Euro Lessons We Should All Learn

- Bryan Gould

The euro crisis seems to have been with us so long, and is still so far from resolution, that many will have become inured to it, as though it is simply a permanent part of the economic landscape which no longer has the power to frighten or damage us. Nothing, however, could be further from the truth. The fact that the crisis has been around for some time is not a source of comfort. It simply shows how deeply embedded it is and how difficult and dangerous it has become. If it continues unresolved, and continues to get worse, it threatens to engulf not only most of Europe but the global economy as well.

Those who have followed the crisis will have become familiar with the pattern of events. A single country - Greece, Spain, perhaps Italy - gets into trouble, has problems funding its growing indebtedness, borrows to ward off its creditors, its indebtedness rises, the cost of further borrowing rises to unacceptable levels as creditors lose confidence, a bailout is requested and is granted subject to onerous conditions that require austerity measures to be put in place, the markets recover for a brief period but then realise that nothing has changed other than that the debts have got bigger and the ability to repay them has diminished, and the cycle then begins all over again.

The June 2012 Spanish bailout is a case in point. It was initially greeted as evidence of the determination to protect the euro and as a step towards much needed European economic stability. Yet, as subsequent events have quickly shown, what really happened was merely a further staging post in a slow-motion and ultimately inevitable disintegration of the eurozone as we currently know it. The first signal that the bailout was not the triumph proclaimed by the Spanish Prime Minister was that the need for it was repeatedly denied, right up till the last minute – and denied largely because it was recognised that it represented a defeat for the policies pursued both by the Spanish government and by the European authorities. The attempt to argue that the bailout vindicated those policies must be regarded as simply putting a brave face on a serious reverse.

Rescue Measures Do Not Address Underlying Issues

There are, however, much more substantial reasons for reservations about the bailout. Once again, the measures put in place in order to avert disaster have done nothing to recognise, let alone address or remedy, the underlying issues. Those issues, for as long as they remain unresolved, will continue to throw up crises which seem increasingly likely to drive the European economy into recession and the eurozone into a failure that will threaten the whole European project. What are those underlying issues? There are probably two that warrant particular attention. The first is what might be described as a fundamental flaw in the initial design of the euro which made it unlikely that it could ever succeed; and the second is the determination to continue with economic policies, particularly in response to the global financial crisis, that have made recovery from that crisis more difficult than it should be.

As to the first issue,  I argued from the outset, as a British Labour MP first elected in 1974, that neither the euro’s two predecessors – the European Monetary System and the Exchange Rate Mechanism - nor the euro itself could possibly work. Twenty five years ago, I was a fairly lonely voice and my Kiwi background was sometimes thought to prejudice my thinking, but I argued this because it seemed clear to me that in a hugely diverse European economy, (and that diversity has surely now been demonstrated beyond doubt), it was beyond belief that all parts of that economy could be equally well served by the single monetary policy which a single currency would require

In particular, it seemed inevitable that that single monetary policy would be dictated by and would serve the needs of the most powerful parts of the European economy, which inevitably meant Germany. A monetary policy that was congenial to the Germans would almost certainly be less appropriate for weaker parts of the European economy – and today we can see that those weaker parts necessarily include countries like Greece. The Greeks were of course misled into believing that their membership of the eurozone was the entry ticket to the prosperity that the stronger members enjoyed. They were encouraged by the apparent guarantee of support from those stronger members – the sense that “we’re all in this together” – to take advantage of the asset inflation (what can now be seen to have been a “bubble”) created by easy Europe-wide credit, and were allowed not to worry too much about the potentially damaging concentration of productive capacity in Europe’s industrial heartland, coupled with the de-industrialisation of the remainder, that a single economy made inevitable.

The crisis is caused, we are told, because eurozone governments have irresponsibly spent like drunken sailors and have allowed their deficits to spiral out of control. This narrative is of course very congenial to fiscal conservatives. The facts, however, tell a quite different story. Virtually all of the eurozone countries,, and especially those like Spain, (Greece is virtually the sole exception), have maintained a generally prudent stance, either staying in surplus or running deficits well within the 3% limit dictated by the 1992 Maastricht Treaty, which created the European Union and the euro.

There have been of course occasions when individual governments have, for a short time and for good reason, temporarily run deficits above the 3% limit. And interestingly, these supposed miscreants have included those governments, like the German government, that are now leading the charge to tighten the rules yet further. Even the Greek deficit is to be explained in terms that do not correspond with the story told by Chancellor Merkel. Greece is as much a victim as a culprit. Greece was never going to live with the monetary regime required by eurozone membership. It was the attempt to do so, without being able to devalue or frame its’ own monetary policy, that led directly and predictably to Greece’s current plight. For the eurozone as a whole, as well as for Greece, the deficit contagion is the result and not the cause of the crisis.

