An unfamiliar calm sits over the continent of Europe as Eurozone members buckle-up by implementing tight austerity measures and tough structural reforms. With less talk of crisis and disintegration, and waning public discontent (with the exception of occasional unrest in Greece), the untiring turmoil of the Eurozone debt crisis seems finally to have tired. This raises the question: has Europe finally weathered the storm?
Debt: A Structural Problem
Only several months ago Europe seemed to be on the brink of calamity of a Lehman-like magnitude. The financial meltdown of late 2007 had triggered a chain of events which forced European governments to – as J.M. Keynes had argued – ‘spend against the wind’. Rising expenses on stimulus packages, bank bailouts, and unemployment benefits fell on the state just when tax receipts collapsed. Government borrowing within the Eurozone ballooned, as did government debt.
To blame the financial crisis, however, would be overly simplistic. The problem dates back to the creation of the Economic Monetary Union (EMU) over the course of the 1990s. The EMU took away one of the two core economic tools of member states, notably monetary policy. While this was not a major problem for the core (i.e. Germany, on whose Bundesbank the ECB was modelled), this left the peripheral countries with only fiscal measures to respond to exogenous shocks, such as the financial meltdown of 2008/09.
Then, in 1997 the E.U. leaders agreed to a tight “fiscal compact” that would limit their government’s total borrowing to just 3 percent of their economy’s output. But during the boom years of 1999 to 2007, cheap access to credit caused most countries to exceed any such limits and acquire substantial debt.
In addition, during these ostensible boom years the Eurozone experienced a silent divergence. While German unions agreed to hold wages steady, the European peripheral economies – as well as France – did little to discourage wage inflation. The result: German exports flourished as the peripheral countries acquired ever growing trade deficits because their economies were out-right uncompetitive. What is more, and rather ironically, most of Germany’s surplus cash ended up propping up the structurally uncompetitive peripheral economies via on-lending.
No Easy Fix
In May 2010, the European Union announced a 110bn-euro bailout package to rescue Greece from an otherwise devastating default. Bailouts for Ireland and Portugal followed suit as fear of contagion forced up interest rates on bonds, making it even more difficult for the troubled governments to service their debts. But the bailouts came at a price: tight austerity and tough structural reforms – very much to the mandate of a fiscally conservative Germany.
Getting the conditions for economic revival right, however, proved to be highly complex. Continued spending risked financial collapse, and such a strategy would fail to tackle the root cause of the crisis: uncompetiveness. Austerity, on the other hand, would deepen the recession, increase unemployment, and make it more difficult for the troubled economies to service their debt. But in Germany’s eyes, the crisis is all about recklessness, with Greece setting the tone when it lied about its circumstances and lived beyond its means. Nevertheless, Germany’s approach suffers from a fallacy of composition. It is not possible for everyone to save their way to prosperity.
The dilemma: Germany needs to save the troubled governments in order to save the E.U., but also wants to keep up market pressure for reforms and to establish the principle that governments are on their own – so that German taxpayers will not be landed with the bill every time an E.U. country goes on a spending spree. Germany worried (and still does) that reducing the pressure on weak states will lead to complacency. While this concern is absolutely correct, the merits of making countries reform by dangling them out of the window are questionable.
Stepping Back from the Abyss
A broad consensus, however, exists among Europe’s political and economic leaders that a breakup of Europe’s monetary union would be catastrophic. While this realization is chiefly economic, its ideological foundation must not be discounted. The roots of the European Union are profoundly connected to post-WWII European reconciliation: embodying the values of peace and mutual cooperation. As Joseph Schumpeter, the great Austrian economist, once wrote: “The monetary system of a people reflects everything that the nation wants, does, suffers, is.”
Since the signing of the EU “fiscal pact” by 25 of the 27 members of the EU in late January of this year, the alarming urgency of the Euro debt crisis has receded. This summer, the European Stability Mechanism – a permanent bailout fund and de-facto firewall equipped with 800bn euros – will be activated. And thanks to the massive provision of liquidity to banks by the ECB under Mario Draghi’s new management, both a financial collapse and a nasty credit crunch seem to have been averted.
There is no denying that 2012 will be a very challenging year for the Eurozone. Tight credit conditions persist, large amounts of public and private sector debt need to be refinanced, and further fiscal austerity will certainly lead to job losses. The Eurozone is almost certainly going to experience a mild recession in 2012, with Ernst & Young forecasting a 0.5 percent decline in overall GDP.
While the Euro debt crisis is by no means behind us, one can confidently say that the Eurozone has avoided the abyss. And not only has Schuman’s European project survived in-tact, it looks as though even greater integration is set for the future. Promisingly, the EU member states are now jointly heading along an elongated path towards economic recovery, hopefully to emerge a stronger monetary and political union.
– Elias Kühn von Burgsdorff