Issue 6 - December 2011
Restoring The Union
Writing from Athens, a leading economist sees in the eurozone financial crisis the potential seed of a stronger union. But the cost may be more than financial.
Those among Europe’s political and business elite who favor greater political and economic integration have had a rough few years. The global recession slowed output in nearly every European country. In many cases, recovery has been weak and faltering, due partly to Europe’s greatest act of political and economic integration: the creation of the euro.
The eurozone’s weaknesses have sat in plain sight from the start. The group of countries that constituted the eurozone did not meet the preconditions for a single currency to operate sustainably. Productivity and prosperity vary widely from country to country, and there are no financial transfers between them on a scale that would correct for those differences. And linguistic, cultural and economic barriers to migration hinder the labor mobility that would alleviate persistent unemployment.
The consequences have been felt most keenly in the country of my birth: Greece. In 2001, Greece was allowed to join the eurozone, ostensibly having met the economic preconditions. In reality, Greece had manipulated and falsified its economic data.
Entry into the eurozone gave Greece’s consumers, businesses and government access to credit at much lower interest rates than they otherwise would have had. The risk of Greece’s taking a haircut through devaluation disappeared, and the financial markets assumed that the eurozone would stand behind any of its member countries’ debts.
The result was unsurprising: Greece went on a spending spree. In the meantime, it failed to press ahead with the difficult reforms that might have improved its productivity and competitiveness relative to other members of the eurozone, such as Germany. In fact, taking real unit labor costs as a measure of industrial competitiveness, the gap between Germany, the eurozone’s largest economy, and the peripheral economies (those of Portugal, Ireland, Spain and Italy, as well as Greece) widened rather than narrowed.
This could not go on forever. In 2010 the markets decided that Greece’s debt was unsustainable. The risk premium on government debt soared, and Greece faced insolvency. The International Monetary Fund, the European Central Bank and the European Commission financed a bailout. Greece now is implementing major fiscal consolidation and structural reforms, such as improving public sector efficiency, opening up the professions and liberalizing markets.
But austerity programs themselves reduce demand in the economy and slow economic growth. The latest forecasts for Greece are that 2012 will see the fourth consecutive year of falling gross domestic product, with a cumulative fall in output of some 12%. A second bailout package has been agreed to that will involve a significant element of debt forgiveness. Although the risk of Greece defaulting on its debts has been reduced somewhat, the markets still think there is a high chance of it happening within the next two years. Portugal and Ireland also have been forced to take bailout packages because they could not finance their debts at sustainable rates.