THE BLOG
11/24/2014 12:36 pm ET Updated Jan 24, 2015

Podenomics vs. Podemology, or Reality vs. Economic Illusions

Societies have an absolute desire for change. Although not everyone sees this the same way, it does seem clear that we have brought about a widespread desire to change the current state of affairs. The problem lies in the identification of the change required, which is largely determined by our ability to imagine alternatives. This imagination has been over-enthusiastically pruned back in the last few years.

The partisanship in which Spanish society currently lives does not allow us to perceive the real nature of change, crushing us under a discouraging "this is what has to be done." We must escape from this partisan framework, and focus on the immediate problems and the solutions proposed for them. Podemos, the new party that surprised Spain in recent European elections, is suffering precisely from this. It is new, and this novelty brings the uncertainty associated with the unknown. This encourages some, but causes others to keep their distance. Traditional political parties unfairly use this uncertainty to attack Podemos' economic proposals. However the attack does not come because economic proposals are unrealistic, but because they are based on different economic frameworks.

It is not true to say that Podemos' economic program has intrinsic weaknesses. That would be tantamount to saying that the proposals of the Partido Popular (PP, the centre-right party currently in power) are more "realistic." Some say that the economic proposals that have been put forward over recent decades by heterodox economist are fantasies, and that should perhaps be called 'Podemology'. In this article, we argue the contrary: that those heterodox proposals are not astrological conceptions, but instead economically justified independent approaches, based upon different ways of thinking about, and applying, economics. A better term could be be 'Podenomics' -- understood in the same sense as Clintonomics, Reagonomics or Abenomics.

Faced with the deterioration of the situation in which we live, it is necessary to find monetary and fiscal policies, and structural reforms, which are different to those applied so far. It is necessary to use the public sector for economic stimulus. And we must see a new way to address economic, social and political problems. Our thesis is: we possess a solid economic foundation with which to face up to these changes, although the official thinking insists on ignoring this, and on making us believe that there are no alternatives.

Consider an especially important case (noting that this reasoning can be extended to all aspects of the economy): sovereign debt. The solvency of a country is basically guaranteed by future primary surpluses being greater than the difference between long-term nominal interest rates minus the growth rate, multiplied by the debt/GDP ratio. In other words, public sector income minus expenditures have to be sufficient to pay existing debt plus any new debt generated. This calculation shows the level of primary surplus we have to generate to stabilize the debt/GDP ratio. It shows that if we had wanted to stabilize Spanish debt/GDP ratio in 2013, we should have generated a primary surplus of six percent in 2014!

It goes without saying that we did not even get close. The debt/GDP ratio will continue to increase in Spain (and it is already at 100 percent). To this analysis we must also add some factors that worsen the scenario. For instance, we have assumed constant long term nominal interest rates. We used the previous average of the last five years' long-term (10 years) Spanish bond yields, implied that it will stay at that level for the next five years. This risks ignoring the Eurozone's situation and excess liquidity created by the ECB (which shows signs of increasing) which keeps the risk premium under control, but is also generating a financial assets bubble.

Stock indexes are hitting record historical highs, even though none of the European peripheral countries' "fundamentals" have improved since 2007. Quite the opposite, the reduction European peripheral countries' risk premiums is only being sustained by the ECB's resolve to do "whatever it takes" to save the Euro. This has translated into the provision of huge quantities of liquidity, with probable increases in the near future via quantitative easing. This is a fragile equilibrium which can be disturbed at any time, with the additional problem that the macroeconomic framework is significantly worse today than it was five years ago.

A second element that aggravates the situation is that in the formula cited above, we have assumed a constant growth rate (the average of the prior five years). However, the current situation does not provide grounds for optimism regarding the future growth rate. The monetary policy of the ECB, always lagging the needs of the Eurozone, has been combined with an over restrictive fiscal policy by the austerity enthusiast governments of the Eurozone's peripheral countries. This has generated an unprecedented destruction of productive capacity in these countries. The best unemployment rate that Spain has produced (during periods of democracy) was eight percent (in 2007). But the growth that allowed this outlier was due to the real estate bubble that absorbed 3 million of workers, financed by a rampant inflation of real estate prices.

