Fiscal Federalism: Hints of a Greek Tragedy to Come?
The Greek crisis has prompted numerous commentators to remark on the dangers of a monetary union which has no common fiscal policy.
From the perspective of euro members, the external value of the euro is threatened by large deficits and growing public debt in the so-called PIIG countries, notably Greece and Portugal.Â There is no effective mechanism in place to enforce the fiscal rules which were part of the euro agreement, and the European central bank has no power to buy government debt.Â In this context, bond spreads have grown dramatically between the euro countries, and especially between Germany and Greece.
From the perspective of Greece and other high deficit/debt euro countries, the euro has become a box. Faced with soaring deficits and debt, soaring interest rates and slumping growth, they do not have the option to devalue. Fiscal austerity is held out as the only solution. (Of course, the radical option to default on at least part of the debt and to leave the euro does exist – which is precisely why credit default swaps on Greek bonds have now risen to almost 4% of the face value.)
Are there lessons in this for Canada? Of course, the fiscal and economic situation is dramatically different. Nonetheless Canada is not totally unlike the euro area. From a provincial perspective, we have a monetary union, rather large differences in fiscal and economic circumstances and, crucially, no common fiscal policy worth speaking about.
Today (extrapolating a bit from the latest TD numbers), total provincial net debt is about 22.5% of GDP, or 38% of the total combined debt of the federal government and the provinces. That is a big number compared to most other federal countries where the federal spending role is much larger.Â Provincial net debt peaked at almost 30% of GDP in the mid 1990s, and is again on an upward trajectory due to recession induced deficits and the shared costing of stimulus measures.
The recent very gloomy prognostications of the Parliamentary Budget Officer built a rather scary long term scenario of the federal fiscal situation on some rather heroic assumptions regarding fiscal federalism. A key assumption was that federal transfers to the provinces would, after current arrangements expire in 2014, grow in line with health care spending, which is now running at close to 7% of GDP and expected to rise quite rapidly (ultimately to 12% of GDP according to the PBO, which sounds rather extreme.) The Canada Health Transfer will be running at about $30 Billion per year when the current deal expires.Â The Canada Social Transfer and equalization payments have also been growing following short-term arrangements made under the Martin and Harper governments. Ultimately, however, equalization and transfers are federal spending programs whose size is determined by the federal government (and the Harper government would prefer to return to the classical federalism model of divided responsibilities.)
The key point is that some provinces have fairly high debts and face much more acute spending pressures than the federal government. Equalization will help, but I for one would not assume that the federal government will necessarily maintain the rate of growth of health and social transfers. Meanwhile, Ontario and Quebec in particular likely face much weaker growth prospects than the rest of Canada, and, of course, have no ability to set interest rates and, with interest rates, the exchange rate. Debt will grow rapidly in provinces with slow growth rates as and when interest rates start to rise. The key dynamic here is thatÂ it will be very difficult for some provinces to return to balance andÂ to avoid a compounding of debt under “normal” circumstances in which nominal interest rates exceed the nominal growth rate.
Little wonder, then, that the provinces are having to borrow at significantly higher cost than the federal government. Bloomberg reports that the average yield gap between federal and provincial bonds is now 54 basis points, rising to 77 basis points for Quebec, and 80 basis points for Ontario.
The austerity being inflicted on Greece today by financial markets is an order of magnitude greater than Harris era austerity in Ontario. ButÂ austerity will beÂ increasingly forced on the weakest provinces and may well assume Harris era dimensions. Unless, of course, interest rates are keptÂ down below the growth rate, and the federal government assumes its proper share of future provincial spending responsibilities.
The Government is the “monopoly” issuer of the currency in Canada. In Europe each country is the “user” of the currency. Canadian debts are in its own currency, for europeans they are in a foreign currency i.e. the euro. They have no control over anything.
Provinces could pursue their own industrial strategies and ameliorate their rates of growth.
They could also increase corporate, personal and consumption taxes. Although here some inter-provincial agreement on minimum tax rates would be required which is highly unlikely. So that leaves the Feds which could unilaterally increase CITS and PITS without facing the race to the bottom problem. The trick however would be to get the Feds to agree to transfer that to the provinces.
