Editor’s Note: Greek Prime Minister Alexis Tsipras traveled to Germany Monday to meet with Chancellor Angela Merkel in a bid to get more credit for what the New York Times called its “looming cash crunch.” The narrative is a familiar one: irresponsible Greece is the problem child of the European Union and has to go begging Daddy, in all his Teutonic frugality, for help. But this tale is misleading, argues Mariana Mazzucato, professor of economics at the University of Sussex and author of “The Entrepreneurial State.”
In an adaptation of that book on the Making Sen$e page last year, “Apple didn’t build your iPhone; Your taxes did,” Mazzucato made the case that public – not private — investment is at the heart of much of society’s most vital research and development. She continues to champion public investment, arguing that that’s what the EU needs to get back on its feet. And it’s disingenuous, she argues, for Germany to masquerade under the banner of austerity, when its own public spending has contributed to its economic strength.
— Simone Pathe, Making Sen$e Editor
We often hear that the problem in Europe is that there is a monetary union with no fiscal union and that this cannot work, has not worked and is the origin of the current fiscal crisis in the Eurozone.
What is usually meant by this is that some countries were allowed to spend too much (i.e. were fiscally irresponsible), which got them into trouble with high debt-to-GDP ratios, while others were more “prudent” (i.e. fiscally responsible), tightened their belts and became more competitive. The recipe that follows from such an analysis is that what we need today is for the weaker countries (e.g. Italy and Greece) to cut their public budgets (and of course, as usual, workers’ wages) to become strong.
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Nothing could be further from the truth. And at the Ambrosetti meeting in northern Italy’s Cernobbio on Lake Como last week (what William Safire called an “elitist” version of Davos), we heard some better arguments from Richard Koo, of the Nomura Research Institute in Japan, Greek Finance Minister Yanis Varoufakis, and … myself. As the meeting was Chatham House Rules, I’ll focus on the issues that we have all been discussing for some years now outside the walls of the magnificent Villa D’Este. Let me focus on the short-term and the long-term reasons why the tale above is just a tale, and is continuing to keep the EU in dire straits.
First, the short-term reasons. Koo argues that Europe has confused its structural problems with its balance sheet problems and that while the latter are much more urgent, we have wrongly prioritized the former (though many say not enough). By balance sheet problems he means that when an economic crisis is provoked by excessive private debt, after the crash, business naturally focuses on de-leveraging – in other words, saving rather than taking on more debt. And no matter how low interest rates go, business will not invest.
Indeed, today we are witnessing very low consumption and investment at zero interest rates, which is causing deflation. The usual prediction is that such low rates would increase inflation. If this saving by the private sector is accompanied by saving by the public sector — if government acts “pro-cyclically” and tightens its belt — then we get into serious trouble: recessions can become depressions. Koo has argued that Europe should have learned from Japan’s mistakes when 15 years ago, after its own crisis, its government increased taxes and cut spending, which, instead of reducing its deficit, increased it by 70 percent (due to the massive fall in investment and demand).
Europe is unfortunately still not learning the lesson. National governments continue to focus on cutting spending. And, as I’ve argued elsewhere, the European Commission investment plan is inadequate, based on the assumption that a €21 billion investment (of which €8 billion is taken from another EC pot dedicated to innovation) can have a leverage ratio of €15, magically turning €21 billion into an investment of €315 billion. How can European governments cut spending precisely in an era in which the private sector is not investing enough — let alone with such a kick?
The U.S., on the other hand, learned from the Japanese lesson and in 2009, after the beginning of the crisis, not only created new money through massive quantitative easing (QE) but also increased government spending by $800 billion through an investment plan (the American Recovery and Reinvestment Act), which, in the short run, increased the deficit to 10 percent. In the long-run, however, that investment reduced the debt-to-GDP ratio because of the incredible stimulus on growth (the denominator) being witnessed today.
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Now I come to the long-term reasons, on which I focused during my Cernobbio session on financing innovation. The countries that are doing well today in Europe are those that have been investing more (not less) in all the areas that increase productivity: human capital formation, education, research and development, and key public institutions like public banks, which provide patient capital to innovators and organizations that increase the links between science and industry (e.g. Fraunhofer Institutes in Germany). That interconnectedness increases productivity across sectors. What has been lacking is a common investment plan in the EU — an investment pact. The EU doesn’t need a common plan for where to cut (a fiscal compact).
And indeed, Yanis Varoufakis, who also presented earlier this month in Cernobbio, had been arguing for such an investment plan before becoming Greek finance minister. He is often accused of being too academic and not “politically savvy.” Nothing could be further from the truth. What we need today are politicians who know how to make the link between long-term thinking and short-term crises. Since 2010, Varoufakis has been working on a “modest proposal” for an investment-led recovery for Europe. He’s been ignored.
His proposal sought to allow the European Investment Bank (EIB) to issue bonds directed towards productive investment, with the ECB ready to purchase those bonds. In essence, this would have amounted to a form of “directed” QE, allowing money creation to actually increase growth in the real economy rather than simply letting it sit in the coffers of banks. And since EIB bonds are triple-A rated, this would be much less risky for the ECB than buying national bonds. Only if money creation is “directed” towards productive areas and invested in viable projects that can produce long-run returns will we get a more balanced Europe.
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In his speech in Cernobbio, which is now on his website, Varoufakis said his plan should be called the Merkel Plan (!) because Germany will benefit from an investment-driven Europe that is less skewed, between member states, in its competitiveness. But until Germany admits that the real crisis in Europe is not due to differences between member states’ spending but to differences in their innovation and investment activities, unfortunately, this proposal is not likely to be adopted.
Europe should have a common investment plan so that more countries do what Germany actually does — invest in R&D and vocational training, construct a strategic public investment bank, invest in science-industry Fraunhofer Institutes, envision a green transformation of all sectors through their ‘energiewende’ policy, and redistribute wealth between its regions — not what it says it does (tighten its belt).
In the end, no matter how many structural reforms we engineer, and how much money we create through QE, Europe will go nowhere until it begins to construct a new future — a future in which both the public and private sectors invest more in the key areas that will foster future growth. There is nothing inevitable in “secular stagnation.” It seems to be the road we have chosen. Let’s change direction.