It was not just Greece, of course, whose interests were put at risk in this way. Other stronger economies - Spain springs to mind - also suffered in due course from the same combination of apparently risk-free expansion and consumption on the one hand and the weakening of their productive base on the other; both being the inevitable consequences of throwing in their lot with much stronger core economies in the wider Europe. In due course, even those stronger countries (Germany and its more or less satellite economies), which were the immediate beneficiaries of the single currency and the single monetary policy, began to suffer a downside. As the periphery of the wider European economy began to slow down – even to close down - this was inevitably bad news even for the central core, whose markets would be less buoyant and whose obligations to weaker members would be likely to increase.

It was precisely because the euro would eventually handicap the whole European economy, as well as individual actual and potential members, that I opposed it so strongly. Sadly, any such stance was dismissed at the time by most commentators as being simply “anti-Europe”. The adverse impact of the euro on the European economy began to come to a head, as luck would have it, just as the global financial crisis (GFC) burst upon us. We need not pause to dissect the global causes of the GFC, other than to observe that they included factors that were already at work in Europe. What has mattered, however, is the response that has been made by the eurozone to the difficulties created by the GFC.

Dictated From Berlin

In line with, and illustrative of, the economic dominance of Germany in the eurozone, the measures adopted to help Europe escape from recession have been largely dictated from Berlin and reflect a particularly German view of what is required. Those measures focused on the suddenly revealed vulnerability of governments in weaker countries to rapidly increasing public sector deficits – deficits made inevitable by the constraints imposed by euro membership and by the impact of the GFC on the relatively loose policies pursued by those countries within the apparent comfort of the eurozone. 

The reduction of those deficits became the main (though essentially short-term) goal of German policy. The Germans were increasingly nervous that they would be required to finance any rescues that might be needed; and the German government’s own domestic political and ideological preferences (themselves now increasingly challenged within Germany itself) pointed strongly to austerity as the correct response to recession. The consequence has been that the travails of eurozone, and particularly of its weaker members, have been exacerbated by the inevitable consequences of austerity.

In most circumstances, an economy that discovers that it has become uncompetitive, as evidenced by a trade or public sector deficit, or in the longer term by falling comparative living standards, will respond with a range of measures that will usually include the devaluation of the currency. A devaluation will have the effect of immediately improving competitiveness across the board and doing so in a fair and impartial way, so that everyone bears some share of the short-term burden of the necessary adjustment.  It also has the advantage of underpinning and launching an obvious and well-tested strategy for overcoming problems of lack of demand by promoting growth and expansion on the basis of the newly established competitiveness.

The devaluation option was not of course open to eurozone members. Without it, they could grow themselves out of recession – which by definition occurs because of a deficiency in demand - if at all, only with the aid of a policy framework, in terms of both monetary and fiscal policy, that would encourage greater rather than less economic activity. That, however, is precisely what has been denied them by the proponents of austerity. The insistence that Greece and Ireland, Portugal and Spain, and perhaps eventually Italy as well, should cut spending and reduce demand in order to eliminate deficits has ensured that recession becomes persistent and almost impossible to shake off. As the experience of Spain shows most recently, slamming on the brakes means immediately higher unemployment, falling production, a slump in living standards, decimated public services, social unrest and – most significantly for the proponents of austerity – larger and growing, not smaller, public deficits. This is because a depressed and shrinking economy necessarily generates lower tax revenues. The Spanish people have not only paid a high price for that mistake but the bailout that has been made necessary has been accompanied by conditions that ensure that the mistake is perpetuated.

Austerity Policy Doomed To Failure

Even within in its own terms, the policy is in other words doomed to failure. Austerity is meant to provide an escape route from debt; but it has ensured instead that the bailouts provided to Greece, Spain and others constitute an increased debt burden that they have little hope of repaying while they are going backwards. Little wonder that the money markets immediately saw the Spanish bailout for what it was – a postponement of the inevitable. The threat to the future of the eurozone, which may also engulf the global economy, is therefore the outcome of policy mistakes, both in terms of deficiencies in the project itself and in the response to recession. If the measures taken so far have made matters worse, what should now be done to offer better prospects?

