martedì 29 gennaio 2013


Productivity differences between Northern and Southern Europe caused the eurocrisis



Between 1999 and today, a cost and productivity gap of 20-25% (more as concerns Greece) gradually arose.


Northern Europeans are more disciplined and controlled than Latins. This in the past caused their currencies to steadily appreciate versus their Southern neighbours.


Flexible exchange rates realign competitivity and avoid permanent trade unbalances. This is not anymore case following the introduction of the euro.


From 2004 onwards, Northern European countries generated yearly trade surpluses of € 150-200 bln, in aggregate exceeding € 1,500 bln. “Latin” countries trade deficits where similar in size, as the total euro area trade versus the rest of the world was approximately balanced.


This caused surplus (deficit) countries to accumulate financial credits (debts).


As unbalances pile up, debtors solvency becomes more and more doubtful.


This implies Southern European countries indebtedness (governmental and / or private) to be too high, taking into account their production level and their growth potential, to make financial markets comfortable as concerns their ability to reimburse and / or refinance it.


Austerity alone is self-defeating



Actions taken to cope with the crisis are based on two main pillars.


Several European countries need to reduce their debt, in particular public debt. This requires cutting government expenditure and raising taxes.


Those countries must also become more competitive by restructuring, improving productivity and cutting costs.


It basically is an “internal devaluation” strategy.


Problems: (1) the productivity gap took thirteen year to develop and cannot be significantly reduced in a much shorter timeframe. Wages, and labor costs in general, cannot be reduced so quickly as contracts take time to expire and be renegotiated. In addition, several segments of the labor force enjoy legal or political protections.


(2) As long as costs are reduced, income, consumption, and asset values (ie real estate) decrease as well. This spells troubles for the banking system. Banks are restricted in providing credit to firms and individuals who face reductions in pre-tax income and even more (due to the higher taxes) in after-tax income and saving.


So a downward spiral develops: less income, less consumption, more taxes, less saving, less bank credit, less production. Higher tax rates notwithstanding, the public debt / GDP ratio does not meaningfully improve due to the GDP contraction.


Tax Credit Certificates (“TCC”)



Troubled European countries currently face depressed, ie much lower than their potential, demand and production, which implies elevated unemployment. Traditional economic policy tools are currently ineffective.


Expansionary fiscal policies cannot be pursued: financing higher public expenditure or lower taxes is too expensive or impossibile. Indeed, contractionary fiscal policies were introduced instead, to avoid interest costs spiraling out of control.


Expansionary monetary policies are impossibile too: depressed economies can expand money circulation with no meaningful impact on prices. But the euro is the currency not just of the depressed Mediterranean area but of the Northern European countries, where the employment picture is much brighter, as well. The required monetary expansion will push inflation to unacceptable levels in Northern Europe.


TCC (Tax Credit Certificates) would overcome the limitation of the traditional economic policy tools in the current environment.


TCC basic features would be:

They would be assigned to residents of specific, economically troubled countries.

Starting from a future date (eg two years from their issuance) they will enjoy unlimited acceptance to pay taxes or whatever liability or expense due to the issuing government.

They will be freely tradeable to make possible to the owner to convert them in euros, even before the usability date.


A market discount rate (eg 10% upon the issuance date = 5% per each year between the issuance and the usability date) will apply, declining to zero as the usability date will approach.


TCC to reduce the “tax wedge” and the cost of labor



TCC will be primarily issued to employers and to employees, to partially offset tax and social costs (ie contributions to the national pension and health systems).


This reduces the difference between the total cost of labor and employees net income (the “tax wedge”) and


allows to significantly reduce the main cause of the eurocrisis, the competitivity and productivity gap between Northern and Mediterranean Europe.


As far as Italy is concerned, the most relevant data may summarize as follows (based on 2012 forecast):


Total labor costs: € 985 bln, of which private sector € 818 bln and public sector € 167 bln.

Social costs paid by private sector employees: € 60 bln.

Social costs paid by private sector employers:  € 120 bln.

Social costs paid by public sector employees: € 12 bln.

Social costs paid by public sector employers: € 26 bln.


TCC will be issued equal to 70% of social costs paid by employees (both private and public sector) and to 70% of social costs paid by private sector employers. No issue will be made to the public employer (ie the State) as it would be a self-offsetting accounting entry.


