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A Euro theory

Giancarlo Elia Valori

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[yt_dropcap type=”square” font=”” size=”14″ color=”#000″ background=”#fff” ] I [/yt_dropcap]f it were not for the euro, Germany’s trade balance would have caused a revaluation of the Mark, which would automatically have reduced the exchange rates of the other “European currencies”, thus favouring them on international markets. The single currency was not created to stimulate exports and improve productivity.

In fact, for the first time, the then President of the European Economic Community, Roy Jenkins, proposed a common currency which, however, was also based on a common budget, equal to 10% of the sum of all Member States’ GDPs.

Initially the Euro was based on the “optimum currency area” theory developed by the Canadian economist, Robert Mundell, in 1961. It also rested on the fact that an economy open to international trade always tends to a low exchange rate.

Furthermore, as assumed by Mundell’s group of economists, in a highly diversified national economy the exogenous shock is always very limited.

This would lead a country open to trade and with a diversified economy to accept, in principle, a currency common to other countries.

Provided, however, that there is flexibility on the capital and labour markets and that its economy is very diversified and open to international trade.

However, to what extent can an economy be “diversified”? Does excess of diversification not lead – as natural – to a different and sometimes negative gain margin between products?

In Mundell’s model, the national currencies were described by the economic theory as simple barriers to international trade, as well as limits to productivity and finally obstacles blocking commercial transactions.

At that time, Jacques Delors and Romano Prodi theorized that – rebus sic stantibus – with the mere introduction of the Euro, the European economy would grow 1-1.5% per year.

Later Perrson and Nitsch proved that the econometric model used for those predictions was wrong, while other academics and experts studied the influence of the European monetary union on international trade.

Once again the analyses carried out on macroeconomic data demonstrated that the assessment of the benefits resulting from the single currency had been greatly exaggerated.

Obviously, for political purposes, economics is not so much a “sad science”, but rather rhetoric used to convey political and social messages and choices.

According to these more realistic models, the monetary union was responsible only for a 4.7-6.3% increase in foreign trade, while the most pessimistic forecasts of the first analyses on the Euro-induced growth pointed to a 20% or even a 200-300% increase in international trade.

We have always known that economics is ideology in disguise.

In other words, the Euro does not change international trade transactions, but rather tends to change competitive pricing.

Furthermore, there is no factual evidence of a stable structural difference between foreign trade and exchange rate.

Moreover, according to the International Monetary Fund, a 10% decline of the exchange rate leads to a 1.5% average increase of GDP.

Yet another demonstration of how a healthy and sound devaluation is good for international trade.

The persistently “high” single currency has also hampered recovery in the Eurozone countries, while other European countries, such as Sweden, could quickly rebuild their economy.

This implies that the Euro could do nothing to avoid the crisis, except in Germany, where the per capita GDP has been growing incessantly since 1999.

As to investment in fixed assets, only France, Belgium and Finland have been successful.

Portugal and Greece have fallen to the levels of fixed capital investment of the 1980s, while per capita fixed capital investment (housing, infrastructure, roads, railways, airports, machinery, etc.) has levelled off since 1999.

With the Euro introduction, investment in infrastructure was put to an end.

Furthermore, as repeatedly noted, the crisis of the single currency and of the Eurozone began with Greece’s tragic situation.

Greece is worth almost 3% of the Eurozone GDP and the banking crisis following tension in Greece, at first, and later in Spain, Germany and Italy, cannot be solved with the EU banking union, but only with the action of individual governments.

The signal to international markets is clear: if the Euro is hit with a speculative action, the Eurozone individual countries shall try to solve it, with their limited resources.

With its crisis Greece has later demonstrated that monetary and credit tensions in each country of the single monetary area are never supported by the rest of the Eurozone – as would happen in any real monetary union – but the country in trouble is blamed for being “spendthrift”. The result is that the other Eurozone countries buy the assets of the nation in crisis below cost.

In fact, the single currency works only in really federal States, such as India or the United States, where the internal market and financial networks are wide and can manage the income gap between the various regions of the country.

If we were to support the economies of Italy, Greece, Spain and Portugal, the cost of recovery for these four countries would be 260 billion euro per year for ten years.

Hence the issue does not lie in Germany being wicked, but in the fact that the Euro has been conceived and designed badly and leads to crisis the countries which do not adjust their domestic economy to a structurally and unreasonably overvalued currency.

