26th September 2012
Where one country in a monetary union is running a current account surplus, it is a good bet that a large part of it is being funded by deficit spending from other member states. If there is then a market disruption those countries with a deficit can quickly get into trouble unless they are able to rebalance their economy.
The narrative fits neatly for countries such as Germany and Greece. Between 1997 and 2007, GDP growth in Greece averaged 4% – around twice the average for the region as a whole. This impressive growth rate was financed through low borrowing costs provided by the apparent security of the monetary union and allowed the country to run up huge government borrowings.
In turn it facilitated the increased consumption of, among others, German exports at a higher rate than would otherwise have been possible. However, it also increased the fiscal vulnerabilities of the Greek state so that it was ill prepared when the financial crisis struck and it became difficult to meet its spending commitments.
Unfortunately, while the Greek example may be a useful parable for proselytisers of austerity the case of Spain does not fit the pattern so neatly. As Paul Krugman, Nobel-winning economist and columnist for the New York Times, wrote in April:
"In a way, it doesn't really matter how Spain got to this point – but for what it's worth, the Spanish story bears no resemblance to the morality tales so popular among European officials, especially in Germany. Spain wasn't fiscally profligate – on the eve of the crisis it had low debt and a budget surplus. Unfortunately, it also had an enormous housing bubble, a bubble made possible in large part by huge loans from German banks to their Spanish counterparts. When the bubble burst, the Spanish economy was left high and dry; Spain's fiscal problems are a consequence of its depression, not its cause. "
The point is not that Germany alone was at fault for creating the Eurozone's crisis. Indeed the allocation of blame ignores the interconnectivity that provided the conditions for the crisis. The failure to frame solving the fiscal woes of Southern European countries as a common cause, however, is having real-world implications and is driving fractures in the union ever deeper.
The human condition
A principle failure has been the inability of Eurozone politicians to communicate with their electorates. How opposed would German taxpayers be to fiscal transfers for struggling member states if they were told that a disorderly break up could cost Germany around €1,000 billion in write downs?
Moreover in countries where the need for fiscal consolidation is considered urgent a demonstration of support by European partners could go a long way to assuaging the rising tide of anger against government reforms. Even if politicians deem it accurate, There Is No Alternative neither appears a particularly democratic way to justify policy decisions nor a compelling argument for having almost a quarter of the working-age population out of a job.
This looks to be what is currently playing out in Spain. With the unemployment rate running at 24.6%, news today that the economy is expected to contract in the third quarter of 2012 will make for grim reading. After images of police firing rubber bullets at protestors in Madrid yesterday, who had taken to the streets to protest the "kidnapping of democracy", it seems the mood of the country is turning from indignant to angry.
Adding to Prime Minister Mariano Rajoy's woes, the inability of the government to address the concerns of its citizens has allowed Artur Mas, the Catalan President, to piggyback on hostility to press for greater independence for Spain's richest region. It may be populist politics but Mas is simply exploiting the democratic gulf opening up between elected officials and voters in Europe.
Failure to address the democratic deficit alongside the fiscal one will only increase the likelihood of these types of situations occurring. Across the crisis-hit region anti-austerity parties have been gaining ground, many of which have attempted to use nationalist rhetoric to stoke hostility against the Euro project. Here the European Central Bank (ECB) cannot come to the rescue without a political mandate.
What needs to be done
Firstly, a campaign is required to candidly explain to the public what the consequences of a Eurozone collapse would be and allow them to vote on it. If they decide that it is a risk they are willing to take then they can choose either to continue with current policies or begin a discussion on a route to a more orderly dismantling of the monetary union.
If, however, the majority wish to remain part of the euro then this would provide the democratic mandate to institute thoroughgoing reforms necessary for its long-term survival. These would have to include removing the conditionality from the ECB's Outright Monetary Transactions to cap borrowing costs as well as some form of fiscal transfer from core to periphery.
Only then would a comprehensive package, such as Yanis Varoufakis and Stuart Holland's Modest Proposal for Resolving the Eurozone Crisis, become plausible.
Contrary to what eurosceptics assert, it remains possible for structural weaknesses to be addressed and a democratic solution reached without the full or even partial destruction of the single currency. Yet, as the situation in Spain demonstrates, for policymakers to achieve this political timidity is no longer an option.
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