Yannos Papantoniou: Europe’s Global Crisis
European economies register substantial losses in output and employment as a result of the global crisis. In fact, EU GDP is expected to fall faster than in the US during this year while the recovery, when it takes place, may be slower.
Many factors seem to contribute to this performance. European banks have been substantially exposed to toxic assets while the UK economy is critically dependent on finance. Several Eurozone banks are considerably involved in Central and Eastern European economies facing sharp downturns in economic activity and considerable default risks. Housing bubbles have played a large part in the slowdown of some other economies like Spain and Ireland. Export – oriented economies, and most prominently Germany, suffer from the contraction of world trade.
Decoupling is no longer relevant in the globalized economy as is also attested by the spread of the recession in the emerging economies which did not initially display the weaknesses accounting for the eruption of the crisis.
Moreover, rigidities and fragmentation of policy making in the Union, including the Eurozone, reduce the effectiveness of initiatives taken to revive the economy. The national stimulus packages that have been introduced lack cohesion while sectoral measures having a protectionist focus carry little value added for Europe’s economy as a whole.
Tax cuts, expenditure increases and employment subsidies are variously used in alternative policy mixes sending confused signals to market participants which do not add up to optimal outcomes. Moreover, the overall size of the fiscal packages falls far short of the equivalent package of the US. Germany, in particular, was reluctant to incur new debt so as to boost domestic demand. At the sectoral level, aid packages are inward – looking projecting a beggar – my – neighbour approach which cancels much of their contribution to overcoming the crisis.
Problems are compounded by the fact that the global crisis revealed cracks within the Eurozone. Lending risks have been sharply differentiated with spreads for heavily indebted countries like Greece and Italy rising substantially above the German norm. This tendency, reinforced by negative ratings by international agencies, may lead to credit crises in coming months.
Eurozone performance is conditioned by the structural deficiencies of the system of economic governance for the Euro. There is a central bank but not central treasury while the supervision of the banking system is exercised by separate national authorities.
The absence of central fiscal and supervisory authority has created tensions within the EU as a whole. The capacity of individual member states to protect their banks has been questioned. Outside the Eurozone the pressure was reflected in substantial currency depreciations following sharp reversals in international capital flows. Capital balances worsened considerably for the weaker EU economies, mostly the Central and Eastern European new comers.
Within the Eurozone, weaker members remain better protected because of the Euro but, as evidenced by the widening interest rate spreads, are not immune from credit crises.
The Eurozone lacks bail – out mechanisms for countries facing credit risks. The European Central Bank does not function according to the model of the International Monetary Fund (IMF). Moreover, issuing Eurobonds covering all Eurozone members, is viewed with skepticism by Germany, which is unwilling to pay for the “sins” of its unruly partners.
It can, certainly, be attempted to find a compensation mechanism for Germany with corresponding charges for the weaker economies. In fact, it would correspond to Germany’s longer – term interest, as Eurozone’s dominant power, to pay a price for securing the stability and credibility of the common currency. The problem lies in establishing the “right” price. Recent statements by German officials indicate a fresh willingness to discuss the matter with a view to devising a mechanism for addressing a credit crisis within the confines of the Eurozone.
The change in the German attitude reflects the realization that an eventual involvement of the IMF in the bail – out process will inflict a blow to the credibility of the Euro while the interference of an external authority will weaken the cohesion of the Eurozone. On the other hand, of course, an EU bail-out will not by itself resolve the problems of the weaker Eurozone economies. Deep overdue structural reforms, initiated by the governments of these countries, are a prerequisite for their economic recovery and convergence with the core.
Issuing Eurobonds and creating a Eurozone government bond market may offer a way out from the present credit crisis problem. Properly structured it may not be very costly for Germany while it will help unify Eurozone’s financial system. The European Central Bank could undertake the task of regulating the financial system while the Eurogroup could assume the responsibility for guaranteeing and, when required, rescuing financial institutions.
It could also be the first step for improving the system of economic governance within the monetary union. The target would be tighter coordination of fiscal policies so as to prevent diverging behaviour patterns on the part of the Eurozone members and thereby protect the integrity of the Euro. Reinforcing the power of the Eurogroup as well as the ECOFIN will achieve better fiscal policy coordination while establishing a more balanced framework for cooperating with the European Central Bank. Fiscal and monetary policy should act in better harmony than is presently the case in pursuing growth, employment and inflation targets. Central bank independence should not be allowed to create, as is presently the case, conditions of antagonism with fiscal policy objectives.
European monetary unification has been a success so far. The Euro has conquered a status similar to the dollar in the world stage. It may be shaken by the present crisis but, historically, it has been proven that in such times the EU develops mechanisms to protect the stability of the edifice.
This is a much more realistic conclusion than the dissolving scenarios envisaged by unbelieving Eurosceptics.