By Michael Prowse
From a US perspective Europe may appear to be self-destructing. Speaking on Tuesday Oli Rehn, the EU monetary affairs commissioner, warned of a “lost decade” in the wake of the financial crisis if member states failed to introduce structural economic reforms to boost productivity and innovation. The euro, meanwhile, seems in free fall with talk of parity against the dollar against $1.60 as recently as the summer of 2008.
While the US and UK are enjoying a hesitant economic recovery, the eurozone is mostly stagnant. Germany appears to have no conception of its responsibilities as Europe’s anchor economy. Instead of expanding domestic demand, as the US undoubtedly would if in its place, it seems interested only in belt-tightening and the accumulation of ever bigger current account surpluses.
Meanwhile many of the smaller southern economies are falling apart. Having run up an unsustainable national debt in recent years, Greece now faces a decline in gross domestic product of at least 10 per cent. Shut out of financial markets, it finally obtained an emergency loan from its EU partners only by becoming a ward of the International Monetary Fund – the first western European state in decades to face this humiliation.
Few competent independent economists believe the IMF’s austerity plan will work: slashing spending and raising taxes is hardly likely to create the rapid growth needed if Greece is to have a chance of servicing a debt equivalent to 150 per cent of its GDP. But the point of the austerity plan was largely to convince Germany to cough up some money and appease the bond markets. It turned out not to be enough to prevent the threat of contagion.
So, with the prospect of Spain, Portugal and Ireland going the way of Greece, the EU, together with the European Central Bank, finally decided a dramatic statement of intent was unavoidable. In one of the boldest policy moves since the Treaty of Rome inaugurated the Union in 1957, it announced its Euro750bn “shock and awe” rescue package. Flinging – or promising if necessary to fling - this much money at the problem seems to subdued the speculators, at least temporarily. Yet it raises more question than it answers.
The IMF, for instance, has already bent its rules by lending Greece far more than its tiny quota technically allows. In contributing up to Euro 250bn of the broader EU support package, Dominique Strauss-Kahn, its French managing director, has effectively thrown away the rule book. A perfectly justifiable thing to do in dangerous times, but it will not necessarily prove popular with the rest of the IMF’s membership. And what of the contribution of eurozone governments to the EU support package. Who believes that Germany will actually lend what it has promised to lend?
So, as I stated at the outset, Americans can be forgiven for believing that Europe is self-destructing. And, to be fair, leading US economists never were convinced the euro made any sense. Looking across the Atlantic all they could see was a patchwork quilt of economies, at differing stages of technical development, with differing attitudes to work, inflation and debt, and with dramatically different levels of productivity. It was insane, they warned, to expect one currency – the euro – to meet the needs of nations as diverse as Germany, Ireland, Greece, and Poland (in fact every EU economy differs substantially from those of its partners). The singe currency, their argument ran, was the invention of megalomaniac bureaucrats. It was certain to lead to disaster.
Why in the face of this seemingly incontrovertible evidence am I nevertheless saying: don’t write off the EU? First, both markets and the media are apt to take a short-term view of events. Yes, the euro is weak – but not that weak. It has fallen sharply but remains well above its trading range in the early 2000s. The depreciation is necessary and will ease the strain on the weakest European economies. And although some EU members states such as Greece, have very high budget deficits, overall the eurozone is in better fiscal shape than the US. Its aggregate public deficit as a percentage of gross output is projected at about 6 per cent of gross output next year, well below most estimates for the US. The average unemployment rate in the EU is also far lower than in the US. And its member states mostly have more effective social support programmes for vulnerable groups. Both regions have challenges – they just happen to be different challenges.
The more important reason for not writing off the EU is that this is a political project that cannot, and will not, be allowed to fail. The member states, especially the smaller ones, know that they could not survive alone in a globalized world economy, where capital flows freely and financial markets are lightly regulated. Imagine the Bank of Greece trying to defend a re-invented drachma from speculative attacks. But the issue is not just economic. The EU’s political integration is so far advanced as to be irreversible. And many Americans overlook the enormously significant role of the European Court of Justice which, since the early 1950s, has been developing a common legal structure that in many spheres now takes precedence over the national laws of member states. Even Germany’s constitutional court – long a renegade – has formally accepted that, where there is a conflict, EU law takes precedence over German law.
Against this background, there is a silver lining in the recent financial turmoil. The EU always advances by fits and starts. The many passionate believers in political integration do what they can when they can. The single market programme of the 1980s (eliminating barriers to internal trade) led logically to the euro, since multiple currencies created endless headaches for businesses trying to establish pan-European operations. But although there was then political support for a unified monetary policy (except in the UK), it did not extend to fiscal policy. EU leaders went ahead with the euro anyway, knowing that the fiscal issues could be resolved only when the pressure of events made reform seem imperative.
That pressure is now being applied and, as usual, the EU is rising to the challenge. The Euro750bn package is itself the beginning of a meaningful pooling of fiscal resources. It is supposed to be limited to three years, but in the nature of things such guarantees can never be withdrawn. We are almost certainly present at the birth of a new institutional structure that within a few years will seem so essential that Europeans will wonder why it was not created decades ago. Moreover, member states are finally negotiating seriously on rules for the effective joint oversight of national budgets.
In a recent FT article, Romano Prodi, a former president of the European Commission and former Italian prime minister, detected the beginnings of “fiscal federalism”. That is provocative talk but there is no doubt that greater fiscal integration is coming: the EU is not going to allow a repeat of the Greek fiscal disaster which occurred not just because the Greek Conservative government (since ousted) borrowed far too much, but because it was also dishonest in reporting its data to the EU authorities. By the time its partners knew what had happened, it was too late to avert the crisis.
The EU is holding a two day economic summit next month (June 17th-18th) to discuss ways to strengthen the eurozone’s governance, with the emphasis naturally on more robust fiscal cooperation. It will be fascinating to see what emerges from these talks. EU members are never quick to agree policy initiatives, still less institutional innovations. But their historical record is excellent: they do eventually succeed, because they have no alternative. Every sane observer now knows that fiscal anarchy in a monetary union is a recipe for disaster. Agreement on better fiscal controls will be reached. And when it is, the world’s first genuine transnational political community will be that much stronger.
None of this, however, is deny that these are turbulent times. There is bound to be more bad news out of Europe. Share prices and the euro will probably slide further. And financial markets doubtless will target another southern economy, in the process testing the EU’s resolve. Europe is also further than the US from getting its act together on financial regulation, partly because this has hitherto been a responsibility of national governments. The important point to remember, though, is that the EU is a robust political entity that will stay afloat no matter how choppy the financial waters.