In memory of Dr. Andreas Höfert

Mario Draghi’s triple Cs

This is not about a new European credit rating but about Mario Draghi’s recipe to restore growth in the Eurozone, which is currently stagnating at best. At the beginning of the latest EU summit on March 14, which saw an unfortunate outcome for Cyprus, the ECB President and erstwhile professor of economics gave European leaders a crash course on the current economic misère of the Eurozone and ways to remedy it.

His PowerPoint presentation entitled Euro area economic situation and the foundations for growth can be found under: Especially telling is slide 8, presenting three dimensions that need to be restored to ensure growth in Europe: confidence, credit and competitiveness, Draghi’s three Cs.

Concerning the first C, confidence, Europe is a long way from where it would need to be. The rather disastrous initial decision to tax bank deposits in Cyprus has actually dented confidence both in the euro as well as in the willingness and/or abilities of European leaders to solve the crisis.

Mario Draghi used the yields on European periphery government bonds, which declined significantly from their peaks last year until February 2013, to illustrate that confidence was returning to Europe after the euro crisis surged in the summer of 2012. Unfortunately, the latest summit led to a brief pause in the decline of Portuguese, Irish, Italian and Spanish bond yields. In the next couple of weeks we will have more clarity on whether the Cyprus episode damaged confidence or if the market, which has until now stoically digested the bad news out of Nicosia, Brussels and Moscow was right to be wary.

Credit activity, the second C, appears on the main slide but is not illustrated thereafter. However, the latest ECB monthly bulletin shows that credit activity remains sluggish in the Eurozone. Credit to governments – basically increase of government debt – showed a yearly growth rate of 4.6% in January 2013. But credit to the private sector declined by 1.1% over the year, making overall credit activity (public and private sector) stagnant compared with a year before.

Many analysts see balance sheet repair and shrinkage by European banks as far less advanced in Europe than in the US. This can explain European financial intermediaries’ reluctance to lend. But there is also a reluctance to borrow by the private sector, given the uncertain economic environment still gripped by the euro crisis.

Draghi’s third C, competitiveness, takes the bulk of the presentation. Not naïve enough to reduce this dimension to the currency alone and say that the euro is overvalued, the ECB president illustrates the concept through the evolution of unit labor costs of different Eurozone member countries by plotting wages and labor productivity side by side. The difference between two core countries, Austria and Germany, and three peripheral ones, Spain, Portugal and Italy, is striking. Wages and productivity in the former move more or less in synch since 1999, while in the latter wages have increased at a much faster pace than what productivity gains would have warranted.

Equally spectacular is the case of France, which according to this metric looks much more like a peripheral country than like the core country it still pretends to be.

A conclusion one can draw out of Mario Draghi’s charts is that wages needs to come down quite significantly to ensure that the peripheral countries regain competitiveness. But there is another valid conclusion: Increase productivity to catch up with wages. This might be one of the only positive spins in the presently dismal Southern European prospects.