Thursday, May 31, 2012

The Eurozone’s long quest for gold

Higher, faster, longer. With the Olympics and the European Soccer Championships, Europe will once again celebrate these superlatives, enjoying the race for the gold medal. However, when looking at the Eurozone, these superlatives remain limited to sports. The economic outlook looks rather dire and will take a lot of time before superlatives return into the economy.

There is no quick fix for the Eurozone sovereign debt crisis. Most Eurozone peripheral countries have been surfing on a debt wave during the first ten years of the monetary union. Sometimes it was a public sector debt wave (Greece), sometimes a private sector debt wave (as in Spain or Ireland). Other countries did not even experience the pleasure of surfing at all but have been suffering from increased competition from emerging markets, thereby pushing the economies into sluggish growth (Portugal and Italy). The global financial crisis has brought an abrupt end to these smaller and bigger pleasures.

The only way forward is to reform economies, deleverage public and private finances and to bring the economies on a more sustainable footing. Contrary to what some observers sometimes claim, there is no alternative to austerity measures. With ageing societies and interest rate payments often the second largest expenditure post in national budgets, the principle necessity of austerity should not be discussed. The short history of the Eurozone has actually shown that good times have hardly ever been good enough to start big-shot expenditure cuts. As consequence, fiscal austerity will have to be part of the economic game in the Eurozone in the coming years.

Of course, austerity measures push the Eurozone peripheral even further into a vicious circle of reforms, recession and reduction of debt. Double-digit unemployment rates and youth unemployment close to 50% in countries like Spain and Greece is the best illustration of how painful the so-called economic adjustment will be. But is there an alternative?

It is often said that core Eurozone countries should simply spend more, increase domestic demand or even engage in direct transfers to help peripheral countries growing again. This is easier said than done. At the current juncture, core Eurozone countries are not very likely to be able to alleviate peripheral pain as most of them also have to implement austerity measures and are not free of concerns. For example, the Netherlands still has to cope with a creeping process of deflating of a real estate bubble. France, the second largest economy of the Eurozone, will have to implement structural reforms to regain international competitiveness. Even the last economic stronghold, Germany, is facing more difficult times as export demand from both outside and inside the Eurozone has been weakening. Latest positive wage developments could quickly turn out to be a flash in the pan. Moreover, as Germany is an ageing society, the hope for more domestic consumption and less savings could easily fall on deaf ears.

With such a bleak outlook for the Eurozone, the quest for growth has become increasingly popular. However, even the best growth compact can only be a supplement not a substitute for structural reforms and austerity measures. The effect of more European investment in countries with rather too many than too little investments over the last years is questionable. It would also do little to stop Spanish housing prices from dropping or unemployment from rising. Traditional Keynesian recipes might have worked in economies or sectors, which were structurally healthy (e.g. the German car scrap scheme), but their scope should be very limited when the problem is of a structural nature. Of course, the Eurozone needs growth and there is more to the crisis management than only austerity. However, a new Eurozone growth compact should only be the sweetener for the unpalatable austerity and reform medicine not an entirely new crisis treatment.

Whatever the Eurozone will try, there is no silver bullet to solve the current crisis. The short-term prospects for the Eurozone look anything but rosy. The Greek drama is approaching a new climax, more bailouts look probable, more debt restructurings cannot be excluded and as a result of all of this growth will continue to disappoint. Therefore, it is time to come up with a master plan for the future. The vision thing. Such a master plan could re-invent the Eurozone’s economic model, identify new sources of growth, commit to the goal of sustainable public finances, but also come up with a clear and binding roadmap towards more integration with at the end of such a process possibly a common Eurozone bank supervision, a bank resolution scheme and even Eurobonds.

All top athletes know that winning a gold medal is the result of years and years of practicing. Champions are not made overnight. If the Eurozone economy wants to compete again for a gold medal in the global race for economic top performance, it will require at least three qualities from Olympic athletes: a good plan, hardship and a lot of stamina.

This article was a guest column for Bloomberg Briefs.

No comments:

Post a Comment