FutureChallenges

Bertelsmann Stiftung (ed.)

Latin America and Europe in ConversationFuture Challenges authors respond to “Surviving a Debt Crisis: Five Lessons for Europe from Latin America”

Future Challenges authors respond

The economic and political crisis Argentina experienced in 2001 and 2002 has been described as the worst since the country’s independence. Around 1900, Argentina, to all appearances, was one of the richest countries in the world. A

hundred years later, no one could imagine of how the country would ex-tricate itself from its economic black hole. Yet twelve years after the default and ten years since Néstor Kirchner became president, Argentina is a vi-brant, growing country.

Today, Greece is facing one of the most difficult times in its history. And despite the differences between Greece and Argentina, the countries have in common the experience of grave economic crisis.

Crisis breeds creativity, so it’s no sur-prise that when confronted by eco-nomic collapse, Argentinians came up with innovations to help them sur-vive day to day. A great example is the unofficial dólar blue. Yes, in Argen-tina the dollar is blue—or black, if you prefer. In other words, there is a black market exchange rate between US dollars and pesos called dólar blue or dólar negro. And the website www.

dolarblue.net enables Argentineans to compare the official and unofficial ex-change rates. Officially, the exchange rate is approximately five pesos to one US dollar versus 8.5 pesos to the dollar for the dólar blue.

Despite a 25 percent per year inflation rate and significant political divisions, Argentina had a real GDP growth rate of 2.6 percent in 2012, 8.9 percent in 2011, and 9.2 percent in 2010 according to the CIA World Factbook. Beyond economic issues, Argentina now recognizes gay marriage and, in the past few years, has begun prosecuting former government officials for human rights abuses during the dictatorship.

Thus, despite its current problems, Argentina has managed to bounce back. And Greece can too. Greece may not have a region like the Pampas to grow soy-beans and raise livestock, or China and Brazil as its main export partners. But Greece has people—and one of the great histories of mankind. If Plato and Ar-istotle were here today, they would likely be humble enough to admit that Greece stands to learn a lot from Argentina.

Foreword

This pamphlet is a complement to the paper

“Surviving a Debt Crisis: Five Lessons for Europe from

Latin America” by Samuel George of the Bertelsmann

Foundation in Washington, DC. In Mr. George‘s paper,

he argues that the experiences of Latin American

countries in previous decades provide valuable lessons

for the European Union as it struggles to emerge from

its own debt crisis. Five bloggers from Europe and

from Latin America, all writers for the Bertelsmann

Foundation’s “Future Challenges” platform

(www.futurechallenges.org), responded to Mr. George‘s

ideas. Each incorporates his or her own experience and

knowledge, and their responses help to bring further

nuance and detail to the paper, as well as to illuminate

potential points of argument. We hope you’ll enjoy

perusing this collection.

Argentina and Greece: A Shared HistoryYohana de Andrade

Yohana is a Bra-zilian journalist, interested in international re-lations, human rights, feminism and anything re-lated to “minori-ties. ” Her hobby is to learn new languages and, after living in São Paulo, Wash-ington, D.C. and Buenos Aires, her dream is actually to live in a bor-derless world.

Cover photo:http://ow.ly/lRUFy Breakfast ConversationPhoto by Roey AhramCC BY-NC-ND 2.0

http://www.flickr.com/photos/maha-online/64458832/Aristotle – Photo by flickr user “maha-online” – CC BY-SA 2.0

3Latin America and Europe in Conversation

By contrast, as an imperfect currency union, the EU cannot implement a one-size-fits-all monetary policy that would help the peripheral states boost their exports while safeguarding the core’s stability. Moreover, peripheral Europe lacks endogenous growth factors: it is neither competitive nor innovative nor endowed with rich natural resources. It also has far less potential for growth than did the Latin American countries, and, to top it all off, it is facing much fiercer global competition from emerging markets.

So how can Europe restore healthy, cohesive growth within both the core and peripheral states? The strategic vision is clear: more EU.