And in these cases, monetary expansion combined with economic “austerity” does not solve the problems.

Public spending and discretionary spending, as well as wages and salaries and, in some respects, even profits are now regulated by the Solidarity Pacts of 2011, in addition to the Treaty on Stability, Coordination and Governance signed in 2012.

They are inter-European agreements prohibiting the redistribution of funds within the EU. They were signed upon German pressure and it is worth recalling that Germany cannot objectively take upon itself the cost for restructuring Southern countries’ debt.

Indeed, we could devalue the Euro.

Nevertheless the relations between the Eurozone members would not change and Germany would gain even more from a devalued Euro.

Therefore the only way then to change the exchange rate between the various countries of the single currency is not to devalue the Euro, which is based on fixed exchange rates established ne varietur in 1999, but just leave the Euro area.

Furthermore, considering the differences of economic integration in the Eurozone, if the single currency were devalued, the least integrated country, namely France, would gain much more than the others.

It is worth making clear that it would be a gain at the expense of the Euro Mediterranean countries.

It would be tantamount to go back with the Euro to the old gold standard of the 1930s, with the Euro: either it is fully dissolved or you decide to leave.

In this sense, the single currency is a severe loss of economic flexibility in the relationship between inflation, productivity and public debt.

Relations between macroeconomic values which can be manipulated for the better only in a national context, given that the EU still records very significant micro and macroeconomic differences.

It should be noted that the impasse resulting from the gold standard led to the Great Depression after the 1929 crisis.

At the beginning of the Great Depression, Germany and Great Britain tried an internal devaluation, but in these cases, if there is a fixed monetary standard, devaluation only means domestic deflation.

Considering price rigidity, unchanged financial costs and the money supply restriction, any policy of this kind finally makes both politics and society unmanageable.

What about leaving the single currency?

Meanwhile, it is worth recalling that, in international financial law, what matters is not the lender’s nationality, but rather the law applicable to the contract.

If, for example, the debt were regulated by French law, regardless of the parties’ nationality, the payment should be made in the French national currency.

Moreover, statistics throughout the single currency EU tells us that the private debt would not be affected by the transition to the new Franc, Lira, Peseta, etc.

According to the studies of the Bank for International Settlements, which has already analysed these issues, the cost to be borne by EU countries for leaving the single currency would be approximately 5 billion euros – a figure that can be easily managed by everybody.

Hence, after the end of the Euro, the EU countries could appreciate or devalue their currencies, by offering competitive prices and thus recreating precisely those competitive advantages which had been basically removed by the single currency.

In this way the German Mark would surely appreciate as against the Lira and the Peseta, thus favouring the Southern countries’ currencies and making the huge German trade surplus disappear, as if by magic.

Probably this is the best prospect and the best way forward.

Advisory Board Co-chair Honoris Causa Professor Giancarlo Elia Valori is an eminent Italian economist and businessman. He holds prestigious academic distinctions and national orders. Mr Valori has lectured on international affairs and economics at the world’s leading universities such as Peking University, the Hebrew University of Jerusalem and the Yeshiva University in New York. He currently chairs "La Centrale Finanziaria Generale Spa", he is also the honorary president of Huawei Italy, economic adviser to the Chinese giant HNA Group and member of the Ayan-Holding Board. In 1992 he was appointed Officier de la Légion d'Honneur de la République Francaise, with this motivation: "A man who can see across borders to understand the world” and in 2002 he received the title of "Honorable" of the Académie des Sciences de l'Institut de France

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U.S. policy and the Turkish Economic Crisis: Lessons for Pakistan

M Waqas Jan

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Over the last week, the Turkish Lira has been dominating headlines the world over as the currency continues to plunge against the US dollar. Currently at the dead center of a series of verbal ripostes between Presidents Donald Trump and Recep Tayyip Erdogan, the rapidly depreciating Lira has taken center stage amidst deteriorating US-Turkey relations that are wreaking havoc across international financial markets. Considering Pakistan’s current economic predicament, the events unfolding in Turkey offer important lessons to the dangers of unsustainable and unrealistic economic policies, within a dramatically changing international scenario. This holds particular importance for Pak-US relations within the context of the impending IMF bailout.

