The IMF has released its so-called Article 4 reports on the Euro Area and some of its member states over the summer. For the reader unfamiliar with the IMF language code, these are annual reports that are prepared by a team from the IMF visiting the country. Before final publication, these reports are discussed with the entire board of the IMF in Washington DC. The policy advice in these reports is a recommendation, not an obligation (although, of course, the whole financial market world is co-reading what the IMF is saying and what governments are arguing in response).
The IMF tends to look at countries through ‘neo liberal’ glasses. Sometimes however, the IMF does come up with surprising conclusions. This contribution highlights some of these.
Euro Area: Fiscal policy and the elusive recovery
Second quarter estimates of GDP dynamics suggest that the Euro Area’s double dip recession seems to be ending, even if exit from the recession is uneven. It did not take long for the ‘very serious Europeans’, spearheaded by Commissioner Olli Rehn, to use these slightly positive figures and claim that they are right after all and that Europe should stay the course of ‘building a stability culture’ (read: austerity).
The IMF however has a somewhat different take on this. Its report reads on page 9:
Fiscal consolidation will continue to be a drag on growth even if the pace of adjustment is expected to moderate, fiscal adjustment for the aggregate euro area is expected to reach 1% of GDP in structural terms, after a 1.5% of GDP adjustment in 2012.
In other words, if the recession in the Euro Area seems to be bottoming out, this has something to do with the fact that the screws of fiscal austerity have been loosened somewhat. If you cut by 1.5% of GDP (as was done in 2012), you get a profound recession. If you cut by 1% (as is being done in 2013), you get a smaller recession. And if you only cut by 0.3% of GDP (which are the IMF estimates for the annual structural consolidation efforts in 2014 and 2015 that are planned thus far), chances are that the economy does grow a little bit. The drag coming from fiscal policy is then small enough for the economy to overcome. To conclude otherwise and claim that the economy is growing thanks to the policy of austerity, not because the initial hard austerity line is being put aside for the moment, is disingenuous.
In fact, the IMF actually takes a step further. It even raises the question whether the recent postponement by the Commission for reaching the excessive deficit deadlines is going far enough:
Nevertheless, given weak growth prospects, these deadlines may still prove to be overly ambitious in some cases, and even more flexibility may be useful (…) if downside risks materialise, countries that are not under market pressure would benefit from a slower pace of fiscal adjustment (point 27).
France as the good pupil in the fiscal austerity class
Remember the French election campaign one year ago, promising to shift the priority to growth and jobs?
It turns out that the opposite has been done. The IMF report on France in point 5 states:
With a view to closing the gap relative to the European Commission’s excessive deficit procedure, the pace of adjustment was accelerated further under the 2013 budget, with a targeted structural adjustment of 1.8% of GDP
Indeed, the figures are that the (previous) French government squeezed 1.1% of GDP out of the economy in 2011 and another 1.1% in 2012. The 1.8% of GDP fiscal cut in 2013 (implemented by the present government) comes on top of this. Moreover, the intention is also to undertake an additional 1% of GDP fiscal squeeze in 2014, an effort the IMF calls substantial.
This actually made the IMF mission to France raise the issue that a more modest fiscal cut than the 1.8% of GDP would have been more appropriate for 2013. To which the government representatives replied the following:
The authorities explained that fiscal policy decisions for 2013 had been constrained by European commitments and the need to solidify market confidence (point 20)
The experience with fiscal consolidation in France also allows to illustrate (once again) the dangers of the policy of austerity. Yes, France did a substantial effort to cut the deficit by 1.8% of GDP in 2013. However, the dynamics set into motion by this substantial austerity are such that economic growth got killed and the economy got caught in recession. Because of falling tax revenues and increasing unemployment benefits, the public deficit in the end only fell by 1% of GDP, not by 1.8%. The end result is that the deficit at 3.9% of GDP still remains above the 3% threshold in 2013, while unemployment has risen from 10.2% to 11.2%.
To be fair, political pressure at the European level from the newly elected French government did play an important role in the Commission decision to postpone by one or two years the deadlines for reaching the 3% deficit threshold for a set of member states (see above).
