Guess What Country?

Here is a guessing game from BCA’s Geopolitical Strategy: what European country did The Economist refer to as incapable of pursuing structural reforms and bent on redistributing income? A country run by policymakers looking to ease monetary policy and stimulate with government spending, but incapable due to constraints of their euro area membership. Clue… the analysis was penned in 1999. Can you guess correctly?

The following are all sentences written by the venerable editors of The Economist in a single article about one European economy:

  • Some of the blame for this can be laid at the door of a tight macroeconomic policy… fiscal policy has been kept in check by the need to comply with the single-currency countries’ “growth and stability pact”. These constraints still bind: left to itself, country X might respond to its latest bout of weakness with lower interest rates and a bigger budget deficit, but it no longer has these options.
  • The ECB’s president has said that country X’s problems are not cyclical but the result of too little basic reform to social security, the labor market and so on.
  • In the longer run, the main factors tugging down country X (and indeed European) economic performance do indeed remain structural and microeconomic: a byzantine and inefficient tax system, a bloated welfare system and excessive labor costs.
  • But the fear lingers that the ruling center-left party remains bent on redistributing income at the expense of big business.
  • Another big reason not to invest is the cost of hiring and firing workers… The welfare state is largely financed by payroll taxes, half of which are paid by employers and half by individual workers. As welfare costs have swollen, non-wage labor costs have shut up too.
  • “The jobs market doesn’t really deserve to be called a market,” says one disgruntled company manager.
  • Progress will come only gradually, however. “We got 90 minutes extra shopping after a decade’s debate, or nine minutes a year. Call it the country X’s way,” sighs Random Economist, chief economist at Random Bank.
  • The main barrier is politics: this government, like the last one, worries that such reforms will be unpopular if they are widely perceived as a handout for the rich at the expense of the average citizen.
  • The other big challenge for the government is to defuse country X’s welfare timebomb.
  • The government could also do the economy a favor by speeding up privatization and further deregulating the underdeveloped services sector.
  • Unfortunately, progress in most of these areas is likely to be agonizingly slow — indeed, it could even go into reverse. The country X government has already backtracked on the efforts to cut pension entitlements that were made by its predecessor.

Any luck? Let us review the clues from above excerpts:

  • The country in question could do with less austerity and easier monetary policy, its policymakers appear to want to pursue reflationary policies, but its euro area membership is a constraint on both.
  • The euro area partners of the country in question are calling for reforms, with the ECB president specifically calling for labor market reforms.
  • Red tape, bureaucratic incompetence, and overregulated service sector are all impediments to growth.
  • Labor market is in woeful need of reform.
  • Politics stands in the way of progress, the ruling center-left government is opposed to reforms, wants to redistribute wealth, and is unwilling to pursue privatizations.

France? Nope. Italy? Nope. Belgium? Nope. Greece/Portugal/Ireland? Nope on all counts!

Would it help if we said that the article was written in 1999?

Let’s give everyone a few moments to think about it…







The answer is Germany.

Yes, in 1999, The Economist wrote a “world is ending” feature on Germany that lambasted its politics, its economy, and any hope of reforms. And yet a few years later, the very center-left government that The Economist proclaimed to be “bent on redistributing income” and backtracking on reforms accomplished a set of labor-market reforms that are today the golden standard of successful, pro-market, policymaking. In fact, the Hartz IV labor market reforms were so positive for Germany that they have become a ubiquitous example of successful pro-market reforms.

The point of this note is to emphasize the folly of linear thinking. Mediterranean Europe has dragged its feet on pro-market reforms for decades, lulled into complacency by the success of the euro area and the Maastricht Treaty-induced convergence of borrowing rates. This is true. However, the gravy train is over. Without painful structural reforms, these economies will underperform for decades.

We would be skeptical of success were there no evidence of nascent reform efforts. But, both Spain and Portugal are rapidly moving up the ease-of-doing-business surveys. Meanwhile, Madrid’s labor reforms have brought down Spanish’s labor costs and exports are booming. Both France and Italy are led by precisely the type of right-leaning social democrats that Germany’s Gerhard Schröder emblemized back in 1999 when The Economist rained on his parade. We could go on… but won’t because this is a blog post.1 The point is that there are green shoots of reform all around Mediterranean Europe, but most of us remain too constrained by old ideas and assumptions to even notice them.

As the economist Herbert Stein used to say, “if something cannot go on forever, it will stop.” The Mediterranean Europe’s penchant for dragging its feet on reforms cannot go on forever. It will stop. On the other hand, the penchant for lazy analysis to extrapolate linearly will probably go on forever.

1 You can read some of our thoughts on structural reform efforts in Europe in BCA’s Geopolitical Strategy Special Report, “Europe: Is Political Risk Back?” dated October 8, 2014, available at

U.K. Election Preview

In a recent Special Report, our European and geopolitical strategists discussed investment implications of the upcoming U.K. elections.

The U.K. general election is set for May 7, with the outcome too close to call at this point. If we had to put our money on the outcome, we would favor the center-left Labour Party to pull off a tight victory that produced a center-left coalition with either the Liberal Democratic Party (Lib Dems) or the Scottish Nationalist Party (or both).

The election is likely to have only a modest impact on the equity market. The reason is that over time, the U.K. stock market has become a collection of large multinational companies that are listed on the London Stock Exchange but have very little exposure to the U.K. economy or politics. The main driver of the U.K. stock market’s relative performance is its sector skew: overweight Energy; underweight Industrials, rather than domestic economics and politics. Hence, the FTSE100 outperforms when Energy outperforms Industrials and vice-versa.

However, the election outcome will be much more significant for the interest rate and gilt market as well as the pound. A center-left Labour-led government is likely to slow down the pace of austerity. The U.K. has one of the largest budget deficits in the developed world and its fiscal thrust is expected to be deeply negative in the coming years. A Labour-led government, particularly one supported by the more left-leaning SNP, would slow the pace of consolidation. Together with the recent improvements in the labor market, consumer confidence, and real wages, this could force the Bank of England to tighten monetary policy earlier than the market is currently expecting – putting upward pressure on gilt yields and the pound.

Furthermore, a win for the pro-EU Labour government would remove uncertainty over the EU referendum.