Achieving true integration means advancing a political union that goes hand in hand with an expanded fiscal union. And yes, Berlin, this will involve fiscal transfers. If the goal is maintaining the union, the underlying principle must be solidarity. The EU has such massive inequalities (member states’ GDPs per capita range from EUR 8,000 to EUR 35,000) that it can hardly be called a union—and it certainly cannot function like one. The EU budget, which includes structural and cohesion funds, comprises less than one percent of the EU’s GDP. The EU either needs to greatly increase its budget (problematic due to management challenges) or do the (politically) undoable and create Euro-bonds.

In addition, painful and unpopular structural reforms must continue: imple-menting genuine, full labor mobility within the EU; increasing the pension age; investing in attracting and retaining the most brilliant minds of the Con-tinent through support for research, development, and innovation; boosting public sector productivity; and implementing the Single European Market in-stead of merely paying it lip service.

Throughout the various mini-crises Europe has been muddling through since 2009, there have been several apparent “make it or break it” moments. At pres-ent, we can only hope there won’t be a second Cyprus before we start to ac-knowledge the truth.

The Big Puzzle: How to Restore Growth in Europe?Corina Murafa

Corina Murafa holds an MPP from the Hertie School of Gover-nance in Berlin. An energy expert, Corina’s current work in Romania was preceded by stints with the United Nations Development Pro-gramme, with Deloitte consult-ing, and with the Romanian Academic Society. She is a former Open Society Fellow (New York University) and is currently an asso-ciate fellow for the Aspen Insti-tute Romania as well.

http://ow.ly/lRVfF PuzzledPhoto by Kate Ter Haar CC BY 2.0

There are lessons the European Union can learn from the debt crises that plagued Latin America in the late 1980s and early 2000s. In “Surviving a Debt Crisis,” Samuel George of the Bertelsmann Foundation illustrates five of them, some of which the EU would undoubtedly be wise to follow: make austerity part of a larger consolidation strategy and not an end in itself; accept an orderly partial default within a clear-cut framework; beware of backlash (i.e., anti-sys-tem parties seizing political power while riding on the nationalistic and popu-list feelings of an electorate fed up with austerity). What Europe cannot learn from Latin America, however, is the alpha and the omega of any continuation of the European construction: how to restore growth.

Indebted Latin American countries managed to restore growth and regain com-petitiveness primarily because of their freedom to engage in independent na-tional monetary policy. In other words, they devalued their currencies so as to make their exports competitive. They also benefited from abundant natural re-sources, ample export markets, cheap labor, and a high potential for growth.

5Latin America and Europe in Conversation4 Latin America and Europe in Conversation

Luciano has been working in financial markets since 2001, in-cluding time as an analyst/ econ-omist at Banco Santander and a partner/ portfo-lio manager at FRAM Capital. He holds a BA in Economics from the University of São Paulo and will start the MPA/ID program at the Harvard Kennedy School of Government in August 2013.

Capital Sin: What European Banks Can Learn from Latin America’s ExperienceLuciano Sobral

In 2011, Georgetown University professor Jay C. Shambaugh wrote a superb paper called “The Euro’s Three Crises.” The three crises he identified are a growth crisis, a sovereign debt crisis, and a banking crisis, all of which are in-terconnected and and which feed each other. Samuel George did not address the third of these crises in his paper, but the banking crisis is a significant part of the Eurozone’s problems, and it has important parallels to the Latin Ameri-can banking crises of the 1990s.

The chart below gives dimension to the problem: The vertical axis shows the domestic credit provided by the banking sector as a percentage of GDP. The horizontal axis shows bank capital in proportion to total banking assets. Euro countries are the red diamonds. Data shows that in most euro countries, bank-ing systems are both very large in relation to the size of their respective econ-omies and have a small capital to assets ratio (compared, for example, to the Eastern European and Latin American countries shown at the bottom-right por-tion of the chart). In short, relatively small write-downs in assets could destroy the entire capital base of European banks, and recapitalization would be costly as a fraction of the total economy.

