How to fix the euro zone
LONDON Disagreements over how to reform the European Union’s economic governance could leave the E.U. stumbling from crisis to crisis, unable to punch its weight in the world or work with the US on fixing global problems.
Most economists warn that the euro is not out of the danger zone. Greece, Portugal and Ireland still face punishing high borrowing rates. And many analysts worry about the financial health of bigger economies such as Spain and Italy. Nevertheless, the risk of the eurozone breaking up has receded considerably.
Greece has just received the second tranche of its €110 billion emergency loan package put together by the EU and the International Monetary Fund. Eurozone countries have also put in place a €440 billion financial safety net in case other highly indebted members can no longer finance themselves in the bond markets. Discussions about how to reform the euro’s governance are in full swing.
If Europeans made the euro sustainable, the currency could be a boon, encouraging competition and monetary stability.
If the Europeans managed to make the changes required to render the euro truly sustainable, the single currency could be a boon, encouraging competition, growth and monetary stability. The euro could even someday rival the dollar as a global reserve currency.
For this scenario to come about, the euro needs to be underpinned by a better system of economic management. Many of Europe’s top economists agree more or less on what’s needed.
FISCAL RULES. No doubt, the fiscal profligacy of Greece and other Southern Europeans is at the heart of the crisis. The eurozone needs binding budgetary targets and proper enforcement.
The Germans want quasi-automatic sanctions imposed on over-spenders, ranging from a loss of EU payments for their farmers to a suspension of voting power in EU decisions. Other EU countries, including France and Italy, balk at this idea.
The eurozone needs binding budgetary targets and proper enforcement.
The existing euro framework already includes the possibility of fines for countries that consistently violate fiscal rules. They have never been used, partly because it makes little sense to burden an already struggling government with further financial penalties and partly because in a tightly-knit club like the EU bad political blood is best avoided.
It might be more promising to adopt national rules to guarantee long-term fiscal stability. Germany has already changed its constitution to force future governments to balance the budget. France contemplates a similar plan. Others should follow in due course. National rules would be policed by national parliaments in a way that external rules are not.
FINANCIAL STABILITY. Greece has violated the EU’s 3 percent limit on budget deficits every year since it joined the euro. But Spain and Ireland ran budget surpluses until 2008. In these latter two countries, the problem was ballooning private sector debt, linked to unsustainable housing bubbles; much of this debt ended up on government books in the financial crisis. Today, Ireland and Spain run double-digit budget deficits, and investors still worry about the health of their banking systems.
The EU has already decided to set up a new watchdog, led by the European Central Bank, to monitor bubbles, bad loans, ballooning trade deficits and other sources of financial instability. It’s not clear how this “systemic risk board” will be linked to a new system of fiscal surveillance and sanctions.
POLICY COORDINATION. By relying almost exclusively on exports to power economic growth, Germany has unwittingly contributed to the current mess. Following a post-reunification slump in the 1990s, German workers and businesses tightened their belts to regain competitiveness. Wages have hardly grown in a decade.
The result is a ballooning trade surplus and stagnating domestic demand. Businesses in much of the rest Europe have struggled to compete with their lean German counterparts, but booming domestic demand, fuelled by cheap credit, kept up economic growth regardless. By 2007, Greece, Portugal and Spain ran external deficits worth 10 percent of their GDP or more. German banks helped to finance these deficits, using the savings that German households and businesses had squirreled away. That is why a government bankruptcy in Greece, let alone Spain or Italy, would destabilize the banking system in Germany, as well as France and Belgium.
To avoid such imbalances in the future, the eurozone countries need to better coordinate their policies. Proper coordination would also examine why core countries such as Germany, Austria and the Netherlands consume so much less than they produce. Yet the Germans are in no mood to discuss their economic model. They see the euro crisis as proof that they have been right all along: Saving is better than spending; wage restraint is a virtue; exports are better than imports. Some German politicians want all EU countries to adopt the German recipe – ignoring the fact that this would condemn the whole of Europe to a prolonged economic slump and probably force some southern Europeans to default on their debts.
Germany for the first time in 50 years shows signs of euro-skepticism. A majority of Germans opposed bailing out Greece and most now think that the euro is bad for them.
The Franco-German alliance – traditionally the motor behind big integration projects – is fraying. Chancellor Angela Merkel and President Nicolas Sarkozy disagree on fundamental points of eurozone reform. Merkel prioritizes strict rules for all EU members and sanctions on fiscal sinners while Sarkozy wants discretionary economic policy coordination among the eurozone members.
There’s a growing consensus on what the EU needs to do to escape the euro crisis. But the crisis has exposed a dearth of leadership and solidarity in the European Union. A more likely scenario is therefore an EU that muddles through without making the euro the success it deserves to be.
Katinka Barysch is deputy director of the Centre for European Reform.
International Herald Tribune, 26/09/2010