“Like Hitler, like Stalin, the énarque believes that power will always prevail over economics.” ― Bernard Connolly, The Rotten Heart of Europe: Dirty War for Europe’s Money
“Everybody aspires to an affordable home, a secure job, better living standards, reliable healthcare and a decent pension. My generation took those things for granted, and so should future generations.” ― Jeremy Corbyn
Señor Mario Draghi pledged in 2012 to do “whatever it takes” to save Europe from the sovereign debt crisis that engulfed many members of the European Union. Those momentous words took the eurozone out of the throes of a crisis and put into motion an epic collapse in bonds yields in Europe first, the rest of the developed world second.
Mario Draghi’s resolve brought about an immediate shift in the market’s mood. Traders reacted with alarming speed, jumping into European sovereign bonds, reaping huge rewards as yields collapsed across the Eurozone. Mario Draghi understood well the importance of psychology on market participants when he stepped up to avert the EU’s existential crisis.
Today, the European Union faces a different kind of existential crisis. One brought on by healthcare systems in Italy, Spain and other parts of Europe bursting at the seams, unable to provide the necessary care to contain the suffering of those afflicted with the coronavirus.
The physical world is defined by constraints. Neither words nor policy can be used to conjure up more hospital beds, deliver vaccines or transform able citizens into frontline healthcare professionals. Yes, war time like measures can be taken to divert productive resources away from the expendable to the essential, even such measures, however, require time, energy and a requisite set of skills and resources.
Words are unlikely to suffice this time around.
Europe Divided
“Italy’s political leaders from Left to Right have erupted in fury over the EU’s minimalist, insulting, and cack-handed response to the Covid-19 pandemic, warning that lack of economic solidarity risks pushing the bloc’s festering divisions beyond the point of no return.” ― Ambrose Evans-Pritchard, EU project in ‘mortal danger’ if Italy and Spain are abandoned
Jean Monnet, one of the founding fathers of the European Union, famously argued that “Europe will be forged in crises, and will be the sum of the solutions adopted in those crises.”
The COVID-19 pandemic has revealed the fragility of the bond that holds the EU together. In a matter of weeks, the EU has gone from a single bloc to each member fending for themselves in a bid to contain the damage wrought by the pandemic.
France, Italy, Spain and six other members of the EU, in a joint letter to European Council president Charles Michel, have called for the issuance of ‘coronabonds’ — that is, joint European debt to finance the fight against coronavirus. Germany and the Netherlands, in response, have expressed reservations and are ruling out any such issuance.
The Europe Union has not put forth a solution to the current crises, will the consequence be a continent divided?
Currency Straitjacket
EU membership comes with many constraints. Particularly onerous are the budgetary limitations placed on those economies unable to live within their means or suffering from an economic slowdown. Further exacerbating the issue is the common currency, which has eliminated the flexibility to depreciate previously availed by the economic laggards remain competitive.
Take for instance, the ratio of the purchasing power parity (PPP) based exchange rates for Germany and Italy. (In the chart below, a downward sloping line implies a depreciation of Italy’s exchange rate relative to Germany’s exchange rate in PPP terms.)
During the 1990’s, the Italian lira almost consistently depreciated relative to the deutschemark. This process of continuous depreciation enabled the Italian economy to compete with the German economy, if not in terms of sophistication, most definitely in terms of price. Since the introduction of the euro, however, Italy has lost this flexibility and can improve upon the German offering neither in price nor in sophistication.
This lack of flexibility combined with the budgetary and fiscal constraints that come with EU membership, is unlikely to escape the scrutiny of the Italians and their Mediterranean neighbours. Especially as they come to weigh the costs of EU membership in shadow of the suffering of their citizenry during the COVID-19 pandemic. The evidence is particularly damning, when one considers how these constrictions have translated into systematic underinvestment in the healthcare systems of countries that have lagged behind economically.
Healthcare Expenditure
The chart below compares healthcare expenditure, as a share of total government expenditure for Germany, Italy and Spain.
Healthcare spending, relative to other forms of government spending, in Germany has increased by almost 2 percentage points between 2010 and 2019. Whereas it has declined by 1 percentage point in Italy and remained about the same in Spain.
In both absolute and relative terms, this has translated into a significant increase in the amount Germany spends on healthcare. In 2010, Germany spent, in current euro terms, approximately €60 billion more than Italy on healthcare. In 2019, the difference in healthcare expenditure between the two nations amounted to more than €120 billion. In per capita terms, Germany spent 9.2 per cent more than Italy on healthcare in 2010; in 2019, the difference was 46.3 per cent.
Given its robust economic performance, Germany, within the confines of the EU’s rules, has been able to substantially increase its government expenditures. Whereas, Italy and Spain, in the aftermath of the sovereign debt crisis, have been unable to increase overall government expenditure. The unfortunate corollary of which is a stagnation of investment in their respective healthcare systems.
The growing disparity in healthcare investment across the EU is even more stark when comparing the availability of hospital beds. In 1995, Italy had 6.3 beds per 1,000 people, Spain 3.9 and Germany 9.7. At the end of 2017, Italy was down to 3.2 beds per 1,000 people, Spain 3.0 and Germany 8.0.
Italian and Spanish hospital bed capacity per capita has declined by half and one third, respectively, even as their populations have aged and the need for healthcare services has increased not decreased.
A New Way Forward
Whether it is German conservatism, Mediterranean profligacy or a combination of both that has contributed to the woeful under investment in healthcare in Spain and Italy, we do not know for certain. We do, however, see the statistics as a powder keg that could bring about the end of EU in its current form.
For the populace may withstand economic hardship in pursuit of a lofty goal; there are few, however, that will accept the suffering or loss of loved ones. If they are not already, it is only a matter of time before Italians and Spaniards begin questioning why they given up sovereignty over their laws, their borders, their budget and their currency, when in their time of need their membership in the EU has hindered, not supported, them.
From Arundhati Roy in the Financial Times:
“Historically, pandemics have forced humans to break with the past and imagine their world anew. This one is no different. It is a portal, a gateway between one world and the next.
We can choose to walk through it, dragging the carcasses of our prejudice and hatred, our avarice, our data banks and dead ideas, our dead rivers and smoky skies behind us. Or we can walk through lightly, with little luggage, ready to imagine another world. And ready to fight for it.”
The European experiment, once these trying times pass, may ultimately hinge upon which nation chooses to walk into the future lightly. Will it be one of Italy, Spain or any one of the other member nations suffering under the weight of the euro, choosing to leave behind the currency? Or will Germany overcome the scars of her past and shed its fiscal conservatism?
Time will tell. For now, we believe the Europe of tomorrow, will be unlike the Europe of yesterday.
Stay safe.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.