The Feds could also borrow at their lower rate and loan the cash to the provinces thereby end-running the monetary union problem. The Europeans lack a central government with the same range of powers on both the tax and spending ends. So I find the comparison a little fragile although I take Andrew’s point that Canada has regional economic imbalances which cannot be cured by the blunt instruments of exchange and interest rates. Indeed these crude policy instruments are increasingly, exaggerating the problems of a highly disarticulated national economy: the perennial issue of Canadian political economy.
And can you imagine, the government in Greece was supposedly progressive and green oriented. Seems like today, similar imbalances and risk assessment is spreading rather quickly.
Is someone or some interest trying to pull Europe apart. I thought the whole point of the creation of the Euro and the union was to protect against things such as they are experiencing right now. Is this an internal problem being exasperated by the speculators.
One would have thought there would be a lot more foresight and planning put in place to defend against such crisis.
Potentially the robustness of the EU model became over extended, but if you are going to have a monetary union, one would think the union would come forward and protect against the wolves picking on the weaker of the herd.
The chief executive of the ANZ Bank blamed the reluctance of Germany to finalise a Greek solution for fuelling the fears of sovereign debt contagion throughout Europe
Germany drags feet on Greek bailout
Europe’s biggest economy is refusing to hand over any money to help the indebted Greek government until more due diligence is done to make sure the money from the bailout is not misused.
The heads of the International Monetary Fund (IMF) and the European Central Bank have appealed to Germany to make good on its promise to help debt-stricken Greece, saying Eurozone stability is hanging in the balance….The central bank’s president, Jean-Claude Trichet, says Germany cannot afford to teeter on its commitment.
“We have an absolute necessity, taking into account the situation, to decide very rapidly,” he said…..German chancellor Angela Merkel knows being Greece’s saviour will not sit well with her voters.
She says she will not sign the cheque until more details are established about what Greece intends to do to ensure its economy will not need another bailout in the future.
“This is about the stability of the euro area as a whole and we will not withdraw from this responsibility,” she said.
“The precondition, however, is that Greece will accept an ambitious austerity program so that trust of the financial markets can be restored.”
This is not working out for Germany as it had hoped. Greece is keeping its cultural and hard assets for their own people and not passing on its heritage to Bankers.
Reminds me of the Roosevelt’s Lend for Bases Program to Great Britain during the WWII. Germany’s hardball playing made it harder for Greece to raise funds at reasonable rates in the market due to widening spreads. Perhaps that was precisely the Senior EU member’s strategy.
There must have been some logic behind the eagerness on EU’s part to admit Greek Cypriot in the Union while isolating the Turkish Cypriot community. Merkel is proposing “Priveleged Membership” and demands that Turkey open its sea and air ports to Greek Cypriot vessels.
And why is anyone paying attention to the Rating Agencies which have given Junk Status to Greek Bonds. As if these investment companies funded agencies have any credibility left since their Credit Default Swaps ratings.
Greece should not let anyone else own its Heritage sites. No amount of austerity measures on its part will be sufficient to please German Chancellor and the French President. Usually Economic policies are a subtle way of achieving other ambitions on behalf of undesirable parties.
Hi Paul, I think what the Greek (GIIPS) case partly illustrates is the degree to which regional Monetary Unions require strong Federal Governments that have the capacity to tax at the national level and redistribute to the regions (although did have a limited regional redistribution program). But the fact that the IMF has to be invited to the table shows the degree to which EMU is too politically brittle and fiscally constrained. Even if Merkel wanted to she cant’ bail out Greece because of the electoral dynamics. Imagine if Albertans could effectively use a veto against transfer payments to Newfoundland. The countries in the EMU are either going to have to tackle the problem of under-institutionalisation or throw the south to the wolves. If they do the latter then the EMU will be unmasked as what its critics claimed it was: an imperial device of largely France and Germany.
