Is There a Case for Optimism About the Eurozone?

I know, we don’t generally do optimism here at Naked Capitalism. And truth be told, I’m having trouble accepting the Financial Times’ John Dizard’s argument that things are going to get better in the Eurozone. Admittedly, John has a taste for investing on the wild side: he’s typically recommending exotic trades in his weekly column. But his argument isn’t based on catching a near-term trading bounce; it’s based on…..fundamentals.

He has two prongs to his argument. One is that the Eurocrats realize that they have painted themselves into a corner, which is leading to a second development: they are getting more serious about promoting innovation.

Let’s look at Dizard’s first cause for cheer:

Contrary to the sentiment of most of my European friends, I’m becoming a euro-optimist. It’s not just that the current euro area policy “solutions” aren’t getting more ridiculously destructive; they are; it’s that I see more recognition of this on the part of the policy tribes at the national government level. That means that there is light at the end of the European growth tunnel…

we are now near the end of the game of pretending these sorts of fixes will result in a new growth cycle. Just below the level of headline making political players on both the right and the left, the next generation of policy leaders are putting together policies that could actually work. The career rewards for pretence and myth making are nearly exhausted; all that’s left is the recognition of reality.

Let me play devil’s advocate. Understanding reality does not mean you have the political degrees of freedom to change trajectory. Technocratic fixes on innovation policy, which is what Dizard is hanging his hat on (we’ll get to that soon) is not going to come even close to compensating for a Eurozone-wide austerity hair shirt.

I’m reminded of time when policy makers clearly knew that the course they were committed to was failed, yet they felt they had no option. For instance, the start of World War I, when no one save Germany wanted conflict, yet the what was to be the Allied Powers were locked into mutual commitments, and the communication methods of the day did not allow them to communicate and devise other approaches; they felt honor and treaty bound to declare war. Richard Bookstaber has used the onset of WWI as a textbook example of a tightly-coupled system, where a sequence of pre-progammed executed, with no possibility of human interruption of the sequence that unfolded.

Similarly, Daniel Ellsberg recounts how Vietnam and SouthEast Asia policy experts like himself believed if they could only get the ear of the President, they could convince him of the folly of continuing the war in Vietnam. In his book Secrets, Ellsberg tells how he came to have access to the classified record of the US decision-making regarding Vietnam, the documents he later released to the press.

He expected the history to be one of overoptimism, of Presidents making bad decisions because they had bad information. Instead, the record showed clearly that the the assessment from the very beginning had been that our likelihood of prevailing was zilch. Nevertheless, no President was willing to withdraw because they felt US prestige was at risk, until the domestic political costs became too high.

And what Dizard is missing it that even though the young elite technocrats may want to do things differently, they can’t make the biggest change that needs to happen, which is figure out how to write off and restructure debt, particularly debt held by banks, while providing enough stimulus to offset the deflationary downdraft. Yanis Varoufakis, in his update on the Greek negotiations, explains what the real logjams are:

To accomplish the task of taking Greece off the minds of markets and Northern European electorates for this space of time, Eurogroup ministers came to an agreement with the IMF on how to patch up their conflicting agendas on Greece by means of a joint communiqué according to which Greece’s de-railed Bailout Mk2 is, supposedly, back on track. The basis of their agreement is twofold:

• The IMF will pretend it believes Europe’s claims to have rendered Greece’s public debt viable without an OSI (i.e. a haircut in the loans provided to Greece by the troika, aka its European partners), while
• Europe will pretend that it can do this without an OSI.[1]

The idea here is that, yet again, the Eurogroup-ECB-IMF alliance is not ready, politically, to reveal the truth to its various constituencies.

• The German and Dutch governments (not to mention the Finnish) feel it is impossible to tell their Parliaments, and voters, the terrible truth that some of the money they have put up as part of Bailout Mk1 & Mk2 will not be retrieved.
• The IMF cannot admit that it allowed Europe to involve it in a country program that does not fulfill the debt-viability conditions that any IMF program ought to.
• The Greek government has invested its survival on misleading its constituency into believing that the tailspin of the Greek macro economy can be arrested under the current arrangements.
• And, finally, the ECB is struggling to maintain the illusion that it can remain faithful to its no bailout clause vis-à-vis governments, especially in view of the great challenge awaiting in relation to Spain and Italy.

….So, what will come of Greece, given the latest Eurogroup ‘decision’? It is my fear, and belief, that the country is becoming a version of Kosovo – a protectorate in which the euro remains the currency, sovereignty is minimal, the population is ruled over by a glorified kleptocracy with strong links to Berlin and, last but not least, a permanent migratory flow is established that sees the young and the skilled move to northern Europe and beyond.

Turning briefly to the significance of the latest ‘Greek Deal’ for the Eurozone as a whole, the omens are particularly troubling for Spain and Italy. First, there is the small matter of the inbuilt domino effect. The reader is reminded that the reduction in Greece’s interest rates (which will be enhanced in the not too distant future further, as the Greek state grows increasingly unable to repay its partners’ loans), will translate into losses by the Spanish and Italian governments (since other troika ‘program’ countries, i.e. Ireland and Portugal, have been spared). The fact that the markets’ expectation of some OMT assistance for Italy and Spain are keeping their bonds’ yields low, for the time being, does not alter the fact that the vicious contagion dynamic is gathering strength.