This problem is too large to be ignored—and of course European authorities are not overlooking it. However, they have been choosing to act reactively, tack-ling crises in an ad hoc mode as they emerge and relying on cheap funding and steep yield curves as a long-term capitalization plan. This strategy looks similar to what Japan has been doing since its financial markets imploded more than twenty years ago. In that case, the results were “zombie” banks and companies that were constantly repairing their balance sheets and unable to deliver profits—and a stagnated economy always flirting with deflationary risks.

Two large banking crises in Latin America were solved in a different way, with results that look more auspicious. The first example is Mexico following the 1994 currency crisis. Mexican banks were privatized in 1991–92, only to be crushed by a combination of currency devaluation and economic contraction three years later. The government acted quickly, offering liquidity windows, buying non-performing loans, and injecting new capital—at a total cost of 14.4 percent of GDP. As a result, a group of eighteen privatized banks was reduced to ten, with half of the controlling capital changing hands. Since then, the cap-ital to assets ratio has remained relatively high, and the country weathered the most recent global downturn without widespread banking problems.

In Brazil, the currency stabilization of 1994 exposed solvency problems in sev-eral banks that had been obscured by permanently high inflation and loose su-pervision. In 1995, the government responded by launching the Program of In-centives for the Restructuring and Strengthening of the National Financial System (“PROER,” for the name in Portuguese). PROER insured depositors and split problematic institutions into “good banks,” which were acquired by healthy institutions, and “bad banks,” which were liquidated. The program cost around 2.7 percent of GDP and left Brazil with one of the strongest banking systems in the world.

In both Mexico and Brazil, control of banks changed hands, punishing incom-petent shareholders; new capital was injected at a cost to national treasuries; depositors were not hit; and some banks were closed for good. The result in both countries is more concentrated but better regulated and capitalized bank-ing systems, both of which emerged nearly unscathed from the biggest global crisis in almost a century. These countries’ responses should serve as exam-ples and frameworks for future actions in Europe.

http://www.flickr.com/photos/worthbak/3093937818/Global Economic CrisisPhoto by flickr-user “worthbak”CC BY-NC-SA 2.0

CyprusMedian = 6.4

Median = 142

Bank capital to assets ratio (%)

Domestic credit as a % of GDP vs capital-to-assets ratio

Dom

estic

cre

dit p

rovi

ded

by b

anki

ng s

ecto

r (%

of G

DP)

350

300

250

200

150

100

50

00 6 8 10 12 14 16

Japan

Spain

Portugal

Italy

Austria

Greece

SloveniaEstonia

FinlandBelgium

GermanyFrance

Netherlands

Luxembourg

United Kingdom

DenmarkSwitzerland

Sweden

India Chile Poland

Mexico

Eurozone non-Eurozone

Brazil

Turkey

Russian Federation

United States

South Africa

AustraliaChina

Argentina

Risks to national banking sectors in and out of the Eurozone

Source: World Bank, 2010

http://data.worldbank.org/indicator/FB.BNK.CAPA.ZS, http://data.worldbank.org/indicator/FS.AST.DOMS.GD.ZS/countries

7Latin America and Europe in Conversation6 Latin America and Europe in Conversation

Policies and Politics of AusterityLuis Felipe Morgado

Luis Felipe Morgado lives in São Paulo, where he works in busi-ness intelligence and risk consult-ing. He is pas-sionate about the intersection of ethics, business and governance in developing countries. He is also an avid trav-eler and writer.

http://www.flickr.com/ photos/eurocrisisexplained/ 7811043664/Euro Debt Crisis Word Cloud—Black and WhitePhoto by flickr-user “EuroCrisisExplained.co.uk”CC BY 2.0

There are several leitmotifs in Europe-related world media as of late. The key words have been crisis, depression, and, with growing frequency since early 2011, austerity. From Le Monde to the Economist, austerity has been discussed, explained, and alternatively disdained or revered by numberless authors. The study of economics during this crisis means an ever-changing understanding of “austerity economics,” yet it is underpinned by one constant observation: there is a disconnect between austerity policies and the politics of austerity.