I am not sure I would agree on your last statement. I do believe at one point he EU was a good thing and maybe still is for progressive measure. For example, countries that joined the EU had to meet not only debt objectives, but also had to bring labour standards up to specific levels. Which from my readings had some significant policy net benefits for workers across the EU. It also served as a shelter I thought so that some kind of monetary protection away from IMF intervention could be afforded. That is a small countries such as Greece would not be held hostage to the IMF because of the EURO and its umbrella protection.
Today though it was announced that the EU along with the IMF are demanding actual paycuts to workers, but apparently just “bonuses” to these media personified over paid Greek civil servants- how pathetic I must say.
I was speaking about the EMU as opposed to the EU. And Yes there is a lengthy debate on the progressive and regressive aspects of the EU. But the EMU with its strong line on budget deficits, hawkish stance on inflation and weak fiscal capacity it has been widely argued the Euro was largely of benefit to the Germans and French.
As an aside, and interestingly, it is the French and German banks that are holding a significant chunk of the Greek Bonds. I do not know why the Greeks do not play a tougher game: a 50 percent haircut or ciao.
right my mistake.
I wonder if anybody in the IMF, EU, or elsewhere in Europe has been watching the films coming from Greece. It is uncanny that institutions that just relieved the global financiers of trillions in losses, now want to walk in and hand out pay cuts to workers in Greece.
It make me wonder, what would wall street bankers write on their rally placards if they all lost their bonuses and had their pay and pensions cut, ** assuming they did not own a whole pile of assets they could part with to keep the income up for a while.
And yes I am sure the Germans and others are upset for having to pay into the re-balancing of these imbalances. However, as you mention it is many of the Southern countries. (I refuse to use the acronym)
By letting it get this far without any action by members states leads me to believe this was not just by chance that we have a crisis here. If they wanted to stop this they could have at least put the brakes on this a while back and potentially kept it off the radar a bit more.
However, the costs are rising, and without some kind of miraculous recovery, this could be the end of the EMU and for that matter the EU.
Isn’t that somewhat similar to what happened in the 30’s- as imbalances started queuing up and festering, politically a reaction was born that had many unintended consequences- to a point that well we all know the history. There is a lurking danger here.
You can feel history and the failure to act and instead it just unfolds, like the tongue of a rattle snake.
“I wonder if anybody in the IMF, EU, or elsewhere in Europe has been watching the films coming from Greece. It is uncanny that institutions that just relieved the global financiers of trillions in losses, now want to walk in and hand out pay cuts to workers in Greece.”
That is the point, they already broke the bank to pay for the bank bailouts. You can see why the German citizenry might want not to be on the hook for Greece. Hence the SD’s demanding that the German and French Banks take a hair-cut. Problem is the banks already took a hair cut if they have to eat Greece their respective governments will have to bail them-out. It is totally out of control. Nobody thinks the Greeks can pay and everybody needs the Greeks to pay.
Pop the popcorn!
So maybe Greece should just go bankrupt. Bring in the liquidators! But what happens if Portugal, Spain and some of the others go the same way. The IMF and the Eu will not have the resources to save these.
So in the case of sovereign Bankruptcy, you would see a run on the Euro, interest rates climb, and eh lot. So what is worse for workers in Greece, they are already facing, pension benefit cuts, 20% or more pay cuts, public spending cuts, mass lay-offs, etc. Is this any worse than going bankrupt? At least with bankruptcy, you can clean the slate. Just like the corporations do, bankrupt and move elsewhere, so maybe Greece can be moved to say the high arctic or Greenland and start a brand new country and France and Germany and whoever else is owed can divide up the Inventory and assets.
If memory serves Argentina defaulted and then began the long process of negotiating just what percent of their debt they would pay, to whom and at what interest rate. The real politik of it is: creditors do not have armies countries do.
Now as Andrew pointed out (and as many others have) Greece does not have its own national currency. So a default would amount to government with a complete fiscal constraint. Spending would have to = tax receipts because the Greek government could not print money. And this would cause a serious bought of austerity. The question for the Greeks is simply which form of austerity would be less traumatic and would be most likely to free them from debt bondage.
I think these dynamics are well known by all the major players and that is why a firm deal has yet to be inked.