Re­form or di­vorce in Europe?

Financial Mirror (Cyprus) - - FRONT PAGE -

The worst-per­form­ing euro­zone coun­tries are mired in de­pres­sion or deep re­ces­sion; their con­di­tion – think of Greece – is worse in many ways than what economies suf­fered dur­ing the Great De­pres­sion of the 1930s. The best­per­form­ing euro­zone mem­bers, such as Ger­many, look good, but only in com­par­i­son; and their growth model is partly based on beg­gar-thy-neigh­bour poli­cies, whereby suc­cess comes at the ex­pense of erst­while “part­ners.”

Four types of ex­pla­na­tion have been ad­vanced to ex­plain this state of af­fairs. Ger­many likes to blame the vic­tim, point­ing to Greece’s profli­gacy and the debt and deficits else­where. But this puts the cart be­fore the horse: Spain and Ire­land had sur­pluses and low debt-to-GDP ra­tios be­fore the euro cri­sis. So the cri­sis caused the deficits and debts, not the other way around.

Deficit fetishism is, no doubt, part of Europe’s prob­lems. Fin­land, too, has been hav­ing trou­ble ad­just­ing to the mul­ti­ple shocks it has con­fronted, with GDP in 2015 some 5.5% be­low its 2008 peak.

Other “blame the vic­tim” crit­ics cite the wel­fare state and ex­ces­sive labour-mar­ket pro­tec­tions as the cause of the euro­zone’s malaise. Yet some of Europe’s best-per­form­ing coun­tries, such as Swe­den and Nor­way, have the strong­est wel­fare states and labour-mar­ket pro­tec­tions.

Many of the coun­tries now per­form­ing poorly were do­ing very well – above the Euro­pean av­er­age – be­fore the euro was in­tro­duced. Their de­cline did not re­sult from some sud­den change in their labour laws, or from an epi­demic of lazi­ness in the cri­sis coun­tries. What changed was the cur­rency ar­range­ment.

The sec­ond type of ex­pla­na­tion amounts to a wish that Europe had bet­ter lead­ers, men and women who un­der­stood eco­nom­ics bet­ter and im­ple­mented bet­ter poli­cies. Flawed poli­cies – not just aus­ter­ity, but also mis­guided so-called struc­tural re­forms, which widened in­equal­ity and thus fur­ther weak­ened over­all de­mand and po­ten­tial growth – have un­doubt­edly made mat­ters worse.

But the euro­zone was a po­lit­i­cal ar­range­ment, in which it was in­evitable that Ger­many’s voice would be loud. Any­one who has dealt with Ger­man pol­i­cy­mak­ers over the past third of a cen­tury should have known in ad­vance the likely re­sult. Most im­por­tant, given the avail­able tools, not even the most bril­liant eco­nomic czar could have made the euro­zone pros­per.

The third set of rea­sons for the euro­zone’s poor per­for­mance is a broader right-wing cri­tique of the EU, cen­tered on eu­ro­crats’ pen­chant for sti­fling, in­no­va­tion­in­hibit­ing reg­u­la­tions. This cri­tique, too, misses the mark. The eu­ro­crats, like labour laws or the wel­fare state, didn’t sud­denly change in 1999, with the cre­ation of the fixed ex­change-rate sys­tem, or in 2008, with the be­gin­ning of the cri­sis. More fun­da­men­tally, what mat­ters is the stan­dard of liv­ing, the qual­ity of life. Any­one who de­nies how much bet­ter off we in the West are with our sti­flingly clean air and wa­ter should visit Bei­jing.

That leaves the fourth ex­pla­na­tion: the euro is more to blame than the poli­cies and struc­tures of in­di­vid­ual coun­tries. The euro was flawed at birth. Even the best pol­i­cy­mak­ers the world has ever seen could not have made it work. The euro­zone’s struc­ture im­posed the kind of rigid­ity as­so­ci­ated with the gold stan­dard. The sin­gle cur­rency took away its mem­bers’ most im­por­tant mech­a­nism for ad­just­ment – the ex­change rate – and the euro­zone cir­cum­scribed mon­e­tary and fis­cal pol­icy.

In re­sponse to asym­met­ric shocks and di­ver­gences in pro­duc­tiv­ity, there would have to be ad­just­ments in the real (in­fla­tion-ad­justed) ex­change rate, mean­ing that prices in the euro­zone pe­riph­ery would have to fall rel­a­tive to Ger­many and north­ern Europe. But, with Ger­many adamant about in­fla­tion – its prices have been stag­nant – the ad­just­ment could be ac­com­plished only through wrench­ing de­fla­tion else­where. Typ­i­cally, this meant painful un­em­ploy­ment and weak­en­ing unions; the euro­zone’s poor­est coun­tries, and es­pe­cially the work­ers within them, bore the brunt of the ad­just­ment bur­den. So the plan to spur con­ver­gence among euro­zone coun­tries failed mis­er­ably, with dis­par­i­ties be­tween and within coun­tries grow­ing.

This sys­tem can­not and will not work in the long run: demo­cratic pol­i­tics en­sures its fail­ure. Only by chang­ing the euro­zone’s rules and in­sti­tu­tions can the euro be made to work. This will re­quire seven changes:

· aban­don­ing the con­ver­gence cri­te­ria, which re­quire deficits to be less than 3% of GDP;

· re­plac­ing aus­ter­ity with a growth strat­egy, sup­ported by a sol­i­dar­ity fund for sta­bi­liza­tion;

· dis­man­tling a cri­sis-prone sys­tem whereby coun­tries must bor­row in a cur­rency not un­der their con­trol, and re­ly­ing in­stead on Eurobonds or some sim­i­lar mech­a­nism;

· bet­ter bur­den-shar­ing dur­ing ad­just­ment, with coun­tries run­ning cur­rent -ac­count sur­pluses com­mit­ting to raise wages and in­crease fis­cal spend­ing, thereby en­sur­ing that their prices in­crease faster than those in the coun­tries with cur­rent-ac­count deficits;

· chang­ing the man­date of the Euro­pean Cen­tral Bank, which fo­cuses only on in­fla­tion, un­like the US Fed­eral Re­serve, which takes into ac­count em­ploy­ment, growth, and sta­bil­ity as well;

· estab­lish­ing com­mon de­posit in­surance, which would pre­vent money from flee­ing poorly per­form­ing coun­tries, and other el­e­ments of a “bank­ing union”;

· and en­cour­ag­ing, rather than for­bid­ding, in­dus­trial poli­cies de­signed to en­sure that the euro­zone’s lag­gards can catch up with its lead­ers.

From an eco­nomic per­spec­tive, these changes are small; but to­day’s euro­zone lead­er­ship may lack the po­lit­i­cal will to carry them out. That doesn’t change the ba­sic fact that the cur­rent half­way house is un­ten­able. A sys­tem in­tended to pro­mote pros­per­ity and fur­ther in­te­gra­tion has been hav­ing just the op­po­site ef­fect. An am­i­ca­ble di­vorce would be bet­ter than the cur­rent stale­mate.

Of course, ev­ery di­vorce is costly; but mud­dling through would be even more costly. As we’ve al­ready seen this sum­mer in the United King­dom, if Euro­pean lead­ers can’t or won’t make the hard de­ci­sions, Euro­pean vot­ers will make the de­ci­sions for them – and the lead­ers may not be happy with the re­sults.

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