Moreover, as also pointed out by the IMF, France (in contrast to many other European member states) has pursued fiscal consolidation mainly by raising tax revenues, not so much by cutting public and social expenditure. Initially, the IMF seems to support this line of action:
The decline of the savings rate (…) also reflects the fact that tax increases have fallen mostly on higher income households who have a higher capacity to adjust their savings rate to smooth consumption’ (point 10)
In other words, the IMF is suggesting that if France had cut expenditure instead of raising taxes on higher incomes, fiscal contraction in France would have been even more damaging for growth and jobs.
In the final policy recommendations, however, the IMF links the relaxation of the pace of fiscal adjustment in 2014 with the proposal that cuts should focus solely on the expenditure side. The fiscal cut of 1% of GDP that is planned for next year would become 0.7% of GDP but is then to be reached by compressing expenditure and not by increasing taxes (point 23). Any consideration of the probability that such type of consolidation would hit demand dynamics and growth especially hard is completely missing.
Germany: Do increase wages (but do not play Fiscal Superman)
In the German report, the IMF does raise the issue of high current account surpluses. Some of the language seems to suggest that Germany has the single currency to thank for its surplus (point 38). Indeed, if Germany still had its own currency, markets would react to these high external surpluses, driving the national exchange rate up and thereby slowing down exports while accelerating imports.
Even if the policy advice how Germany should tackle its external surplus of 6 to 7% of GDP starts out with the traditional recommendation of ‘growth enhancing reforms in non-traded sectors’ (whatever this may mean), what follows is something we are not used to hearing from the IMF (paragraph 39) :
Reflecting a strong labour market, it would not be inappropriate for real wages to rise, and therefore help improve the labour share of national income
So here we have the IMF, not only using trade union language on wage shares, but even making a plea in favour of higher wages and wage shares. This is indeed surprising.
It is also making the European Commission look a bit awkward. Indeed, the Commission, in its country specific recommendations on Germany, limits itself to advocating cuts in taxes and social security contributions on low wage earners while staying clear from any recommendation on wages themselves (see here for further analysis of the Commission recommendation).
On the related matter of a fiscal stimulus in Germany, the IMF pours a cold shower over those who would like to see Germany functioning as the ‘demand engine’ of Europe. To do so, the IMF refers to an econometric model simulating a two year 1 percent of GDP fiscal stimulus in Germany. Whereas GDP in Germany over these two years would be boosted by 0.7 to 0.9%, its impact on economic activity in the Euro Area (excluding Germany) is almost zero. In fact, the impact on Central and Eastern European economies would actually be bigger (although still restrained) than the impact on the Euro Area (excluding Germany). Some small neighbouring Euro Area countries (Belgium, Austria, Netherlands) would benefit most from a German stimulus, but the rest of the Euro Area would not see much improvement of their situation (see graph). The IMF explains this by the fact that trade linkages are very weak (Portugal, Greece) and by the relatively large size of countries making German import demand a relatively too weak factor to pull the whole of aggregate demand in these economies (Spain, Italy).
The IMF that we are used to know
Let’s end with a word of caution to avoid the impression that, from the point of view of trade unions, all is well with the IMF analysis.
Indeed, the IMF would probably not be the IMF if it did not say negative things on labour market regulations, wages and bargaining institutions. Running as a red thread through the different reports is the idea that, even if Europe needs to take a break from fiscal austerity, it urgently needs to accelerate the drive towards labour market deregulation. Structural reforms attacking job protection and wage formation systems (including minimum wages) are a recurring theme in these IMF papers.
There is, however, a certain contradiction here. When fiscal austerity and private sector deleveraging are concerned, the IMF warns against “pushing the periphery into a debt-deflation spiral” (point 10). However, the IMF is at the same time ignoring this identical risk when it is recommending these structural reforms. Scrapping wage bargaining systems and workers’ rights may very well end up in falling wages and falling prices, thereby “unanchoring inflation expectations” (point 42) and triggering the debt-deflation spiral the IMF is warning against. This is, to say the least, not very consistent.