The answer to that question from Europe’s leaders is not encouraging. Because they, and in particular the “troika” of the European Commission, the International Monetary Fund and the European Central Bank have, through a failure of analysis, ignored the actual causes of the eurozone crisis, they have accordingly continued to press for exactly the wrong remedies. As one eurozone country after another succumbs to the burdens of both euro membership and austerity, the remedies proposed are simply an intensification of both of those burdens.

It is simply not admitted that the inevitable outcomes of euro membership have been too much for many members. No attempt has been made to distinguish between those countries that have prospered and those that have not, or to suggest adjustments of the rules that might help those that have not. Those that have already demonstrated by falling into economic difficulties that they find membership burdensome, if not impossible, are now being told that if they want help they must accept still tougher rules within a banking union. This would make it even less possible for them to grow and repay debt and would require them of course to concede what remains of their economic sovereignty.

Even if this proved politically possible (and recent elections in France and elsewhere seem likely to throw doubt on this), it is hard to see how such a “remedy” would do anything other than bury the root causes of the problems even deeper and make them even more difficult to resolve in the long term. It is the equivalent of plastering over the cracks while the foundations are crumbling. Reality is not averted simply by denying it. What is the alternative? The first step must be to recognise the reality that Europe as a whole is handicapped rather than benefited by the current breadth of the eurozone, and that it cannot possibly function well with such diverse membership. There should be a negotiated process for identifying those countries, like Greece, that would benefit from being, or that wished to be, released from the burdens of membership and for helping them to make an orderly withdrawal. Such a process would be complex and difficult, but by no means impossible, and in any case would be less disruptive than a disorderly break-up that otherwise seems inevitable.

Those countries that chose and were able to remain within the eurozone would no doubt proceed to create what would be in effect a greater German economy. Even so, some of those might well baulk at the prospect of being absorbed into such an entity. Countries which chose to leave the eurozone would be able to return to their individual currencies, devalue to the appropriate level, abandon austerity in favour of a strategy for growth, and renegotiate their obligations with creditors on the basis of a credible prospect of improving tax revenues. No one would pretend that this process is without problems, still less choose to start from here, but other countries, such as Brazil and Argentina, have negotiated similar issues and come out on the other side with improved prospects.

The numbers of countries choosing to take this option might swell in due course once the practicality and advantages of opting out of the euro became clear. They could then set about, together both with what remained of the eurozone and actual and potential European Union members who are not members of the eurozone, the task of building a new kind of European cooperation – what might be described as organic or functional cooperation, in which the process of ever increasing convergence in the pursuit of common interests did not get too far ahead of the political and economic realities.

In economic terms, Europe would be much stronger as an entity if the constituent parts were able to apply monetary and exchange rate policies that were more suited to their needs and in particular to their different stages and rates of development. A Europe made up of economies each enjoying optimal macro-economic policy settings, trading with each other on especially favourable terms and negotiating trade arrangements with the rest of the world as a single entity, consciously pursuing convergence across the whole field of regulation, coordinating and aligning policy development wherever possible, increasingly working together in pan-European deliberative and eventually legislative bodies, would serve Europe’s economic interests much more effectively and do more to promote a genuine sense of European identity than the current abortive attempts to impose from above a European super-State that only a tiny elite has ever wanted.

NZ Government Follows Exactly The Same Policies Here

To acknowledge that there is not yet a United States of Europe, with a single political identity that makes it possible to accommodate without undue strain a range of divergent economic interests, is not to admit defeat but to recognise the need to build a Europe on the basis of democracy and popular will if the result is to be sustainable. If that lesson can be learnt, the eurozone crisis may in the end be a blessing in disguise. In the meantime, we must hope that sanity will prevail quickly. In New Zealand, we are involved and concerned not only because we are part of a global economy that could be damagingly impacted by a continuing euro crisis, but because the euro experience is a replica, writ large, of what we have ourselves been through over the past four years, albeit on a less extreme scale.

If by some miracle of geography we found ourselves transported to Europe, there can be no doubt where we (or our government) would find ourselves in the debate about what to do about the eurozone. Our government is a signed up supporter of the austerity tendency; it would be throwing its weight behind the measures that have driven Europe back into recession. How do we know? Because they have followed exactly the same policies here, which is why our economy has stalled and unemployment remains our most pressing social as well as economic issue. They have been saved from European-scale disaster only because their starting point - the legacy of sound public finances, record commodity prices, and buoyant export markets - has been much more favourable and we have therefore been able to weather the adverse effects better. But let us be in no doubt; the outcomes may be better, but the mistakes are just as serious - and ideologically driven.


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