the third consecutive month and is at its highest level in three and a half years. And economic research institutes unanimously expect GDP growth of up to 2 percent next year. Not bad. Felix Germania!

That was the good news. The bad news: Germans not being able to complain? That doesn’t exist. Of course, we can complain; that’s the national cliché, and we also find good reasons for it. Seriously: The picture is not as perfect as it seems. The German economy has a few weaknesses that are by no means trivial and must be taken seriously—some of them more home-grown, others less so. Above all, Germany suffers from an investment weakness. Last year, equipment investment fell by 4 percent, and this year it is heading for a minus of 2.5 percent. Economic researchers primarily attribute this to the uncertainty associated with the euro crisis—here it is again—as well as with the real and expected costs of the energy transition. And the recent recurring discussions about tax increases certainly haven’t helped. Furthermore, we are not at all well prepared in Germany for the gradually emerging, not really surprising demographic change, especially not with our social security systems. The low-interest rates, a consequence of crisis management, make it impossible for citizens to make private provisions in a meaningful way, which does not improve the situation. Instead, we are breeding a real estate bubble because investing in property is the only idea that comes to mind. Just two days ago, the Bundesbank issued a public warning—though Nobel laureate Eugene Fama claims there are no bubbles. However, he sometimes contradicts himself.

Be that as it may, above all that I have described hangs the sword of Damocles, regarding how the euro adventure will eventually turn out. We are currently vaguely feeling the uncertainty associated with it, are annoyed by the low-interest rates that, contrary to the promises of the Keynes effect, have not even led to increased investments, and no one can estimate the comprehensive redistribution effects of the ECB’s manipulated refinancing conditions. But eventually, everyone fears, inflation will come to Germany due to the expansion of the money supply. And what happens if the daring rescue policy fails and the claims that the Bundesbank has against the ECB through the Target 2 payment system, the Eurosystem’s clearing system, turn to dust? No one wants to imagine it, not even Munich economist Hans-Werner Sinn, who introduced the topic into public discourse. In this sense, I can summarize: Germany is unfortunately not a paradise. We are doing well, quite well, but for how long? Don’t be surprised if we all emigrate to you sooner or later.

Germany, the last bastion of economic reason? Just because the Chancellor considers certain conditions for Greek aid reasonable, that does not make her a brilliant advocate of economic policy. Unfortunately. The fact that the once so strict fiscal policy is now being relaxed in Germany is not the worst idea in the current situation. Nevertheless, and I would like to emphasize this, the concept of a balanced budget remains fundamentally correct and necessary. But this, if I may point it out here, as the outgoing German Minister of Finance Wolfgang Schäuble, who is currently being celebrated and would certainly have had his nose in it, is a concept that Wolfgang Schäuble did not invent. One of the current economic misunderstandings is that, in the South of Europe, the opposition to rigid fiscal policy was described as Keynesian. John Maynard Keynes, who once favored public debt in times of economic weakness, would never have described the situation in which we now find ourselves in the South of Europe as normal economic weakness. The situation is different.

But there is something much worse: Germany will find it increasingly difficult in the coming months to understand and to accept the concerns and reservations of its European partners, while simultaneously running the risk of overestimating its own economic situation and clinging to positions that are impossible to sustain in the long run. Chancellor Merkel and Finance Minister Schäuble’s obsession with the balanced budget and debt brake is one example. Both stick to these principles with great stubbornness. Despite her moderation in tone, the Chancellor is increasingly perceived as arrogant in Europe. And there is a danger that, despite the experience of a difficult history, the awareness of how important the European idea really is will fade. Germany has hardly benefited more from the European Union and its predecessors than any other country. The economic importance of the EU cannot be emphasized enough, especially for export-strong Germany. But also, its contribution to the stability and peace of Europe. The German government must show the necessary sensitivity here. And I do not mean only in its words, but also in its actions.

On this optimistic note, I would like to end. Europe is strong and Germany is strong—this much is clear. But we must also remember that in Europe, only those countries will be able to permanently assume leadership roles that contribute to European integration, and not to its weakening. This responsibility falls to all of us. And to conclude with a thought from Goethe, who once wrote: “You must be an arrow and a target at the same time.” Let us all try to achieve this. Thank you very much.