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The crisis in the eurozone

Posted on May 19, 2012 by | Comments Off

The crisis is so complex, intractable and toxic that it’s hard to know where to start. This is not the place to discourse at length on the character, causes and consequences of the crisis or to assess alternative ideas for resolving it. I simply offer some general thoughts, in no particular order of importance.

The single currency: design flaws

As in all major crises, economic and political elements are inseparably intertwined. The 17-member eurozone has turned into a doomsday machine. There were inherent flaws in the design of the single currency which, unlike the US dollar, was supported neither by a federal state with substantial powers of taxation, spending and borrowing nor by a central bank empowered to act as lender of last resort to individual governments. And when EMU was formed, member states gave up the power to alter their exchange rates and set interest rates without making any provision for bailouts, defaults or exits. At the same time, the creation of the euro combined German ordoliberalism, which prescribes balanced budgets, monetary discipline and wage restraint, with the much looser fiscal arrangements of the Mediterranean states which, before they joined the single currency relied on periodic exchange rate depreciation as a safety valve to correct for internal wage and price inflation. The assumption was that southern Europe would eventually converge on the German model.

This did not happen. Instead trade and payments within the eurozone became steadily more unbalanced: Germany and its northern satellites ran persistent surpluses, while the Mediterranean states ran persistent deficits. To take the most egregious example: Greece’s trade deficit is currently equivalent to almost 10% of its GDP despite a four-year slump which has reduced GDP by around 20% below its pre-recession peak. One would normally expect a recession of this magnitude to eliminate a trade deficit by reducing the demand for imports. As it is, Greek businesses simply cannot compete in the single market and Greek trade is in fundamental disequilibrium. The country joined the single currency at around 340 drachmas to the euro. According to The Economist, if the drachma were restored, the exchange rate would settle at around 1,000 drachmas to the euro (leading, incidentally, to a drastic jump in drachma-denominated import prices that would further reduce people’s real incomes at a time when an unemployment rate of 20% effectively precludes any attempt by workers and unions to achieve compensatory increases in money wages).

A crisis of legitimacy and the rise of the nationalist right

Add to these structural flaws the consequences of a credit-fuelled boom in land, housing and commercial property – notably in Ireland and Spain, whose governments did not run excessive budget deficits, but which have nevertheless been overwhelmed by sovereign debt problems through trying to rescue the banks (and with them, it must be said, a large number of ordinary punters who joined in the speculative frenzy) – and you have a toxic brew of economic depression, broken banks and investor panic. At the same time, within the 27-member European Union, the financial and economic crisis has intensified a long-standing crisis of political legitimacy, which goes back at least twenty years. By and large, until the early 1990s, the process of European integration was underpinned by a “permissive consensus” which allowed political leaders to drive it forward without needing to make much effort to carry the public with them. If “Eurocrats” were somewhat remote and unaccountable, this was a defect that could be tolerated in exchange for the benefits that integration was believed to confer: the preservation of peace in a previously war-torn continent and the promotion of economic prosperity. Over the past 20 years, there has been a marked decline in public support for the EU, with adverse shifts in opinion polls, “shock” results in national referenda and falling turnout rates in elections to the European parliament.

Worse still, in one country after another, national elections have brought an upsurge in support for parties of the populist and xenophobic right whose litany of threats to the integrity of the “nation” now includes – alongside asylum-seekers, migrant workers, Islamic terrorists, international criminals, alien cultures and global corporations – Europe’s cosmopolitan political elite who, it has to be said, have failed lamentably to restore the faith of their citizens in European institutions and ideals. Things are not yet as bad as they became in the 1930s when mass unemployment brought the Nazis to power in Germany, fascism consolidated its hold in Italy, Franco’s rebellion plunged Spain into a bloody civil war and democracy was very nearly extinguished across the continent. But the worst economic crisis since the Great Depression has certainly given a boost to the nationalist right and its violent, authoritarian fringe, from Marine Le Pen’s National Front to Greece’s “Golden Dawn” and from Geert Wilders in the Netherlands to Anders Breivik in Norway. These are febrile and dangerous times.

It is also worth noting, as Iain MacWhirter points out in The Herald, 17th May 2012, that just as economic disaster has led most Greeks to oppose withdrawal from the eurozone, despite the hardships and indignities imposed on them, so as we approach Scotland’s referendum in 2014, Scots may well be reluctant to quit the Union: “beware of letting go of nurse for fear of getting something worse”. From this point of view, the resurgence of the right-wing nationalism across Europe is bad news for the civic nationalism of the SNP. The slogan “independence in Europe” now looks distinctly worn and threadbare.

