Challenges for a Squabbling Europe

By Katinka Barysch

A recent European Union meeting to review blueprints for better management of the euro got overshadowed by a noisy row over France's decision to send scores of Roma - or gypsies - back to Bulgaria and Romania. The row cannot hide the fact that EU leaders do not agree on how to reform economic governance. Though Europe's political commitment to the euro is likely to preclude its break-up, such disagreements could leave Europe stumbling from crisis to crisis. Such an EU would be slow-growing, inward-looking and bad-tempered. It would be 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.

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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 would remain attractive to those countries that have not yet joined. It could even someday rival the dollar as a global reserve currency, encouraging the EU to be more outward looking and confident.

For this second 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. But Europe's governments, the European Commission and the European Central Bank do not.

FISCAL RULES: No doubt, the fiscal profligacy of Greece and other spendthrift 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 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 for the EU countries to adopt national rules to guarantee long-term fiscal stability. Germany has already changed its constitution to force future governments to balance the budget, cyclically adjusted, from 2016. France contemplates a similar plan. Others should follow in due course. National rules would be policed by national parliaments and the media in a way that external rules are not. There would still be plenty for the EU to do, including monitoring economic and budgetary developments and ensuring that national budgetary policies are mutually compatible.

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. Like in the US, much of this debt quickly 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.

MACROECONOMIC POLICY COORDINATION: Germany may look virtuous compared with the troubled southern Europeans. But 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 in the country 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 dangerous imbalances in the future, the eurozone countries need to better watch and coordinate their economic policies. Proper macroeconomic 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. On the contrary, 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 mounting debts.

The trouble is that the political constellations of Europe hinder rather than help quick and effective reform of the eurozone. Germany for the first time in 50 years shows signs of euroscepticism. A majority of Germans opposed bailing out Greece and most now think that the euro is bad for them. The EU's central institutions, most notably the European Commission, have been sidelined in the crisis.

The Franco-German alliance - traditionally the motor behind big integration projects - is fraying. Chancellor Angela Merkel and President Nicolas Sarkozy do not get on and they 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. Because they diverge on so many points, there's almost daily consultation between Berlin and Paris.

In this consultation process, smaller countries risk being painfully ignored. Slovakia - one of the zone's latest additions - voted with its feet, simply deciding not to contribute to the Greek bail-out package.

Those EU members that do not share the single currency watch from the sidelines. This may be acceptable for those like Great Britain that think they will never join, but it annoys those like Poland that see themselves as future euro 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, an independent London-based think-tank.

 

Reprinted with permission from YaleGlobal Online (http://yaleglobal.yale.edu). Copyright 2010(c) Yale Center for the Study of Globalization.

 

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