Austerity as an economic policy is part of wider body of knowledge related to fiscal policy, public finance, and economic history. It relies on econometric models measuring the impact of the fiscal multiplier (the tradeoff between gov-ernment expenditure and growth) and on the observation of past economic events. The most relevant past event for Europe is the Latin American debt cri-sis, which has inspired a number of economists and served as a laboratory for improving the understanding of debt crises.

Austerity politics, on the other hand, go beyond this technical, almost scien-tific, scope. They derive from democratic aspirations of the populace toward development and economic welfare and from the political game that plays out among the elected government, opposition, and civil society. In Europe’s case, there are many governments involved, including foreign governments, mak-ing the politics of austerity less a reflection of the austerity policies’ merits than of interests and frustrations from Berlin to Lisbon.

At the time of the Latin American debt crisis, there was little precedent to draw upon, and the few other debt crises of modern times were not well understood. The economics of public finance were incipient and lacked empirical studies. The idea that austerity policies were the best way to deter a debt crisis was de-

1 http://theirelandinstitute.com/citizen/c04-miranda-molina-page.html 2 http://www.economist.com/node/21553464 3 http://www.huffingtonpost.com/2013/04/10/joseph-stiglitz-austerity_n_3048330.html 4 http://krugman.blogs.nytimes.com/2013/03/10/the-imf-on-the-austerity-trap/ 5 http://www.economist.com/node/215534646 http://www.newyorker.com/online/blogs/comment/2012/12/austerity-economics-doesnt-work.html

fended mainly by the International Monetary Fund1, with few dissonant voices in academia or policy circles. Thus, opposition to austerity emerged mostly from non-policy actors, including civil society organizations and politicians who saw the effects of austerity as undesirable for the citizens of Latin American coun-tries. In the fight against austerity in Latin America, politics outweighed policies.

By contrast, in response to the European debt crisis, numerous economists have underscored the negative effects of austerity policies with studies and data. Paul Krugman2 and Joseph Stiglitz3, for instance, have become well-known names. Politicians opposing austerity quote figures from studies, some specifically about Latin America’s experience. Even the IMF itself4 has come to question austerity policies not only in terms of their effect on growth but also as a strategy for breaking out of a debt crisis.

These facts suggest that austerity politics are being enriched by an understand-ing of the policy, thereby giving Europe a clearer path to recovery. While some conservative politicians and institutions continue to defend austerity in the name of politics, their voices are diminishing5. Meanwhile society at large de-mands numbers, concrete answers, and quick action.

After failing to predict the 2007 financial crisis and incurring the rage of the world, this might be the opportunity for economists to restore people’s confi-dence in Europe—and in economics6.

9Latin America and Europe in Conversation8 Latin America and Europe in Conversation

Oligarchy and Populism: Latin America of the 1970s versus Europe TodayCraig Willy

Craig J. Willy is an EU affairs writer and com-munications pro-fessional. A for-mer journalist at EurActiv, he is currently working on online com-munication and social media ana-lytics projects for the European Commission and private organiza-tions. He main-tains a blog on EU affairs at craigwilly.info.

Samuel George very rightly mentions the predictable “backlash” to austerity policies in both Latin America and Europe. He does not mention that, in Latin America, many of the governments were able implement these policies be-cause they were military or one-party dictatorships and were therefore indif-ferent to elections. Europe today has nothing of the sort, but there is a similar problem in that major economic decisions are made by the European Central Bank and the European Commission, institutions over which democratic con-trol is weak to nonexistent. Even europhiles like Jürgen Habermas, Martin Schulz, and Jean Quatremer have expressed ever-increasing alarm at the “elec-torally indifferent” nature of the new institutions designed to save the euro.

The result is that mainstream pro-euro parties, whatever they might say about opposing austerity, will inevitably disappoint their voters by implementing austerity policies, because in fact their hands are tied. The policies are deter-mined by the European Commission and the ECB. And bailout-hostile voters in the core will face the same frustration.