Austerity fatigue

Throughout Europe, the general public is turning against fiscal austerity. This is most dramatically illustrated by the results of the “first round” of parliamentary elections in Greece, where parties opposed to the bailout terms imposed by the troika (European Commission, ECB and IMF) gained two thirds of the popular vote. Austerity fatigue, together with deep antipathy to Sarkozy, also underlies the victory of Hollande in the French presidential election. Likewise, recent regional elections in the German Länder reveal an upturn in the fortunes of the SPD, giving Angela Merkel, who is far more popular than her party, good reason to contemplate reviving the grand coalition and performing a U-turn on macroeconomic policy. She is, after all, a pragmatist: witness her rapid volte-face on nuclear power after Fukushima.

Voters have even turned against Britain’s Con-Lib coalition government, which for nearly two years since the general election of May 2010 has enjoyed a comfortable lead in the opinion polls and even now continues to outpoll Labour on economic competence. Of course, this counts for little on the European stage, from which the British government has become semi-detached, preferring to defend the interests of the City of London from the wings and to appease Tory Europhobes by hectoring the governments of the eurozone.

It seems clear that across Europe, the public has lost confidence in fiscal austerity: (a) because it is hurting, and (b) because it is not working. In most countries – Germany, Poland and the Nordic states are the chief exceptions – GDP is flat or falling; unemployment is high and rising; large firms are hoarding cash, but lack the confidence to invest in fixed capital; public finances remain in poor shape; commercial banks are still trying to repair their balance sheets by selling assets and restricting lending, despite massive injections of free or almost-free electronic money created by central banks; and in marked contrast to the 1930s, when primary product prices fell – ruining farmers but raising the real wages of workers lucky enough to hang on to their jobs – today the terms of trade have turned against Europe as prices of imported food, fuel and raw materials have soared thanks to continuing (though slowing) booms in China, India and Latin America.

The alternative to fiscal austerity

Nevertheless, there is still no clearly articulated and broadly supported alternative to fiscal austerity. There are signs of recognition among Europe’s political elite that they face a serious crisis of political legitimacy, but this has not yet gone much further than the rather trite observation that “austerity is not enough”: i.e. that policies aimed at reducing budget deficits and containing public debt need to be supplemented by “pro growth policies”, generally understood to mean (further) deregulating the labour market, weakening employment and social protection and lowering business taxes. Leaving aside ethical objections and the argument that more of the neo-liberal medicine we have been forced to swallow for the past thirty years will further damage both individual and social well-being, supply-side measures of this kind will make no difference to jobs and growth in the short-run.

In the short run, how much profit-seeking firms decide to produce and how much employment (i.e. total working hours) they offer depends on the revenue they expect to receive from selling the goods and services their workers produce. Firms will not produce more than they expect to sell profitably. Expected sales revenue in turn is governed by actual sales revenue over the current and recent past periods. Thus, across the economy as a whole, output and employment depend, in the short run, on the level of aggregate spending on marketed goods and services. It follows that, as often happens in economics, current conventional policy wisdom is incoherent.

The apparent contradiction between reducing the budget deficit and increasing public borrowing in order to boost public spending can be resolved if we distinguish between different time-scales. In the short-term, we need a strong fiscal stimulus to boost aggregate demand, while assuring the financial markets that in the medium term, once a sustained recovery is under way, the government will raise taxes or restrain public spending so as to bring down the budget deficit and, if necessary, reduce the ratio of public debt to GDP. Austerity, in short, is for the boom. To help win public credibility for such a programme, the fiscal stimulus should be targeted on public investment projects rather than current public spending, preferably slanted towards enhancing energy efficiency, saving energy and reducing carbon emissions. And since the problems we face are pan-European, it makes obvious sense for governments to co-ordinate their macro-economic policies, with those countries that have trade surpluses and/or strong credit ratings acting as locomotive for the rest. Once the immediate economic emergency is over, a long-term green investment programme would form the basis for a new fiscal regime designed to stabilise economic activity in much the way Keynes originally envisaged when plans were being laid during the Second World War for post-war employment policy. A distinction would be drawn between current public spending and public investment. Governments would pledge to balance their current budgets – on average, over the business cycle – while financing public investment by means of borrowing. To counter cyclical fluctuations, an ongoing loan-financed programme of green investment would be speeded up or slowed down, depending on what was happening to the private components of aggregate demand.

The current situation is bad, verging on catastrophic. But we should stay sober and spurn the politics of apocalypse. There is, I think, a chance that a green Keynesian programme along the lines I have sketched could form the basis for changing current conventional policy wisdom and setting in motion a process that would bring an end to the age of neo-liberalism, just as the crisis of the 1930s marked the end of laissez faire and the transition, after the war, to a mixed economy.

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