It must restore more fiscal autonomy to member countries to create space for a political dialogue on the surrender of fiscal sovereignty
The European Union inducted its 28th member state,Croatia,on July 1,and earlier,celebrated the 63rd year of its founding. On May 9,1950,the launching of the European Coal and Steel Community set in motion the process of European integration,perhaps the most inspiring political and social movement in the post-World War II era. The nations of Europe have since come ever closer to each other through extensive institutional harmonisation and removal of trade and capital barriers. European citizens are freer to live and work in other European countries. In the early 2000s,the EU became the home-base from which the ex-communist nations of eastern Europe rejoined the global economy. As a world citizen,the EU
representing its 27 member states has been a voice for peace,moderation and preservation of the global commons.
And yet,far from celebrating its enlargement,Europe is threatening to implode. At the centre of the crisis is the eurozone,the monetary union constituted in January 1999,whose 17 present members share the euro as a common currency. The first decade of the euro was largely uneventful. Indeed,assessments in early 2008,including from the International Monetary Fund,gave high marks to the eurozones conduct of policy and achievements. Although a global crisis was already unfolding,the eurozone was viewed as likely to escape with few bruises,not least because it
had avoided the profligate ways of the United States.
While the US appears to be on a path of muddled recovery,the eurozone is mired in a seemingly unending recession,with its economic crisis rapidly turning into a social tragedy. Youth unemployment is catastrophically high: in Greece and Spain,more than half of those under 25 are unemployed. And European citizens are increasingly distrustful of European institutions. The angst has spread throughout the continent,including to countries not in the eurozone. The United Kingdom,never an enthusiastic member of the EU,is flirting with creating further distance from Brussels and Frankfurt.
The eurozone crisis drags on because the structural problems are deep-rooted and because the tactical manoeuvres to contain the crisis have proven insufficient,even counterproductive. By committing to a single currency,the nations of the eurozone bet on exchange rate stability rather than on flexibility. Stability induced a colossal flow of capital across borders,an achievement that was celebrated. But the capital flows fostered oversized banking sectors as in Cyprus,Ireland,and Spain. The plentiful credit either financed unsustainable consumption or housing booms. And once the crisis began,there was no easy way to reverse the excesses. Everywhere,the fragile banks added to sovereign debt,as governments assumed responsibility for supporting the banks. And the lack of exchange rate flexibility meant that the distressed countries could not depreciate their exchange rates to grow their exports and,hence,their GDPs.
At its core,then,the eurozone crisis was a repeat of emerging market crises of the past three decades. Countries with fixed or quasi-fixed exchange rates are prone to loss of growth momentum because their exchange rates become overvalued (they lose international competitiveness); this loss of competitiveness is propped up by international capital,till suddenly it is not. At that point,as foreign capital begins to withdraw,there is a crisis,which brings down the overextended domestic banks.
But because of its scale,the eurozone crisis is more perilous than past emerging market crises. The macroeconomic imbalances within each country are much larger and the crisis has simultaneously hit several countries. Europe also has no easy route to growing out of its problems: it has been unable to keep pace with the technological dynamism of the US and East Asia,and its population is ageing. Being highly trade-intensive,as European economies slow down,their reduced imports drag down other European countries and weaken growth prospects everywhere. Europes internal problems are spilling into the global economy.
A monetary union is expected to adjust to such crises,in part,by
the movement of people from where businesses are shutting down to where jobs are more plentiful. Such migration from Spain and Greece to Germany is finally beginning to happen,but not at a scale needed to make a material difference. The other response is for the strong economies to pay for the repair and rehabilitation of the distressed economies. Some of that has also happened. But the political willingness to open the cheque books has been limited.
Because the European authorities also initially required that
private creditors to banks and sovereigns would all be repaid,the emphasis of the economic adjustment fell heavily on fiscal austerity governments tightened their belts to repay their own obligations and also those of their errant banks. To make these payments,the governments borrowed from newly created European financing facilities and the IMF. Thus,official debt merely replaced private debt,without reducing the debt burden. The needed austerity to pay the debt down was overwhelming and ultimately unproductive,as it further weakened growth prospects in the already fragile economies.
In recent months,there have been tactical changes. First,the official loans from European sources are being made increasingly concessional,and that trend is likely to continue. There has also been an effort to impose losses on private creditors,most dramatically in Cyprus. After an initially misguided attempt to levy a tax on all bank depositors a move rightly rejected by the Cypriot parliament the ultimate burden fell on
the large depositors. Because the Cypriot economy was so heavily dependent on its banks,this,in turn,has caused the economy to go into a near freefall.
Today,the way ahead remains fuzzy. A painful process of debt restructuring is needed to clear the ground. Allocating the losses is controversial,and so is being delayed. But these wounds of the past must be closed before the healing can begin. The European economy will probably remain weak for longer than currently projected by public and private forecasts,and that weakness will continue to weigh on the global economy.
The euro was a bridge too far. The nations of Europe were not ready to cede fiscal sovereignty,which was needed to make the euro work. But the costs of undoing the euro are so large that all efforts must be made to preserve it. This,paradoxically,may require stepping back from the march towards greater integration. A step back now,by restoring more fiscal autonomy to member countries,could reduce the unending tactical manoeuvring and could potentially create space for a more constructive political dialogue towards the surrender of fiscal sovereignty. The wisdom with which this course is traversed will determine more than the mood on future EU birthdays.
The writer is Charles and Marie Robertson Visiting Professor
of International Economic Policy at Princeton Universitys Woodrow Wilson School
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