Or how a system without collaboration between its parts could break down
By Jordi Cabré
When countries that are part of the same system compete among themselves instead of enhancing collaboration, the system breaks down. In the end all lose, even the ones that optimize their own situation during the crisis. This basic understanding from Deming applied to the parts of a system aptly applies to the current economic situation of the EU.
The actual crisis has many causes, but its current continual worsening is due to additional errors that could have been avoided. One of these errors is the continual disagreements between countries that try to optimize their own conditions with no regard or vision for its effects on the whole Union.
On the other hand most politicians, experts in economics and the media argue that debt, social welfare, and other government expenses are the causes of the crisis, and the main item to fight. How is this to be achieved? As has usually been done in the past, by cost reduction–an old wrong error (See “cost cutting can put you out of business”). It is curious and sad that instead of looking for root causes, humans blame others, pointing in the wrong direction, apparently thinking that cost cutting will free resources to repair the apparent problem. But the problem will remain and history will repeat as usual, unless we analyze and understand with the benefit of profound knowledge.
I have the feeling that causes are being confused with effects and symptoms, as happens in many companies when our mind and memory are focused on solutions, the wrong ones at that.
Let’s follow the arguments.
If the debt were the problem; was it handled better when the deficit didn’t exist? I don’t think so as we’ll see.
Many economists credit the German economy as one that is doing things more seriously and accurately than others, for instance. Is this true?
Accordingly to the UE Treaty and the Maastricht criteria: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3%. And the ratio of gross government debt to GDP must not exceed 60%. [Note: this 3% deficit criteria is going to be reduced to 0,5% accordingly to the last EU commitment of January 2012].
Let’s see first how the debt is now, accordingly with the officially released data, and we will see how we arrived there. (See “Eurostat News Release” ).
From the beginning of the Treaty until 2007, Spain followed both criteria accurately, as its deficit didn’t exist. It was in surplus until 2007 and its debt was far below the accepted 60% criteria, below 40 %, even until 2010.
What happened in 2008 that made the Spanish surplus drop suddenly from surplus to deficit? The government, as most governments did, approved a rescue plan to support the financial system by up to 50.000 million Euros, allowing it to guarantee private banking debt, and this was to be paid by increasing the national public debt. According to some studies, this alone has a direct impact of 4.6 % in the national deficit, probably more.
– The New York Times Free Press –
The increase of the debt is not a cause, but a consequence of the government decision to support private financial organizations by giving them liquidity and credit. In this way the Spanish deficit as a percentage of the annual GDP went from +2% in 2006, +1.9 % in 2007 and then dropped to -4.2% in 2008 and -11.4 % in 2009.
What was high was the private debt supported by banks that created the housing bubble. It was the risk in the financial system that now is harming the whole country, as it happens in many others. (See “Eurozone Problems” by Paul Krugman, in “The Conscience of a Liberal”, New York Times).
As public money runs dry, because it was spent helping the financial system to survive from their errors, the governments seems to believe that the only possible current policy is to reduce welfare, education, health and other social expenses, including some employees’ benefits. I do not believe this is the right way. Nobody is speaking about quality and efficiency, just cost cutting. But what is really pernicious is to blame these services, as most media do, as if they were the problem to fight. No, they are not. Of course they could be done better and more efficiently. Their quality and efficiency can be improved, now and forever, but this is not now the point.
We must clearly analyze and remember the original cause of the crisis. What failed were some banks that followed certain financial practices. Although they had many economists and MBAs, they failed to understand that the economy is a system; they failed in the same way they managed their business. They failed by setting ambitious goals and targets that were outside the capabilities of the financial system and the individual banks. These were achieved by their executives by tampering with that system, but only at great cost to the individual banks, the whole banking system and society. But why do we forget it? Why are we focusing on the people who are suffering first hand the consequences? The mass media and our memory could tell us why.
Remember the Spanish public debt was stable and relatively low before the crisis. It seems that it didn’t help being within the accepted range. Other countries now seen as having higher rigor were not following the Maastricht criteria mainly Germany and France.
Let’s see what happened with Germany, a country most of the media keeps saying is doing well and is lauded as the best economically. They, mainly Germany are pushing the EU to follow their path.
Before the crisis shattered the system, deficit and debt were much higher in Germany than in Spain. Germany had been over the limit criteria of 60 % of debt while Spain was below 40 %. Germany had a government deficit while Spain had a surplus of about +2.0 % in the previous years.
These charts show both, Spanish and German relative deficit and debt. It clearly shows that Spain comes from a better position but ends up in a worse deficit situation, although its relative debt remains much better. The breaking point occurs in 2008.
(following the European and South American manner of displaying figures, the decimal is represented by a comma in this chart, and the thousands by a period, whereas in the US it the reverse.)
