Special Reports
 
 


 

THE EURO: WHAT TO DO ABOUT IT

by

BRYAN GOULD

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Bryan Gould on the Euro
The Spanish bailout last week 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 is 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.

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 was not alone in arguing from the outset (as I had argued about the euro’s two predecessors – the European Monetary System and the Exchange Rate Mechanism) that the euro could not possibly work. 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 would 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 that a single economy made inevitable.

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 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. In the longer term, when 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 potential members like Britain, 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 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.

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 and 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 merit of 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.

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 - 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, not smaller, public deficits off the back of lower tax revenues. The Spanish bailout is the price being paid by the Spanish people for that mistake.

Even within in its own terms, the policy is 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 IMF 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 burdens 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 refinements 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 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 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 re-negotiate 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 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 special terms and negotiating trade arrangements with the rest of the world as a single entity, consciously pursuing convergence across the whole field of regulation , co-ordinating 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.

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. The eurozone crisis may in the end be a blessing in disguise.

14 June 2012