Both employees and employers will pay the same amount of social costs IN EURO as today (so no cash deficit will be created to the government). BUT they will partially offset it due to the TCC they will receive.


TCC to reduce the “tax wedge” and the cost of labor: results



Total TCC issued will be € 134 bln, of which:


To private sector employees: € 42 bln ( = 70% of 60 ).

To private sector employers: € 84 bln ( = 70% of 120 ).

To public sector employees: € 8 bln ( = 70% of 12 ).


Most of TCC, ie € 126 bln, will be issued to private sector employees and employers.


This is a key data. As total labor costs in the private sector are € 818 bln, annual CCF of € 126 bln imply a 15-16% labor cost reduction, if employees net income stays the same.


This strongly reduces the difference of labor cost per unit of output between Italy and Germany (approximately 20%).


TCC then are an appropriate tool to manage the ultimate cause of the eurocrisis: differences in labor cost per unit of output between countries, which exchange rate fluctuations are not available to offset anymore.


Public sector labor costs were not taken into account as public services (public health, public schooling, police, national defence etc.) basically are neither exported nor compete with imports. Then they do not affect the trade unbalances, which are a key element of the eurocrisis.


TCC to the
TCC to the
Pre-tax annual wage (a)
in %
Social costs payable by the employee (b)
Personal income taxes (c)
Net income ( a less b less c )
Social costs payable by the employer (d)
Severance provision (e)
Total cost for the employer ( a plus d plus e )





















TCC to stimulate demand and supplement incomes



TCC could also be a tool to supplement income for needy citizens.


Eg € 21 bln worth of TCC can be issued to the less affluent half of the Italian population (30 million people), ie € 700 each (€ 2,800 for a four-persons family).


This could take place for the timeframe necessary to bring the Italian economy back to normal conditions – say two years.


TCC might also be issued to pay for government expenditure. Mix and size of TCC uses will clearly be a matter of political decisions.



Current economic scenario



Currently (2012) Italy’s GDP is approximately 10% lower than its potential level – ie the level which implies adequate employment and capacity utilization:

The 2009 world financial crisis caused a 5% fall.

Austerity is producing a 2.5% decline in 2012.

From 1999 onwards Italian growth was generally subpar.


Austerity policies aim at stabilizing the public debt at the current € 2,000 bln level (126% of 2012 GDP). This result is far from being assured.


Meanwhile, restrictive tax and spending policies are expected to prevent the Italian economy to recover its potential any time soon. The most recent (September 20, 2012) update released by the government forecast no growth in 2013 and minimal growth (marginally above 1%) in 2014 and 2015.


Public debt as a percentage of GDP would decline from 126% to 120%.


This implies no meaningful improvement in the employment scenario. And the euro area status would keep being precarious.


Troubles affect the whole of Southern Europe, not just Italy, which is already causing the whole world economy to slow down significantly. Further deterioration could easily occur, which would aggravate tensions in the financial markets and rule out even the modest improvement which austerity is expected to bring to public finances.


Benefits from TCC



TCC would be a big game changer. The proposed yearly issue is € 155 bln, ie 10% of th Italian GDP, and implies higher incomes, higher individuals’ purchasing power and lower corporate labor costs.


GDP is likely to increase by a similar order of magnitude. Under the conservative forecast that the full benefit will take three years to be achieved, by 2015 year-end the public debt / GDP ratio will decline to 106% instead of 120%.


While relevant per se, this is much more meaningful as it is achieved in a growing, not in a stagnating economy.


Further, TCC could be introduced not just in Italy but in all the Euro area troubled economies. This (see later) makes the euro project sustainable which implies further benefits:

Stabilization of world financial markets.

Stronger world economic growth.

Higher stock exchange prices.

Lower interest rates spreads within the euro area.

Further public debt reduction achievable by divesting assets at higher prices.


Gross Domestic Product
GDP real growth
Price effect on GDP growth
Public debt
Public debt / GDP
Source: Italian Government - September 20, 2012
Gross Domestic Product
Higher GDP growth (*)
GDP real growth
Price effect on GDP growth
GDP increase vs the W/O TCC scenario
Tax revenues / GDP
Additional tax revenues
TCC issued
TCC redeemed to pay taxes and other liabilities due to the State
Public debt
Public debt / GDP
TCC outstanding at year-end (not included in the public debt)
(*) Higher growth equal to the ratio of TCC issued annually to 2012 GDP; achieved between 2013 and 2015.



