Friday, April 10, 2020

An Organised Hypocrisy: Dutch relent in Covid-19 Eurozone funding

Christine Lagarde, ECB president, signs a Euro note.

Eurogroup finance ministers agreed on Thursday April 9th to present an emergency rescue package in response to the coronavirus crisis, to the heads of government of the 19-country Eurozone for approval. However long-term funding for economic recovery has not been agreed.

The finance ministers on a video conference agreed after the Netherlands compromised on a demand for “economic surveillance” in particular of drawdowns from the bailout fund. The proposed pacakage includes €100bn loan plan for jobless benefits; €200bn in loans for SME businesses, and access to €240bn in loans for Eurozone countries to draw on from the European Stability Mechanism (ESM) bailout fund. The loans of €200bn to EU businesses will be underwritten by €25bn in member state guarantees for the European Investment Bank, the EU's lending unit.

Benjamin Disraeli (1804-1818), the grandson of a Jewish merchant of Venice and a future British prime minister, famously said during a House of Commons debate on the Corn Laws in 1845 that "A Conservative Government is an organized hypocrisy."

Dutch moralism is a hypocrisy that has not been rare in Eurozone

In March 2019 a special committee on financial crimes, tax evasion and tax avoidance, of the European Parliament identified "5 EU member states as corporate tax havens: Cyprus, Ireland, Luxembourg, Malta and the Netherlands" — Cyprus is not a member of the Euro System.

A report said it "Deplores the fact that some member states confiscate the tax base of other member states by attracting profits generated elsewhere, thereby allowing companies to artificially lower their tax base; points out that this practice not only harms the principle of EU solidarity, but also gives rise to a redistribution of wealth towards MNEs (multinational enterprises) and their shareholders at the expense of EU citizens; supports the important work by academics and journalists who are helping to shed light on these practices...Recalls a research study showing that tax avoidance via 6 EU member states results in a loss of 42.8bn in tax revenue in the other 22 member states."

The Dutch Central Bank reported in 2018 that foreign direct investment (FDI) flows to 14,000 Dutch letterbox companies (officially called Special Purpose Entities) had risen 75% in the period 2008-2017 to €4.6tn (Germany's 2019 GDP was valued at €3.4tn) — about 80% of the inward flows are immediately channelled to other countries across the world.

Reality Check on inward US FDI to Ireland: When total (historical) US FDI (not inflation-adjusted) in Germany in 2018 was $140bn and generated 740,000 jobs compared with $714bn in Luxembourg and 28,000 jobs; $442bn in Ireland and 130,000 jobs, shouldn't this raise scepticism or incredulity?

Politics and economics in emerging Euro System

The Committee for the Study of Economic and Monetary Union, known as the Delors Committee (after Jacques Delors, then the French president of the European Commission), was set up in June 1988 to examine and propose concrete stages leading to European Economic and Monetary Union. It reported in April 1989 on “Economic and Monetary Union in the European Community” and the committee comprising Delors, and central bankers suggested 3 stages for achieving Economic and Monetary Union. The original motivation for a single currency was related to the agreement on a Single Market in the then European Economic Community. Politics would soon intervene — the Single Market Act would take effect from January 1, 1993.

The Berlin Wall was breached on November 9, 1989, marking the beginning of the end of Soviet/ Russian control of Eastern Europe.

Helmut Kohl, the German chancellor, championed reunification and by committing to anchor Germany within Europe under a common currency, he won the support of Fran├žois Mitterrand, French president, and Mikhail Gorbachev, Soviet leader, while Margaret Thatcher, the British prime minister, opposed the return of a powerful, united Germany.

The Maastricht Treaty of 1992 limited to 3% "the ratio of the planned or actual government deficit to gross domestic product at market prices and 60% for the ratio of government debt to gross domestic product at market prices."

Maastricht criteria assumed a 5% nominal GDP growth rate, since this rate with an annual budget deficit of 3% of GDP leads to a stable debt ratio of 60%. These are now part of the Stability and Growth Pact.

1997 was the key year for meeting the Maastricht criteria for 1999 aspirants for Euro membership.

Germany, France and Italy engineered budget deficits of 3% or lower— France transferred France Telecom's pension fund to the government while the Italians arranged a currency swap with Japan and front-loaded spending in 1996

The Italian deficit fell 4% in 1997 to 2.7%; Greece's rate dropped 3% to 4.%.

Italy and Belgium were allowed to join in 1999 even though their debt ratios were above 100%. Greece joined in 2001 after Goldman Sachs arranged a currency swap that reduced the amount of its debt in euro terms, by €2.4bn, lowering its debt to GDP ratio to 103.7% from 105.3%.

Belgium's gross public debt rate has fallen from 122% to 99.8% in 2020. Italy is up 14% to 135% and Greece's debt rose 62% to 171%.

A 2005 paper notes that:

"Since member states wanted to meet the convergence criteria, they sometimes found it easier to manipulate figures rather than alter fundamental elements in their economies. Eurostat (the EU's statistics office) experienced strong political pressure to accept the data supplied by the member states."

Ireland joined Euro System amidst a credit and tax-cutting boom

In deciding to join the Euro System the Irish Central Bank would lose its interest rate-setting role and therefore prudent management of the economy would have to rely on budgetary policy.

However in 1999 the year the euro was launched the seeds of disaster were already germinating.

Charlie McCreevy, finance minister, was stoking the emerging property boom with income and capital tax cuts coupled with a massive expansion of property tax incentives.

In April 1999, Maurice O'Connell, the Central Bank governor, issued a letter to financial institutions stating that an analysis of practices had shown that some lenders had no evidence as to how borrowers came by the balance of their money. The governor criticised what he called, the particularly disturbing practice of allowing large amounts of the borrowers after-tax income to go towards paying off a mortgage.

The 1999 annual report noted: "Institutions were...advised that it remains vitally important for them to take a medium-term perspective and to reckon with the potential consequences of rising interest rates and a return to lower rates of growth in the economy. All institutions gave assurances that there would be no slackening in prudential lending standards."

In 2000 the Economic and Social Research Institute (ESRI) recommended that the Government should slow down the economy. Bertie Ahern, the taoiseach, rejected the advice:

Conclusion

The European Central Bank's (ECB) governance has been relatively toothless in the past two decades.

There was no credible enforcement of the Stability and Growth Pact rules while the central bank had no role in controlling the huge property booms in Spain and Ireland.

Member countries must also realise that there are trade-offs in having the protections of a transnational central bank.

Last month Ireland was a signatory to a letter issued with 8 other Eurozone countries calling for the issue of common corona bonds.

However, Ireland also wishes to keep its veto on any changes in taxation and retain fiscal powers.

Member countries can have different corporate tax rates for example but it's crazy to also allow the operation of huge tax havens within the Eurozone.

Finally, it was stupid to have allowed Italy and Greece to join the Euro System on the basis of dogey data rather than awaiting sustainable reforms. 

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