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Draghi's "Growth Pact" = Internal Devaluation

 May 07, 2012 09:27 AM

(By Cam Hui) As we await the results of the French and Greek elections, there has been a considerable change of focus in the eurozone from the paradigm of all-austerity-all-the-time to growth strategies. The villians, according to those who push back at the "fiscal compact", is Angela Merkel and, to a lesser extent, Mario Draghi.

What I don't get is that many analysts have failed to understand (see the post by Yves Smith as one example out of many) is that Draghi has said repeatedly said that the long-term plan has two components:
  1. "Good austerity" in the form of lower taxes and lower government spending. But the Grand Plan isn't all austerity, all the time. The second component addresses the problem of the competitiveness gap between northern and southern Europe, which means:
  2. Structural reform, which is the European version of the step China took to "smash the iron rice bowl" in order to create labor flexibility for all, not just the young but all of the current employees in their cushy jobs and gold-plated pension plans. Draghi went on to characterize structural reform as the old days of the European social model being all gone.
He talked about this in late February when he revealed the Grand Plan for the eurozone. He positioned structural reform as a "growth compact" when he spoke to the European parliament in late April. Last week, he went further when the Telegraph reported that ECB president Mario Draghi calls for binding 'growth pact':
The president of the European Central Bank (ECB) said it was of "utmost importance" for leaders to impose fiscal discipline but also to generate growth by "facilitating entrepreneurial activities, the start-up of new firms and job creation".

He echoed demands for a "growth pact" from leaders including the French presidential hopeful, Francois Hollande. But rather than protectionist policies advocated by some, Mr Draghi said his ideal growth pact would be based on free labour markets and structural reforms that would be "agreed collectively, not unlike the fiscal (pact)".

He said political commitment would be "the most important" part: "Collectively we have to specify the future of the euro; where do we want to be in 10 years' time?"

The "growth compact" in micro and macroeconomic terms
I feel that the market still doesn't really get Draghi's "growth compact". Let me try to explain it in micro and macroeconomic terms. In microeconomic terms, it addresses the barriers to business formation in many Club Med countries. Simply put, it's hard to fire people. The "growth compact" is an Anglo-Saxon, or Thatherite, solution to make it easier to terminate employees. This is what Draghi meant when he stated in the WSJ interview that "the European social model has already gone". His reasoning is illustrated by his response that the current arrangement is inherently unfair to the youth of Europe (emphasis added):

WSJ: Which do you think are the most important structural reforms?

Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.
The Anglo-Saxon reasoning goes, if it is easier to fire people and make them work harder or take away their gold plated pensions, it creates more opportunity for growth and business formation.
In microeconomic terms, the "growth compact" is structural reform, pure and simple. In macroeconomic terms, the "growth compact" means an internal devaluation by the peripheral countries in the eurozone, which is a fixed exchange rate regime. The Greeks, Italians, Spaniards, etc., just have to work harder and get paid less.

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