Another curious fact is that 90 % of Greece’s debt was owned by German and French banks. Spanish banks have almost no risk involved in Greece. In fact Greece and Spain have little commercial relations.
But why is Germany having lower deficits in 2010, even with a relatively higher debt than Spain? Perhaps because they had previously borrowed more, even beyond the European commitment criteria that mandated each nation to maintain debt as a percentage of GDP below 60 %. Did this allow them to slow the effects?
German debt was far above Spanish debt by about 30 % of GDP in the previous years. Perhaps this, while exceeding the rules, helped them avoid the crisis impact almost as if they knew it was coming.
But then, where does the unfavorable common reputation for GIPSIs (Greece, Ireland, Portugal, Spain and Italy) come from? To my view, it comes from the consideration that crisis can hit them as they are the weakest pieces of the system and because Europe is not safe. Greece has been the great test for the market. Its debt is not sure as gold and the view of a non-collaborative EU, scared investors. The economic prestige of the country’s economy has been an important fact taken into account, but not so the level of seriousness.
Germany has been considered a rigorous and economically safe country. So it has been credited from the beginning of the crisis with minimum risk and it has been paying the lowest interest rate for its debt of all the EU countries. Money has been flowing to Germany while reducing the cash for most of the others. A Country like Spain, even though its public debt had been held tighter previously, has been paying for its debt an additional debt risk bonus of about 4% – 5 % above Germany. It is not as bad as Greece, Italy, Ireland and Portugal which are paying still much higher interest rates. Germany is doing a great business in this situation and then, with the excuse of achieving greater rigor in reducing debts it is blocking the creation of a common European Bond offering issued by the European Central Bank –which, most countries realize, would be the best for the whole. It would give more confidence to borrowers. Who gets to enjoy the temporary profit from not finding a solution?
Have a look to this chart by Paul Krugman, in “The Conscience of a Liberal” New York Times. We can see that even in the worse year projected, Spain doesn’t get a debt ratio as high as the one that Germany already has today.
– The New York Times, Paul Krugman, January 30, 2012 –
One fact: Germany has been blocking the support to Greece. I ask if this is right or not. Of course Greek politicians did not do certain things right, even worse, they provided false numbers.
The best for some of the parts is not the best for the whole. This policy could break the European Union, and in the end, all will lose. Now is when Germany and France are beginning to notice their own bad policies. But they keep pushing the others in the debt reduction policy at the wrong moment.
– Public debt and deficit are not the cause of the Spanish crisis, but a consequence of it. It came later. Seriousness in previous Spain’s approach to public debt didn’t help.
– The main cause of the increase of the debt is the rescue plan of the financial system which took place between 2008 and 2009.
– The cause of the rescue plan was a government decision, to support a falling financial system. This was the result of wrong practices in taking risks and the lack of appreciation of the economic system as a system by the financial management leaders and decisions makers. Wrong management practices and using dysfunctional management by objectives. (See similarities in “Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States”).
– German and French banks held most of the Greek debt as their countries are the main exporters to Greece. They should have had better risk analysis and management. These countries didn’t follow the Maastricht criteria that most countries did. Now they blame the others. Isn’t it a shame and ridiculous?
– Countries with less economic prestige and credit than Germany and France are paying dearly for the errors of those 2 countries. To blame the others is not acceptable. To push the others for a debt reduction that Germany and France didn’t apply to themselves is not acceptable either.
– Welfare, health, education and social services are with their cuts, paying for the new funds now needed by the government. They are paying the consequences of the mistakes of others.
– Merkel, supported by Sarkozy, for a while now has been blocking all potential solutions: supporting Greece, European bond offerings, giving the European Bank autonomy and capability, and other necessary measures.
Cost reduction, required from the others, doesn’t mean being more efficient, but worsening quality and increasing costs in the long term as Deming taught us. The actual solutions applied worsen the disease. Following the strongest doesn’t guarantee the success. The right way is following the Deming system.
Long ago, a group of great, intelligent and visionary men began to build a common economic and political community for the best of all, giving real value to society as a whole. Do the current leaders lack constancy on this purpose? Is something lacking? Yes, Deming’s first principle, constancy of purpose that usually disappears when leaders are changed.
When parts of a system attempt to optimize for their own benefit, the whole loses. The parts compete and the system is destroyed.
In my opinion, the main root cause to resolve is a misunderstanding of system patterns, especially the need for collaboration between parts for the welfare of the whole, eliminating any attempt to optimize parts; bad management practices, including ambitious goal setting; and finally the search for solutions before understanding the real causes. All these errors result from a lack of profound knowledge.
Recommended related sites to visit
– “The Conscience of a Liberal” – New York Times – by Paul Krugman –January 30 2012
– “Eurostat News Release” – 6 February 2012
– “Final National Commission on the Causes of the Financial and Economic Crisis in the United States” – January 2011