In his most recent statements, Mr. Erdogan has attributed his economy’s dire state of affairs as an ‘Economic War’ being waged against it by the United States. President Trump too has made it evident that the latest rounds of US sanctions that have been placed on Turkey are directly linked to its dissatisfaction with Ankara for detaining American Pastor Andrew Brunson. Mr Bruson along with dozens of others has been charged with terrorism and espionage for his purported links to the 2016 attempted coup against President Erdogan and his government.  There is thus a modicum of truth to Mr. Erdogan’s claims that the US sanctions are in fact, being used as leverage against the weakening Lira and the Turkish economy as part of a broader US policy.

However, to say that the latest US sanctions alone are the sole cause of Turkey’s economic woes is a gross understatement. The Lira has for some time remained the worst performing currency in the world; losing half of its value in a year, and dropping by another 20% in just the last week. Just to put the scale of this loss in to perspective, the embattled currency was trading at about 2 Liras to the dollar in mid-2014. The day before yesterday, it was trading at about 7 Liras to the dollar.

While the Pakistani Rupee has also depreciated quite considerably over the last few months, its recent drop (-17% against the dollar over the past 12 months) pales in comparison to the sustained and exponential downfall of the Lira. Yet, both the Turkish and Pakistani economies are at a point where they are experiencing an alarming dearth of foreign exchange reserves that have in turn dramatically increased their international debt obligations.

The ongoing financial crises in both Turkey and Pakistan are similar to the extent that both countries have pursued unsustainable economic policies for the last few years. These have been centered on increased borrowing on the back of overvalued currencies. While this approach had allowed both governments to finance a series of government investments in various projects, the long term implications of this accumulating debt has now caught up with them dramatically. As a result, both countries may soon desperately require IMF assistance; assistance, that in recent times, has become even more overtly conditional on meeting certain US foreign policy requirements.

In the case of Pakistan, these objectives may coincide with recent US pressures to ‘do more’ regarding the Haqqani network; or a deeper examination of the scale and viability of the China- Pakistan Economic Corridor. With regards to the latter, US Secretary of State Mike Pompeo has clearly stated that American Dollars, in the form of IMF funds, to Pakistan should not be used to bailout Chinese investors. The rationale being that a cash-strapped Pakistan is more likely to adversely affect Chinese interests as opposed to US interests in the region at the present. The politics behind the ongoing US-China trade war add even further relevance to this argument.

In the case of Turkey however, which is a major NATO ally, an important emerging market, and a deeply integrated part of the European financial system, there is a lot more at stake in terms of US interests. Turkey’s main lenders comprise largely of Spanish, French and Italian banks whose exposure to the Lira has caused a drastic knock on effect on the Euro. The ensuing uncertainty and volatility that has arisen is likely to prove detrimental to the US’s allies in the EU as well as in key emerging markets across South America, Africa and Asia. This marks the latest example of the US’s departure from maintaining and ensuring the health of the global financial system, as a leading economic power.

Yet, what’s even more unsettling is the fact that while the US is wholly cognizant of these wide-ranging impacts, it remains unfazed in pursuing its unilateral objectives. This is perhaps most evident in the diminishing sanctity of the NATO alliance as a direct outcome of these actions.  After the US, Turkey is the second biggest contributor of troops within the NATO framework. As relations between both members continue to deteriorate, Turkey has been more inclined to gravitate towards expanding Russian influence. In effect, contributing to the very anti-thesis of the NATO alliance. The recent dialogues between Presidents Erdogan and Putin, in the wake of US sanctions point markedly towards this dramatic shift.

Based on the above, it has become increasingly evident that US actions have come to stand in direct contrast to the Post-Cold War status quo, which it had itself help set up and maintain over the last three decades. It is rather, the US’s unilateral interests that have now taken increasing precedence over its commitments and leadership of major multilateral frameworks such as the NATO, and the Bretton Woods institutions. This approach while allowing greater flexibility to the US has however come at the cost of ceding space to a fast rising China and an increasingly assertive Russia. The acceleration of both Pak-China and Russo-Turkish cooperation present poignant examples of these developments.

However, while it remains unclear as to how much international influence US policy-makers are willing to cede to the likes of China and Russia over the long-term, their actions have made it clear that US policy and the pursuit of its unilateral objectives would no longer be made hostage to the Geo-Politics of key regions. These include key states at the cross-roads of the world’s potential flash-points such as Turkey and Pakistan.

