The Blog

Bitter Sweet Symphony for Structural Reforms?

Britpop's predictive powers

A tumultuous storm followed the 2008 credit crisis. To calm it, the governments administered liquidity injections with the aim to prop up the financial system. Subsequently, there was a call for far reaching reforms - of the banking system, the job markets, social security, and so on. It was felt that restructuring would bolster the economies and put growth on a sustainable footing.

Economists, analysts, and commentators think only structural reform can protect the global economy against the next Big Recession or even Depression. Many politicians pay lip service to the grandiose measures they have up their sleeves. But has the world really been reforming with a great deal of verve since the credit crisis? Or should we listen to the lyrics of Britpop band The Verve's 1997 monster hit, Bitter Sweet Symphony, "I can't change my mould. No, no, no, no, no"?

Slaves to the market

To quote another line from the same hit: "Cause it's a bittersweet symphony, this life. Try to make ends meet. You're a slave to money then you die."

It may be an exaggeration so say that the credit crisis and its aftermath turned various countries into "slaves to the financial markets". However, to some degree the politicians were "controlled" by what happened in those markets. Whenever interest rates threatened to rise too much and paralyze the economies, the respective leaders suddenly shook off their inertia and took decisive action. And whenever the markets started to nod off again - as reflected in falling interest rates - the politicians heaved a sigh of relief and put their feet up.

In other words, unless the markets breathe down their necks, few politicians seem prepared to contemplate reform. Not coincidentally, most of the reforms that the markets would like to see are unpopular with voters.

A productive winter?

Economists and other commentators are hoping that the US, Europe, Japan, and China will opt for intensive (and fruitful) reforms over the coming months or quarters. Before 13 December, a bipartisan "conference committee" of US lawmakers is supposed to come up with a budget proposal. Next is the 15 January deadline, when funding will run out for many federal programs. Unless the politicians come to an agreement, another shutdown looms and new automatic spending cuts will start to bite. To make matters worse, the introduction of Obamacare has been messy and created more political insecurity.

In other words, notwithstanding some strong payroll data in the past months, the US is not yet on solid ground. It is up to the politicians to determine what will happen over the coming weeks to months. In itself, this is far from reassuring.

Nevertheless, we don't expect a repeat performance of last month's chaos. In the run-up to the recent shutdown and ceiling battle, the (online) media were abuzz and a bloody showdown between Democrats and Republicans was clearly on the cards. Yet, the aggression and pugnacity seems to have lost some of its edge as politicians are beginning to focus more on the midterm elections in November 2014. Therefore the next round of budget and debt limit negotiations is unlikely to trip up the US economy (again).

Eurozone still in dire straits

Europe needs to take some important decisions in the weeks to come. Next year, the banking union should be activated as the ECB starts to supervise the largest European banks (following a series of stress tests and asset reviews). A European summit is scheduled for late December. There is a lot of pressure on the government leaders to strike a deal: the ECB refuses to act as supervisor without an adequate safety-net that can stop a (looming) bank default from triggering a full-blown banking crisis. Time is running out. European elections are due in May. The campaigns have already started and will gain momentum in the coming months. As they eye the polls, few politicians will have the stomach for contentious measures.

At national level, too, many politicians are playing with fire. The ECB has bought the peripheral economies some time to implement structural reforms and some member states have made progress. For instance Spain, Portugal, and Greece. However, they all have a long way to go. In addition Italy, the most important southern EMU state, has done very little. Its economy is set to contract by 1.8 percent in 2013, government debt will exceed 130% and the political situation is anything but stable. Later this month, the Italian Senate will decide whether or not to expel Berlusconi because of a tax fraud conviction. Next month, Matteo Renzi could become the new leader of Prime Minister Letta's social-democratic PD. Some suspect he will bring down the current administration, as this would enable the PD to profit from the dissension in Berlusconi's party. However, unless Italy has a new electoral law by then, the stalemate will likely continue.

Asian reform zest?

Asia has high hopes that China will implement economic reforms in the near future. A third plenary session (or plenum) is the third annual meeting of the leaders of the ruling Chinese Communist Party, who tend to be in power for a decade. Traditionally, it is used as a platform to usher in major change. In 1978, the third plenum was the prelude to economic reforms that pushed the country towards a free market system. This time too, the leadership hinted it may present revolutionary plans.

But let's not get our hopes up. Regardless of his reform rhetoric, Xi obviously believes in the supremacy of the Communist Party. And even if Xi were to take a surprising stance, fundamental reforms would take years and go against the vested interests of many local and provincial authorities. Therefore we do not think the third plenum will lead to large market fluctuations.

Whereas China's economic prospects are still seen in a positive light, investors are less sanguine when it comes to Japan. PM Abe got off to a flying start of his second premiership; stock prices surged and growth picked up. Presently, analysts expect him to take painful measures in order to save the Japanese economy in the long term. Since the summer, many have thrown doubt upon his motivation and capacity for reform; increasingly so. Not least because Mr. Abe himself does not seem convinced.

Central banks pivotal

Clearly, restructuring the job markets and social systems is crucial to the economic future of the US, Europe, Japan, and China. As yet, little suggests that this is imminent. The US may be able to get away with this for another while but Europe risks mounting tensions in the immediate future. As the third plenum in China is unlikely to herald major changes anytime soon, by and large growth expectations will probably stay the same. Over in Japan, the economic situation may become quite tense; a loss of market confidence in Abe could hit the Nikkei hard. As the Japanese public finances are in a bad way, this will increase the chance of a yen crisis.

In any case, central banks will likely remain in the spotlight and play a pivotal role in the economy for as long as the politicians fail to take appropriate action.