Eurozone's long reform wishlist
- 26 June 2012
- From the section Business
Italian Prime Minister Mario Monti claimed Europe had "one week to save the euro" ahead of yet another crunch EU summit on Thursday and Friday.
France's president has called for a "growth pact", Tony Blair has urged a "grand bargain", the markets demand a "big bazooka", while in Germany there are rumblings about federalism.
Yet the economic and financial solutions to the eurozone crisis are actually surprisingly straightforward.
Easy. Just ask how the exact same problems have been solved by the members of that other large (and much better functioning) single currency area - the United States of America.
Europe's real problem is that almost all of the solutions are far from politically palatable.
The eurozone's root problem is that the southern European economies have become fundamentally uncompetitive - their wages rose too quickly during the boom years, which led them to import a lot more than they exported, and borrow the difference.
The southern economies' excessive debts, persistent uncompetitiveness and resulting need to continue borrowing - along with Germany's reluctance to give them the money - is what has driven the financial panic that has made it much harder for southern European governments and banks to borrow from markets.
What's more, the seizing up of European financial markets - not to mention the collective determination of Europe's governments to cut spending, and the European Central Bank's focus on price stability - is threatening to push the entire continent into a long and deep recession, something that would merely compound the debt problems.
So, if the eurozone were to look at the US model for inspiration in its hour of need, what sorts of changes - economic, financial and, ultimately, political - might need to be considered?
Europe's most immediate task is to restore confidence in its banks.
All the bad loans made by eurozone banks (loans to mortgage borrowers, property speculators and even governments that may not be fully repaid) may need to be cleaned up (by injecting money into the banks), with the potential losses borne by the eurozone as a whole - because many national governments probably cannot afford it. In the case of Spain's banks, the current bailout deal leaves Spain's government sitting on all the losses.
Deposits at all eurozone banks may need to be guaranteed in euros by the eurozone as a whole, in order to stop panicky investors from moving their money from banks in southern European countries at risk of exiting the euro, to Germany (and increasingly to Switzerland and Denmark).
All of Europe's banks may need to be placed under a common regime of regulation and supervision, with troubled banks given equal access to rescue loans, and being wound up by a central authority when they go bust.
Europe's biggest long-term conundrum is how to stop governments like Spain or Italy going bust - and restore confidence in their commitment to stay within the euro - while ensuring that all governments are more responsible with their finances in future.
The biggest sticking point is eurobonds. A large chunk of eurozone government debt may need to be amalgamated - with governments standing behind each other's finances - in order to reinforce the commitment of governments to staying in the euro:
- One full-blown version proposed by euro-think tank Bruegel would pool debts equal to perhaps 60% of eurozone GDP, which would (counter-intuitively) create strong market-based incentives for governments to be more prudent with their spending in future.
- Another, lighter version proposed in Germany would only pool debts in excess of the 60% level, as a strictly temporary measure to make it easier for southern governments to borrow.
In the long-run, a US-style federal budget may be needed to cover the cost of recessions, so that individual governments don't risk going bust when their national economies get into trouble. For example, the cost of a minimum level of social security - especially unemployment benefits - could be permanently shared across the eurozone, paid for by a common income tax.
The new French President Francois Hollande was elected on a platform demanding a "growth pact" in Europe - a set of reforms designed to boost European economies and mitigate the pain being inflicted by government spending cuts across the continent.
The European Central Bank may need to have its mandate changed so that it has an explicit dual target to support employment as well as price stability, just like its American counterparty, the US Federal Reserve does, as proposed by Mr Hollande.
The eurozone may need to pay for large-scale investment in infrastructure, particularly in southern Europe, much in the way that West Germany invested in rebuilding East German after reunification in 1990. Proposals on the table include increasing the European Investment Bank's ability to lend, and creating common "project bonds" to finance major construction.
All Europeans (and especially southerners) are having to implement structural reforms that will increase their long-term growth and strengthen government finances (although at the risk of hurting growth in the short-term). These include removing restrictions on market competition, raising the retirement age, laying off (over many years) a lot of state employees, and making it much easier to hire and fire employees. Mr Hollande has resisted many of these reforms in France.
"Rebalancing" means solving the big underlying competitiveness problem faced by southern Europeans that led to their economies racking up so much debt in the first place.
The ECB and German government may need to stimulate high wage inflation in Germany for several years in order to eliminate the country's current massive competitive trade advantage over southern Europe - something that is already beginning to happen .
In the same way that Washington helps out struggling US states, the southern European governments may need to be given money ( given, not lent) by the rest of the eurozone via direct fiscal transfers, so that they can afford to prop up their economies until they have regained their competitiveness. These transfers could end up taking the form of bailout loans that are never repaid.
Structural reforms - particularly labour market reforms - also play a key role in rebalancing, by ensuring that wages in southern Europe do not rise too quickly, as they did in the past decade.
To make a full banking, fiscal and monetary union work, the eurozone governments would need to hand power to a central authority (the European Commission) that can pay for and supervise all of the above, while national governments accept that in future they have to keep their own spending strictly within their limited means.
As most of the above reforms involve Germany sharing its wealth with the rest of Europe (and all European nations handing power to Brussels), Berlin is insisting on the principle of no taxation without representation - in other words a move towards full federalism, with spending and regulation controlled by a directly elected presidency of the European Commission.