Therefore, both Turkey and Pakistan would be well advised to factor in these reasons behind the US’s disinterest in their economic and financial predicaments. Especially since both Russia and China are still quite a way from being able to completely supplant the US’s financial and military influence across the world; perhaps a greater modicum of self-sufficiency and sustainability is in order to weather through these shifting dynamics.

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Social Mobility and Stronger Private Sector Role are Keys to Growth in the Arab World

MD Staff

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In spite of unprecedented improvements in technological readiness, the Arab World continues to struggle to innovate and create broad-based opportunities for its youth. Government-led investment alone will not suffice to channel the energies of society toward more private sector initiative, better education and ultimately more productive jobs and increased social mobility. The Arab World Competitiveness Report 2018 published by the World Economic Forum and the World Bank Group outlines recommendations for the Arab countries to prepare for a new economic context.

The gap between the competitiveness of the Gulf Cooperation Council (GCC) and of the other economies of the region, especially the ones affected by conflict and violence, has further increased over the last decade. However, similarities exist as the drop in oil prices of the past few years has forced even the most affluent countries in the region to question their existing social and economic models. Across the entire region, education is currently not rewarded with better opportunities to the point where the more educated the Arab youth is, the more likely they are to remain unemployed. Financial resources, while available through banks, are rarely distributed out of a small circle of large and established companies; and a complex legal system limits access to resources locked in place and distorts private initiative.

At the same time, a number of countries in the region are trying out new solutions to previously existing barriers to competitiveness.

  • In ten years, Morocco has nearly halved its average import tariff from 18.9 to 10.5 percent, facilitated trade and investment and benefited from sustained growth.
  • The United Arab Emirates has increased equity investment in technology firms from 100 million to 1.7 billion USD in just two years.
  • Bahrain is piloting a new flexi-permit for foreign workers to go beyond the usual sponsorship system that has segmented and created inefficiencies in the labour market of most GCC countries.
  • Saudi Arabia has committed to significant changes to its economy and society as part of its Vision 2030 reform plan, and Algeria has tripled internet access among its population in just five years.

“We hope that the 2018 Arab World Competitiveness Report will stimulate discussions resulting in government reforms that could unlock the entrepreneurial potential of the region and its youth,” said Philippe Le Houérou, IFC’s CEO. “We must accelerate progress toward an innovation-driven economic model that creates productive jobs and widespread opportunities.”

“The world is adapting to unprecedented technological changes, shifts in income distribution and the need for more sustainable pathways to economic growth, “added Mirek Dusek, Deputy Head of Geopolitical and Regional Affairs at the World Economic Forum. “Diversification and entrepreneurship are important in generating opportunities for the Arab youth and preparing their countries for the Fourth Industrial Revolution.”

With a few exceptions, such as Jordan, Tunisia and Lebanon, most Arab countries have much less diversified economies than countries in other regions with a similar level of income. For all of them, the way toward less oil-dependent economies is through robust macroeconomic policies that facilitate investment and trade, promotion of exports, improvements in education and initiatives to increase innovation and technological adoption among firms.

Entrepreneurship and broad-based private sector initiative must be a key ingredient to any diversification recipe.

The Arab Competitiveness Report 2018 also features country profiles, available here: Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, United Arab Emirates.

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The impact of labour market trainings on unemployment process in the global labour economy

Gunel Abdullayeva

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Since the 1990s, the persistence of high unemployment has been followed by two downturns, which affected an economic life over the world across the nation-states. The overt consequences cost unpleasantly social and economic outcomes for the states as well as societies. Henceforth, activation turn has observed once more shifting passive employment policies within the active policy actions of countries upon labour market at the beginning of a new millennium. It was supposed that the activation of jobless people through keeping employees occupied, job-search assistance, job creation and work experience programs, training and invest in up skilling, is an open way to fight against high unemployment and secure economic growth as well. Hereby, the idea of an active labour market policy (ALMP) became again pivotal tool in the domestic policy agendas of states in order to engage in new challenges of labour markets. Since the 1950s,it is an apparent fact that in Europe and the Nordic countries that the effectiveness of ALMPs engenders diminution in a structural and long-term unemployment and leads to increase net income together with the employment ratio of targeted groups in national economies.

