As the fault lines are exposed in the eurozone, Europe struggles to come up with a response. The Stability and Growth Pact is now dead. Even in good times, its underlying logic was dubious, but it has been entirely blown asunder by the international recession.
Europe is being forced to think on its feet and devise a policy that can underpin the single currency. A straightforward bailout of Greece would store up problems for the future which economists describe as “moral hazard”. If delinquent behaviour is rewarded with a bailout, why would anyone bother to observe discipline? Europe is being forced to develop its own “IMF-style” strategy – imposing tough conditions in return for support. This is a responsibility that Europe should be willing to take on. One of the unique successes of the European Union is that it is a genuinely democratic institution that allows states to co-operate with one another to devise mutually beneficial solutions to difficult problems. The IMF has no such democratic underpinning. This is a genuine test of European institutions, from which it can hopefully emerge stronger.
However, it would be totally wrong to imagine that the solution to underpinning the eurozone is simply about devising disciplinary rules and enforcing them in countries that get into difficulty. The countries in difficulty – unflatteringly known as PIGS – have difficult policy adjustments to undertake in confronting their crises in public finances, in banking and in competitiveness. If these are to be implemented without pushing the countries into deep depression, there has to be an economic environment in Europe where an export-led recovery for these countries can succeed. These countries can only correct their chronic deficits if countries who are running large surpluses also adapt their policies to allow a co-ordinated recovery within the eurozone.
There is a worldwide dilemma where China is running massive surpluses and keeping its currency under-valued with resulting huge deficits building up in the US. This is mirrored within Europe, where Germany in particular has been running big surpluses and is operating a very tight domestic policy that is in turn keeping demand and costs down. There is a structural imbalance within the eurozone itself that can’t be addressed by the deficit countries alone confronting their problems. Co-ordination of policy needs to include moves by the surplus countries to relax demand restrictions. All countries can’t simultaneously succeed in a policy of promoting exports and containing imports.
POLITICAL RESISTANCE
The difficulty for Europe is that it hasn’t as yet developed any real tools for policy co-ordination. Policies in each country are reviewed by the Commission, but there is no agreed mechanism for co-ordinated policy moves, now that the Stability and Growth Pact is defunct. Efforts to co-ordinate fiscal policy will undoubtedly meet significant political challenges. A new Macro-economic Stability Council is being developed within the new EU Financial regulatory structure. It will have to move fast to develop new policy instruments if it is to be effective.
Some may think that this is a bit of special pleading on behalf of Ireland which is itself struggling to reinvent an export-led recovery. However, I believe it is a global challenge. Special stimulus measures from the G20 have been necessary to counterbalance the dramatic move to “thrift” right across the private sector worldwide, as a result of the credit crunch. If the G20 now starts to unwind fiscal deficits, there is a real risk that the world will slip back into recession – the double dip that many fear.
To avoid this, there must be a major switch in the make-up of stimulus packages, moving away from supporting day-to-day spending to funding investment. This will ensure that the additional borrowing will be sustainable because it is backed by genuine additions to the productive capacity of their economies. This is a strategy not unlike Fine Gael’s NewERA. It involves tapping into the high rates of private saving to build infrastructure for the future.