Beyond this ‘small’ matter, Rome, Madrid and, indeed, Paris must now reckon with a Eurogroup decision that demonstrates how bogus all talk of a Growth Pact really has been (since President Hollande raised it as an issue a few months ago). The fact that the Eurozone’s finance ministers declared, without the slightest hesitation, that substantial growth will come to depression-hit Greece without an iota of a smidgeon of a hint of fresh public investment reveals that Europe is truly blind to what it will take to deal with the recession it faces in aggregate and with the various depressions in its Periphery.

What is troubling about Dizard’s contrasting take is it has a rearranging-the-deck-chairs-on-the-Titanic feel about it. And Dizard is a very astute columnist. The fact that he can’t grok that the problem is demand and jobs is striking. It’s a weird sort of learned blindness. This is the cheery part of his current piece:

A few weeks ago I had an interesting meeting with Fleur Pellerin, the junior minister in the French government for small and medium enterprises, innovation, and the digital economy. While she came up through an established path to French political authority (schooled at Essec and the ENA), she is attempting to create what she calls “the right ecosystem for a start-ups”, particularly for technology intensive enterprises.

Politicians like to talk about creating successes, or companies of the future. Ms Pellerin, and, I understand, an increasing number of other French policy people, realise that they have to allow for failures, and, following failures, a path to restarts. Most new companies, including seemingly promising technology companies, don’t work out, or have to be folded into others on disappointing terms. Then the entrepreneurs have to be able to start over. That has to become as normal a path in Europe as it is in the US and Scandinavia.

As Ms Pellerin says, “What I saw in [studying technology entrepreneurship in] Finland was the de-dramatisation of failure. In France, we have cultural barriers to giving people a second chance. We need to make people understand that if you fail in starting a new business, your chances of succeeding in a subsequent start-up are much improved.
“There are also barriers on the regulatory side to having a second chance, as well as in the provision of credit. This is something we in the government can work on, and I am working with other ministries on doing that.”

The headlines, and French moans, about taxation of the successful, are pretty depressing. Yet the new government backed down on the taxation of capital gains on start-up enterprises. Particularly for the owners of tech-intensive new companies, capital gains taxes will remain low; after the new US budget, they could be lower than in the US. And working visas for skilled foreigners will be fast-tracked.

Venture-backed technology companies get much better political support everywhere than do older industries. At some point, though, a supportive policy model for this sector could be generalised to the rest of the economy. That is, when the politicians run out of excuses for what they are doing now.

Aiee. This sounds a lot like the Carter era promotion of deregulation as a spur for innovation when even his advisors admitted there was no proof that deregulation does promote innovation (in fact, regulation often produces innovation, witness air pollution control technology).

While reducing the cultural penalties for failure is a good idea, that’s a generation sea-change project. And notice that Denmark and Sweden rate above the US in innovation rankings; one of the reasons cited is their strong social safety nets, which is what austerity is in the process of tearing apart. It’s more attractive to start a business to know you won’t become homeless if you fail (and that is not an exaggeration: I know one failed entrepreneur, in fairly high end tech, who had her somewhat contained drink habit spin out of control and is now homeless, as well as others who would have been if they didn’t have family to fall back on). Similarly, if you don’t have demand, all the innovation in the world is mainly going to cannibalize existing markets. An innovator might also cannibalize markets outside your country, but everyone else is also trying to steal each other’s demand.

Moroeve, this tech/funding intensive assumed profile of new businesses is somewhat fallacious. Amar Bhide did the landmark study of new business creation in the US and ascertained that only 1% were funded by venture capitalists. And even the most successful, highest growth companies had only a minority funded by VC. The overwhelming majority of new businesses are not major innovators like Apple but are started by people who have some knowledge of a particular field and see customer needs that are not being filled well or at all by incumbents. These are advances and are a boost to teh business community, but they don’t make for sexy copy in IT magazines.

It would be much better if I were wrong, but the fact that a smart guy like Dizard can only make an unconvincing case for optimism confirm my outlook: things always look darkest before they go completely black.

If readers think this take is wrong or misses other causes for hope, I’d very much like to hear these views.

This piece is cross-posted from Naked Capitalism with permission.

2 Responses to "Is There a Case for Optimism About the Eurozone?"

  1. redrum   December 3, 2012 at 1:34 pm

    Nope – it's a basket case. The politics can't keep up with the economics, and the region is becoming a separatist, extremist area as desperate voters seek to express their anger and frustration.

  2. DiranM   December 5, 2012 at 3:24 am

    Concur totally with Yves Smith on the Euroweenies. Ideological rigidity of the Politicos always trumps economic logic. Grok is the major problem with the minds of the EU and Greek political elite. Samaras has nominally a Harvard MBA, but conceptually what did he gain from his education in finance, etc.???

    Their single currency/ forced EU integration is the new Communism of the 21st Century. It is no coincidence that Samaras has a coalition government with successors of Nicos Zachariades and the Greek communist dream of Greece being a soviet satellite country is now being realized as a colony of the EU!!! Communism lasted 70 years, how long will the Euroweenies last with their gulag utopia???