With the XXI century’s new technological vicissitudes and industrialization, the active employment policies have been designed to support people with monetary (income) and non-monetary (education) incentives in order to reduce inequality, keep the balance of social inclusion, and stimulate market beyond to decrease unemployment. Consequently, labour market training grew into to become an important measure of ALMP strategies in the background of “welfare to workfare policy approach” to create better-skilled workforce as well as to surge adequate match between skilled manpower and needs of progressive demand in labour markets.

In fact, the scholarly studies state significant impacts of training and vocational programs in the activation of the workforce. For example, the 1950-1960s – Post War Era characterized with the rapid economic growth and labour supply shortage in the European industry. And as a solution, national employment policies started to focus on labour trainings. So that Sweden with its successful retraining system has been the pioneer of ALMP idea in the history. On the other hand, Germany with 1969`s Employment Promotion Act considered training as a principal component of active employment policies to upskill workforce in terms of new industrial needs by market demand.

The UN 2009 reports that education is considered one of the main indicators of poverty reduction: education and human resource investments contribute to an economic development of nation-states and societies. Higher educated people or up-skilled workforce boost up productivity and react the positively to technological changes. Some scholars and interlocutors claim that in long-term perspectives ALMPs should have to aim to develop an education and training system that enhances the productivity and employability of a labour force. Because of the fact that the skilled manpower is one of the cornerstones of the higher employment, developed economy, higher net income and well-being of the whole society.

Many types of research have been carried out to identify the prominence of labour market training, however, the Katz`s study (1993) shows the significant point of job market training as turning “unskilled labour” into “skilled labour”. Perceptibly, the unemployment problem is more common among less skilled individuals and new entrants to the market. Shifting in demand against unskilled labour force causes an unemployment among those people. In contrast to unskilled force reservation wage and labour demand is high for skilled manpower in the market. Here, the training policy helps turn out unskilled to a skilled workforce and to increase total employment in order to decrease unskilled unemployment. Research argues that training policy extends the skilled labour force and close the gap between the unskilled and skilled workers. Caruana and Theuma (2012) refer to Katz (1993) argue that in order to push jobless people towards work, some trainings improve the qualification of those workers who are already in the market. Hence, Katz (1993) emphasizes the importance of labour market training in reducing the unemployment rate of unskilled labour by transferring more workers to the skilled labour pool. They also underline the significant role of a training policy in improving the skills of employees and increasing, the supply of skilled manpower in the economy. The following figure “Development of Unskilled Labour Force” visualizes Katz`s statement andshows how training measure affects the job market in both ways. The points where demand curves intersect supply curves, which are given wages for skilled and unskilled labour respectively. As the author explains, the wages represent the remuneration of foregone opportunity costs that, logically, is higher for skilled labour than for unskilled one. Since labour demand for the skilled labour is stronger than that of unskilled labour, thus, the demand curve for the former one is more elastic. As the figure illustrates, after the implementation of training, part of unskilled labour is moving up to the skilled.

At the same time, scholar states that wage setting regulation, training, and education systems affect differently net income and employment perspectives. Consequently, education and labour training policies create an equal distribution of skills and able to reduce supply and demand shifting on wages and employment. Another study by Calmfors et al., (2001) argue that training programs increase the reservation wage of attendees. However, salary growth and employment perspectives are possible by time after long run participation in the program.

To sum up, the training policy is considered as a main supply-side policy tool of activation to tackle unemployment. Scholars argue that training programs are useful to prevent the long run unemployment and to keep unemployed active in the market via participation. However, ex-post evaluation of training programs is controversial. Country case studies show that training programs are more effective in the background of vocational education reforms and collaboration with demand-side active labour market policies.

Reference list:

  • , Forslund A., &Hemstrom M., (2001), Does Active Labour Market Policy Work? Lessons from Swedish experiences, Swedish Economy Policy Review, 85, 61-124
  • Caruana C. &Theuma M., (2012), The next leap – From Labour Market Programmes to Active Labour Market Policy.
  • Katz, F.L., (1993), Active Labor Market Policies to Expand Employment and Opportunity.
  • United Nations, (2009), Rethinking Poverty: Report on the World Social Situation 2010, Retrieved from http://www.un.org/esa/socdev/rwss/docs/2010/fullreport.pdf
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