TCC to be introduced in other euro area countries



In addition to Italy, each troubled euro country could and should issue its own TCC, in a personalized fashion.


A meaningful part of each country’s TCC should, as in Italy, be used to reduce the difference between labor costs to the employers and net incomes to the employees (the tax wedge).


But Spain, for instance, could elect to issue TCC also to strengthen troubled banks’ equity, thus reducing the recourse to external aids.


If introduced in several countries, TCC would be even more effective and would actually be a permanent solution to the euro area unbalances.


TTC actually vindicate austerity



Austerity aims at reducing public deficits and improving ability to refinance the debt.


BUT higher taxes and lower government expenditure cause demand, production and incomes to fall.


Austerity reduces the public deficit if GDP stays the same, but this is not the case. Benefit on public finances from austerity are largely offset by the fall in GDP – and the economy suffers meanwhile.


If TCC are introduced instead, austerity can raise government euro revenues, while avoiding depressionary effects on the economy.


The government takes euro but gives to the citizens something in exchange – TCC.


TCC will be available eg two years from their issues to pay taxes or whatever liability is due to the state.


An interim period before utilization is needed to make TCC redeemable when the economic recovery will be well underway – thus creating higher tax revenues, which will compensate the redemption of TCC.


The strategy works because the economy potential GDP is much higher than the current depressed level. TCC will support demand and reduce production costs, which will bring GDP much closer to its potential. This will break the negative loop of fiscal contraction -> income contraction -> no public finances healing.

TCC makes the euro system flexible and sustainable



TCC can be introduced in different countries and can have different size and features.


This is key to make the euro system flexible, which is a precondition for it to be permanent.


Troubled euro area countries currently lack the ability to adopt expansionary monetary policies (devaluating, lowering rates, supporting credit) as they do not print their own currency.


Fiscal policies meanwhile have to be restrictive, as troubled countries have problems in refinancing the existing debt.


TCC are a tool which gives back to each country the ability to pursue expansionary economic policies.


In addition, TCC can – and should – be utilized primarily to reduce labor costs without depressing employees income.


The eurocrisis was generated by Northern and Southern European countries having different labor costs dynamics. This created trade unbalances and deteriorated the ability of less efficient countries to refinance their indebtedness.


TCC are the appropriate tool to adjust costs and productivity between countries, which in the pre-euro era was achieved through currencies realignments.


Why TCC are not debt



Are TCC a government liability, to be included in the public debt ?


When they will be redeemed to pay eg taxes (two years after their issuance, according to the proposal) all other things being equal government revenues will be lower.


But this is expected to be compensated by the expansionary effect produced by TCC on the economy.


Were it not the case, actions on the public deficit will be required. However, this does not make TCC a form of debt. Under this respect they are more similar to hidden public pensions liabilities. If current laws imply a deterioration in the pensions / contribution ratio, either the public pension scheme would have to receive more funding, or the laws will have to be modified. However, hidden pension liabilities are not included in the public debt; rather, they are an element to be taken into account in forecasting future requirements.


Why TCC, appropriately used, do not create inflation



TCC are more similar to national currency than to public debt. They will be issued on a country basis and will be redeemable against liabilities where the issuing government is the creditor.


Having said that, there is no reason (neither theoretical nor practical) to issue TCC notes and coins. Only one circulating currency will exist – the euro.


TCC could create inflation in case they are issued in excess of the level appropriate to bring economic activity back to its potential. Currently, however, troubled euro countries are very far from this.


TCC are the appropriate tool to overcome the eurocrisis as each country can issue their own TCC, and tailor them according to its needs: this solves the big weakness of the euro – a single monetary policy in a plurality of countries with different economic conditions.


TCC make it possible to pursue expansionary policies in countries where they are required, while avoiding unacceptable inflation elsewhere.






Marco Cattaneo, b. 1962, Magenta (Italy).


Degree in business administration, magna cum laude (Bocconi 1985).


Between 1985 and 1994 held a variety of financial planning, reporting and corporate finance positions with the Montedison Group, then one the largest Italian industrial concerns.


Since 1995 he was active in managing private equity funds. As CEO of LBO Italia (1995-2007) and chairman of CPI Private Equity (2008 onwards) he completed eleven buy-outs of small-medium sized Italian entrepreneurial companies and oversaw their development.

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