Governments in Europe are quickly losing
legitimacy because austerity programs and a common
currency risk throwing the continent into an
endless recession. Europe's infamous labor laws,
which make layoffs expensive and businesses
reluctant to invest, have long impeded investment
and productivity growth.
During the
expansion of the 2000s, the competitive core -
Germany, other northern economies and important
parts of France - coped better and accomplished
stronger productivity. Consequently, the euro
became undervalued for those economies and
overvalued for Mediterranean economies -
specifically, goods made in the north became
bargain priced and those made in Club Med states
too expensive.
Southern economies suffered
large trade deficits with the north
and insufficient demand
for what they make. Governments in Italy, Greece
and Portugal borrowed feverishly to keep folks
employed, finance early retirements, and provide
inexpensive health care.
Even as northern
Europe and the United States recovered, the
sovereign debt carried by those governments
alarmed investors and interest rates soared. Each
was forced to accept bailouts from more solvent
European governments, led by Germany, on the
condition they accept draconian austerity and
pledge allegiance to the common currency.
Certainly, Mediterranean states must trim
government spending and reform labor markets, but
to pay back what they owe, they must earn euro by
growing their economies and exporting more than
they import. Together, those require more gradual
reductions in government spending and abandoning
the euro, or their economies will endure years of
high unemployment to push down wages and prices
and make their economies competitive with the
north.
In the end, all this will not be
enough and endless recession will result, as new
investments dry up and existing capital - both
machines and workers' skills - atrophy or leave.
The collapse of the south is now threatening the
vitality of the north, as Germany, Holland and
others may fall into recession without customers
further south for what they make.
Excessive government spending did not undo
all the troubled economies of Europe. Spain, the
next government likely to need a bailout, ran
persistent budget surpluses until the financial
crisis. However, it enjoyed real estate and
property booms as wealthier northern Europeans
sought vacations and second homes in its sunny
climate.
Ireland and Iceland, the first
European countries to collapse, were undermined by
banks that helped finance Europe's wider real
estate bubble by selling bonds and taking deposits
from foreigners.
When the financial crisis
came in 2008, central banks in Spain, Iceland and
Ireland could not print money in the manner of the
US Federal Reserve to shore up bank balance
sheets. Instead, their governments were forced to
sell bonds to raise euro to bail out banks, and
borrowing requirements were too large relative to
the size of their economies. Investors fled and
their national finances collapsed.
The
2011 Fiscal Stability Pact, which requires all EU
governments to push down deficits to 3% of gross
domestic product before the continent as a whole
has recovered from the Great Recession, makes the
problems of accomplishing recovery in Italy,
Greece, Ireland and other troubled economies
impossible - they have fewer customers for their
exports, high unemployment and hence, can't earn
the euro and grow their tax bases to pay off their
debts.
Exacerbating matters, the big
European banks are burdened with huge amounts of
private debt that will never be repaid. Since
December, the European Central Bank (ECB) has been
aggressively lending to them, but with bank
regulation remaining the province of national
governments, it lacks the clout to force reforms
the Federal Reserve enjoys when doling out aid.
Hence, the European banks, rather than
raising enough new capital and writing off failing
loans, are employing questionable bookkeeping,
reminiscent of practices employed by US banks
before their collapse, and are using ECB funds to
paper over dodgy loans.
To get Europe back
on its feet, the Germans and broader EU must first
dial back a bit on deficit reduction while
continuing labor market reforms. However, they
will never get out of their long-term quagmire
without abandoning the euro in favor of national
currencies.
This would permit exchange
rate adjustments that would better align prices in
weaker economies with those in Europe's strong
core, and permit exports and debt repayment by
troubled economies. Also, the central banks of
individual European countries, armed with their
own currencies, would be able to tie aid to banks
with genuine reforms - increasing capital and
restoring credible lending practices.
Peter Morici is a professor at
the Smith School of Business, University of
Maryland, and a widely published columnist.
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