In this moment there is neither productive capacity to capable of employing 25 percent of unemployed workers, nor industry sectors with any possibility of creating such capacity. The rate of destruction of industrial employment continues, and long-term unemployment has reached an alarming 13 percent of the active population. A recent national statistics report shows a continued decline in Spanish industrial manufacturing production, with a slight increase in some service sectors. In Spain the service sector has a smaller knock-on effect on the economy than manufacturing, is highly seasonal, and is characterized by an atomization of market structures. A minor increase in some of its activities is not, and cannot be interpreted as, the path to the recovery of the jobs lost in recent years.

Since Spain has a much-reduced productive capacity, and since we have decimated internal demand, our only hope is that Eurozone demand will enhance our exports. However, according to Mario Draghi (the ECB's president), the Eurozone is currently in a deflationary process with France, Italy and Germany close to economic cardiac arrest, with no capacity to generate the demand that would allow Spain to produce enough growth to stabilize its public debt. Christine Lagarde (the IMF's president), always optimistic, called this situation a "new era of mediocre growth."

This analysis illustrates that economic growth is not in the horizon. Even in the more optimistic scenario represented by IMF and Spanish government projections -- with growth rates near one percent -- our calculation shows that growth will be not enough to stabilize the debt/GDP ratio. Furthermore, according to Draghi, if austerity measures do not stop immediately, the ratio might accelerate upwards due to the deflationary process in which we find ourselves.

This economic reasoning demonstrates that there are only two solutions for overcoming deflation and this stabilize Spain's debt/GDP ratio. On the one hand, the government can implement budgets cuts which generate a brutal surplus of, at least, six percent in 2015. Taking into account that the official government projection for 2015 is a deficit of 4.2 percent of GDP, this option would literally collapse the entire economy. This is not the solution to anything. On the other hand, we have the possibility of restructuring the debt. The extent of the restructuring must be enough to reduce, or even eliminate, the need to produce such a large primary surplus.

Those asserting that such a scenario would produce a financial catastrophe and economic collapse are dissimulating, since the question is not if a restructuring will take place, but rather, under which conditions it will happen. For example, the debt restructuring in Greece in 2012 did not stabilize the debt/GDP ratio. On the contrary, it provoked an increase up to an unsustainable 174 percent. This is not Podemology, it is Podenomics. To avoid this, the principles that should guide this process are:

  1. The write-down must be large enough to produce the necessary fiscal space to allow the implementation of an independent economic policy. The further off that day is, the greater the write-down must be, and also the costs. In the case of Greece, current estimations of the required write-down are around 200 billion Euros. The real irresponsibility is that, knowing all the data, the process is being delayed until debt payments turn out to be unsustainable, and so, facing default, sovereign states' margin for maneuver reduced to simply agreeing to Troika conditions.
  2. It must be implemented with democratic controls. Since the reduction affects debtors and creditors, there must be a mechanism to match their negotiation powers so as the result will not be a social catastrophe for the former, and an unbearable financial burden for the latter. The technical term for this is a 'democratic audit.'
  3. Different measures must be combined. This is not the place for describing all the available tools, but there are a collection of measures that implemented together minimize the costs and maximize the gains. Debt sustainability does not depend only on the interests rates, it crucially depends on GDP growth. The generation of moderated and controlled inflation would reduce debt burden for governments, which in turn, would increase their disposable incomes. On the other hand, the reduction in the real value of their mortgages would increase disposable income of families.

The continuous repetition of "TINA" (There Is No Alternative) is not a symptom of weakness of Podenomics. It is the unmistakable sign that conservative recipes hide always behind the supposed technical asepsis of economics. Progressive and conservative economic projects do not diverge in how "truthful" they are. They are different because they are based on different political frameworks. Podemos opens up a political space for the application of economic proposals that have been developed by the heterodox economists of the last decades. The science of economics is also experiencing a period of change. It is possible to confront those radical changes without the fear of the abyss. We have a strong economic argument based on years of development of a critical approach. The case of debt restructuring is an important example: it is not a taboo, nor irrational nor impossible to confront it. But it will become more difficult to handle if it is not rapidly dealt with via a radical modification of the policy instruments that are currently being implemented.