Already monetary policy is outside any democratic control. The ECB lends to banks, businesses, and (bankrupt) countries in a way that is not reviewable or subject to modification by elected representatives at the European or national levels despite the huge impact these loans have on economic prosperity and taxpayer liability. Transparency International has called these indirect redis-tributions from taxpayers to banks and countries a “democratic black hole.”1 The German business newspaper Handelsblatt has noted that this practice has given the ECB tremendous power over elected governments:2 “The Governing Council can at any time, with a majority vote, decide the fate of at least half a dozen governments, supporting them or bringing them down—and that num-ber is increasing.”

The ECB has already used this power on several occasions to coerce or elimi-nate governments: Ireland was forced to bail out its banks in 2010 at taxpayer expense, the Italian and Greek governments were toppled in 2011, and this year saw the rather distasteful Cypriot fiasco.

The loss of democratic control over budgetary policy is increasingly apparent as automatic deficit reduction is now inscribed in effectively non-modifiable European law. As ECB Governor Jörg Asmussen has explained, governments will have ever more limited “wiggle room”3 in this area, regardless of electoral outcomes. This loss of control will ultimately be extended to virtually all eco-nomic policymaking, especially wage-setting and labor policy, which will be centrally determined in Brussels and implemented by national governments through “reform contracts.”4

This trend is not sustainable. It is misguided to think that normal electoral pol-itics can simply be eliminated from the determination of economic policy (mon-etary, budgetary, and structural). Monetary policy and the budget are, after all, the fundamental policies a government has at its disposal to redistribute wealth, determine the pace of economic activity, and increase short-term com-petitiveness, among other things. Putting these policies in the hands of tech-nocrats, however competent they may be, will discredit mainstream europhile parties, as they will not be able to propose solutions to their nations’ economic problems.

Both Mariano Rajoy of Spain and François Hollande of France are hysterically unpopular, and Mario Monti of Italy governed a mere fifteen months. This is because, for all the brouhaha over immigration and social issues, voters’ pri-mary concerns are almost always jobs and salaries, and these leaders can do nothing of significance to address those concerns. Worse still, EU policies can be perceived as simply the dictates of the strongest economic power, Germany, thereby stirring up nationalist resentment and hatred—the very things the EU was created to address.

The eurozone needs to resolve this contradiction. If elections have no impact on economic policy, populism will be the result. In Latin America, many of the most hated economic reforms were only possible because they were imple-mented by undemocratic regimes: military dictatorships in Argentina and Chile and unaccountable oligarchic party regimes in Mexico and Colombia. There was a backlash in many countries that manifested itself in the rise of both moderates (Kirchner, Bachelet, Lula) and radicals (Chávez, Ortega, Cor-rea, Morales).

In Europe, the (inevitable) populist response is more unpredictable and varies significantly by country: True Finns in Finland, Syriza and Golden Dawn in Greece, and the Five-Star Movement in Italy. These movements can be nation-alist, socialist, eurosceptic, radical, or simply fascist. Political repercussions are already apparent outside the eurozone in Viktor Orbán’s Hungary. In any case, a populist movement taking power in any country would likely be incompati-ble with membership in the euro and, in some cases, the EU itself.

Thus, the EU’s current course of electoral indifference and austerity, if main-tained for another five to ten years (the time needed for eurozone fiscal and competitiveness imbalances to be addressed), is likely to prove unsustainable and self-destructive. It could very well lead to the euro-secession of one or more countries or, even worse, the end of their democratic experiment. And it should be recalled how young the democracies of many southern and eastern Euro-pean countries are and what a fragile and, really, rare thing democracy is in European history. The eurozone must be democratized and, failing that, power should return to national democracy.

http://www.flickr.com/ photos/chrisgold/ 8126371893/Huge Euro Symbol— Frankfurt, GermanyPhoto by flickr-user “ChrisGoldNY”CC BY-NC 2.0

1 http://euobserver.com/opinion/1175672 http://www.spiegel.de/international/europe/german-press-reactions-to-ecb-bond-purchase-program-of-mario-dra-

ghi-a-854566.html3 http://www.ecb.int/press/key/date/2013/html/sp130425.en.html4 http://euobserver.com/economic/118411

11Latin America and Europe in Conversation10 Latin America and Europe in Conversation

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Future Challenges authors respond