by Tito Boeri
The leaders of the eurozone finally agreed on a plan. It is a very ambitious rescue plan, as it should be, to stop the self-fulfilling prophecies that brought us to the brink of another Great Depression. But the plan should now be made acceptable also to European citizens.
In the next couple of weeks we shall see how effective these extreme measures are in reducing the spread between Euribor and the ECB refinancing rate. If they are successful, there will be no need to implement these measures. If they are not, public debts in the eurozone are bound to skyrocket. If they only partly succeed in reassuring markets, there will be sizeable outlays to the banking sector. The insurance on the interbank market is potentially very costly – before the crisis the overnight volumes in many Euro countries were of the order of 1-2 per cent of gross domestic product – while the bank recapitalization plans commit so far up to 20 per cent of the eurozone GDP and this share is bound to increase further as national plans are unveiled and countries are forced to raise capital to match the core tier one levels of UK banks (too bad that there was no cross-country co-ordination in this respect!).
Is public opinion in the EU ready to accept such potentially massive transfers of resources from the taxpayer to the banking sector? True, it is mainly gross debt that will increase. By selling assets later on, net public debts may actually go down when the crisis is over. It is also true that in saving the banking system we ultimately save our economies and million of jobs. Nonetheless, there is a non-negligible risk that plans committing large resources to bank rescues will find strong opposition in national parliaments.
Paradoxically, the opponents to “bank socialism” will come mainly from the ranks of the former supporters of the socialisation of the means of production. So far the crisis has contributed to reduce wealth inequalities in Europe. This is due to the relatively low participation of households in financial markets and the relatively low take-up of pension schemes. Based on micro data on wealth assembled in the Luxembourg Wealth Study project, it can be estimated that a reduction of 40 per cent of stock prices significantly reduces wealth of about 6 per cent of Italian families, compared with almost 30 per cent of families in the US. The average wealth loss for those hit by the fall in stock prices is also lower in Italy (roughly 5 per cent compared to almost 10 per cent in the US). No doubt, measures dealing with the stock market crash will be perceived as measures benefiting the top deciles, Wall Street against Main Street, and this even more so in Europe than in the US.
Another reason why these measures will be hard for public opinion to swallow is that the eurozone package postponed much-advertised measures to “punish the bankers”. There is a clear sequencing in the international package: first, rescue financial systems in order to restore confidence in the markets; next, work on avoiding that all this happens again. This was the right thing to do. Mixing up the two phases could backfire, as the priority is currently to anchor expectations to a scenario without domino effects like those that followed the failure of Lehman Bros. However, are European citizens ready to accept measures rescuing banks, giving public money to bankers while deferring the punishment for those who were earning up to $50m (Richard Fuld’s compensation in 2007) and for banks that were before the crisis making profits amounting in some cases (e.g. Unicredit and Banca Intesa) to almost 0.5 per cent of GDP? Are they ready to accept all this after having observed in the last ten years a huge increase of income inequalities driven by the richest 1 per cent of the population (whose share in total income more than doubled in countries like the US)?
Economists have, in the last few weeks, been rather successful in inducing governments to come to terms with the financial crisis. At times of extraordinary politics, they were taken extraordinarily seriously by policymakers, forcing many of them (including George Bush and Angela Merkel) to make embarrassing U-turns. Economists should now be equally effective in addressing the political constraints to the rescue plans and devising ways to involve European citizens in the benefits of this plan. Here are three options to be considered.
First, there is an alternative way to punish banks and bankers that can be operated immediately: increasing competition in the banking sector. After experiencing a major liquidity crisis, banks will compete more to attract savings from the households. Removing barriers to competition in the retail sector is important for this competition to drive down profit margins and improve services for citizens. More contestability should also be allowed. Ms Merkel’s initial reluctance to accept a European initiative stemmed from a fear that other countries might get their hands on German banks. The way out of the crisis will involve a fair amount of bank restructuring. National protections against mergers and acquisitions could severely hamper this process and hence should be removed as soon as possible.
Second, governments have not been at all active in Europe in providing support to low-income families with mortgages. True, the problems are not as acute as in the US, but the increase in Euribor rates (to which often monthly mortgage rates are indexed) is significantly increasing the number of poor families facing difficulties in meeting their payments. Temporary relief schemes for these families should be devised as long as the rates decline. They should be narrowly targeted to minimize costs and moral hazard problems applied to a large population, but they should be implemented.
Third, there is also scope for implementing tax reductions for low-wage earners. These measures would kill two birds with one stone. They would increase popular perception of progressiveness in taxation, thereby reducing opposition to the iniquities of bank socialism. At the same time, they would help anchor expectations of a moderate output fall: the current lack of confidence is also driven by the belief that the crisis will now spread to firms and households, leading to a deflationary trap. Tax deductions for low-income earners have the advantage of acting on both sides, demand and supply. They increase demand as they target the households with the highest propensity to consume and increase supply because induce more people to work without increasing companies’ labour costs. As these measures could reduce the informal sector, they would also have a limited impact on the budget.