Plan B for the eurozone?
- 26 October 2011
- From the section Business
Plan A for fixing the eurozone is turning out to be painfully slow. Even if we get an agreement out of Wednesday's summit, it seems now there will be plenty of details left for officials to fill in later.
If previous deals are any guide, there will also plenty of holes - which investors and commentators will be quick to spot. But for many, the most gaping absence will be the one I discussed in my last post: economic growth.
On today's negotiations, the rule of thumb for officials is that the bigger the 'haircut' for private holders of Greek government debt, the more ambitious the plans for the bailout fund, the European Financial Stability Facility, will need to be, and the more likely it is that France will persuade Germany to go along with the whole thing.
That deal has yet to be done. It's not clear it will be done by the end of play on Wednesday. But the worry for investors - and the likes of the IMF - is that the countries in trouble are simply not going to grow quickly enough to stay on top of their debts. Even if, in the case of Greece, that debt is sharply reduced.
Why? Because, as I have discussed many times before, this is not just a debt crisis for the so-called 'periphery' economies. (I think we are supposed to forget, in these conversations, that the EU came of age with the Treaty of Rome.) It is also a crisis of competitiveness.
The way the German finance minister tells it, the first step on the road to increased competitiveness, for any country, is to bring the public finances under control. The other key element is structural reform - of labour regulations, pensions and the like - to make the country more dynamic and support growth.
These steps might be painful in the short term, but Wolfgang Schauble (and George Osborne) would say, there is no alternative. They would also say that countries that do these things are ultimately rewarded. Look at Germany, Mr Schauble would say: we went through our own period of slow growth and painful reform in the early years of this century. Now look at us.
Now, it will not be news to you that many see this view as dangerously one-sided. They point out that Germany was able to grow in a period of flat domestic demand because external demand was booming. And a lot of that demand for German goods came from the rest of the eurozone (the same countries who are now in trouble).
Put it another way: domestic reform is a necessary condition for successful adjustment, but it's not sufficient. It also matters what's going on in the world outside. This may be especially true in a currency union, where the usual route - a nominal devaluation - is blocked.
Here's the economics bit: if those periphery countries are going to become more competitive, without a currency depreciation, it follows that their domestic prices and wages need to fall, relative to German ones, and their domestic consumption needs to grow more slowly than their net exports.
That will happen - is happening - when their economies collapse and domestic prices and wages fall through the floor. But we'd rather they combine it with economic growth, and at least some stability of nominal incomes (and, incidentally, so would the people holding their debt, because it then has a chance of a being repaid).
That means that external demand needs to be going up, and, as long as the European Central Bank is trying to keep average eurozone inflation slightly below 2%, that probably means that inflation in Germany needs to be significantly above 2%.
Will all of these things happen? It is possible. But it does not seem very likely, when the German finance minister keeps asserting the absolute necessity of price stability, and asserting that there is no "symmetry" between debtors and creditors in the eurozone.
In London last week, Mr Schauble said suggestions that Germany's current account surplus needs to fall "did not make any sense".
Is there anything they can can do to make the "solution" to the euro crisis more growth-friendly? Well, the folks at the Bruegel think-tank have pointed to some interesting possibilities.
First, there are the unused structural and cohesion funds that some of the crisis economies have access to. In some cases these are pretty sizeable. For Portugal, Bruegel's Benedicta Marzinotto, reckons these could be worth over 9% of GDP. Greece has untapped funds worth around 7% of GDP.
She says, in effect, the European Commission needs to stuff procedure and start finding ways to spend this money usefully.
Second, the Bruegel economists say the IMF-EU supported adjustment programmes need to become more focussed on growth. They point out that as market pressure has increased, governments have increasingly turned to growth unfriendly tax increases to fill gaps in deficit plans. That threatens to make a difficult situation even worse.
They also think the so-called "troika" - the European Commission, ECB and the IMF - should be looking for imaginative ways to help encourage structural reform and economic growth at the same time - for example, through temporary wage subsidies for new businesses, or programmes to support lending to SMEs.
Finally, there is a part of Plan B that may move up the agenda regardless, if the European recovery continues to stall: a radical change of heart at the ECB.
Economists such as David Owen have already proposed that the central bank should cut interest rates by half a percentage point and announce 1tn euros (£868bn) in genuine quantitative easing, buying government bonds from across the eurozone to boost nominal demand.
Germany might support the first of these - spending more EU money, at least if it came with enough strings attached.
In fact, Mr Schauble has been publicly berating the European Commission for not moving faster on the "Marshall Fund for Greece" that was promised back in July. (Remember that? I thought not.)
But, you will not hear many Germans advocating a more radical approach to economic growth from the ECB. Quite the contrary.
In fact, it is Germany's reluctance to have the central bank more deeply involved in the rescue of the eurozone that has made it so difficult to agree a deal in the past week.
The "crunch points" and "moments of truth" for the euro will come and go. I'm afraid the question of economic growth will be with us for a long time.