An article by R. DANIEL KELEMEN
The
eurozone's troubles no longer qualify as a crisis, an unstable
situation that could either quickly improve or take a dramatic turn for
the worse. They are, instead, a new normal -- a painful situation, to
be sure, but one that will last for years to come. Citizens, investors,
and policymakers should let go of the idea that there is some magic
bullet that could quickly kill off Europe's ailments. By the same
token, despite the real possibility of Greek exit, the eurozone is not
on the brink of collapse. The European Union and its common currency
will hold together, but the road to recovery will be long.
It
has been nearly two and a half years since the incoming socialist
government in Greece revealed the extent to which its predecessor had
accumulated debt, precipitating an economic storm that has left slashed
budgets, collapsed governments, and record unemployment in its wake.
With each dramatic turn, observers have anticipated the story's
denouement. But again and again, a definitive resolution -- either a
policy fix or a total collapse -- has failed to emerge.
The
truth is that there are no quick escapes from the eurozone's
predicament. Divorce is no solution. Although some economists suggest
that struggling countries on the periphery could leave the euro and
return to a national currency in order to regain competitiveness and
restore growth, no country would willingly leave the eurozone; doing so
would amount to economic suicide. Its financial system would collapse,
and ensuing bank runs and riots would make today's social unrest seem
quaint by comparison. What is more, even after a partial default, the
country's government and financial firms would still be burdened by
debt denominated largely in euros. As the value of the new national
currency plummeted, the debt would become unbearable, and the
government, now outside the club, would not be able to turn to the
eurozone for help.
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The eurozone has, at least in practice, done away with its founding documents
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Some
economists go further and argue that countries on Europe's periphery
could thrive outside the euro straitjacket. This is equally
unconvincing. Southern European countries' economies suffer from deep
structural problems that predate the euro. Spanish unemployment rates
fluctuated between 15 and 22 percent throughout most of the 1990s;
Greece has been in default for nearly half of its history as an
independent state. These countries are far more likely to tackle their
underlying problems and thrive inside the eurozone than outside it.
Others
have suggested that Germany and other core countries -- weary of
funding endless bailouts -- might abandon the euro. That is even less
plausible. Germany has been the greatest beneficiary of European
integration and the common currency. Forty percent of German exports go
to eurozone countries, and the common currency has reduced transaction
costs and boosted German growth. An unraveling of the eurozone would
devastate German banks, and any new German currency would appreciate
rapidly, damaging the country's export-led economic model.
A
number of policy reforms may improve economic conditions in the
eurozone, but none offers a panacea. Eurobonds, increased investment in
struggling economies through the European Investment Bank and other
funds, stricter regulations of banks, a common deposit insurance
system, a shift from budget cuts to structural reforms that enhance
productivity and encourage private-sector job creation -- all of these
could improve Europe's economic situation and should be implemented.
But
none of these measures would quickly restore growth or bring employment
back to pre-crisis levels. That is because they do not address Europe's
central economic problem: the massive debt accumulated by the periphery
countries during last decade's credit boom. The 2000s saw a tremendous
amount of capital flow from the northern European countries to private-
and public-sector borrowers in Greece, Ireland, Portugal, and Spain.
Germany and other countries with current account surpluses flooded the
periphery with easy credit, and the periphery gobbled it up. This
boosted domestic demand and generated growth in the periphery but also
encouraged wage inflation that undermined competitiveness and left
massive debt behind. As the economists Carmen Reinhart and Kenneth
Rogoff have pointed out, when countries suffer a recession caused by a
financial crisis and debt overhang, they take many years to recover.
With
both breakup and immediate solutions off the table, then, the eurozone
is settling into a new normal. As the union slowly digs itself out of
the economic pit, it is important to recognize that its system of
economic governance has already been fundamentally transformed over the
past two years.
First, the eurozone has, at least in
practice, done away with its founding documents. In any monetary union
in which states retain the autonomy to tax, spend, and borrow, there is
a risk that some countries' excessive borrowing could threaten the
value of the common currency. Recognizing this, the euro's creators
drafted the Stability and Growth Pact and the "no bailout" clause in
the Maastricht Treaty. The SGP placed legal restrictions on
member-state deficit and debt levels, and the no-bailout clause forbade
the European Union or individual member states from bailing out
over-indebted states to avoid moral hazard.
The
Maastricht governance regime is dead. The SGP was never strictly
enforced, and when the crisis hit, the European Union tossed aside the
no-bailout clause. Fearing contagion, it extended emergency loans to
Greece, Ireland, and Portugal and set up a permanent bailout fund --
the European Stability Mechanism (ESM) -- which will be up and running
this summer.
Having broken the taboo on bailouts, Europe
had to find a way to limit the moral hazard of states turning again and
again to the European Union for aid. EU lawmakers introduced the
so-called six-pack legislation, which strengthened the European
Commission's ability to monitor member states' fiscal policies and
enforce debt limits. Twenty-five EU member states signed a fiscal
compact treaty, which committed them to enshrining deficit limits into
national law. Only those states that eventually ratify the treaty will
be eligible for loans from the ESM.
Such legal provisions
alone will not overcome the moral hazard, but they have been
accompanied by evolution in bond markets, which now distinguish between
the debt of healthy governments in the core and weak ones on the
periphery. For the first decade of the euro's young life, bond markets
priced the risk associated with the peripheral economies' bonds nearly
the same as that associated with German ones. Today, the yield spreads
are substantial and increase at the first sign of heightened risk. And
by forcing private investors to take a nearly 75 percent loss on Greek
bonds in conjunction with the second Greek bailout in February 2012,
European leaders made clear that private bondholders should not expect
bailouts to cover their losses, too. Now, more vigilant bond markets
will police governments that run up unsustainable deficits or whose
banking sectors grow fragile.
The second major structural
change is that the European Central Bank -- legally prohibited from
purchasing any member state's debt -- has thrown its rules aside and
directly purchased billions in Greek, Irish, Italian, Portuguese, and
Spanish bonds. Moreover, the ECB has indirectly financed billions more
loans through its long-term refinancing operation, which extended over
a trillion euros in low-interest loans to commercial banks.
ECB
President Mario Draghi has repeatedly insisted that the bank is not
engaging in "monetary financing" of member-state debts. If I were an
Italian president of a central bank located in Frankfurt with a mandate
designed by German inflation hawks, I would say that, too. But in
practice, the ECB has shown itself to be far more flexible than many
had anticipated. It has revealed, quite simply, that it will not
oversee the demise of the currency that justifies its existence.
This
new system of eurozone governance is more sustainable than the
pre-crisis regime set in place by the Maastricht Treaty. It will
withstand a Greek exit, for example. If Greece refuses to adhere to the
terms of its bailout package and is forced out of the eurozone in the
coming weeks, the ECB will likely scramble to stop contagion, but it
will not be faced with the entire system's collapse. Meanwhile, by
standing firm on Greece, the European Union will have further
demonstrated that the conditions attached to its bailouts are serious,
motivating other states to stick to their reform programs.
Greece's
exit from the eurozone would be a catastrophe for Greece and a trauma
for Europe, but it would not change the fundamentals of the post-2008
eurozone governance regime, which will still be based on stronger
fiscal surveillance, more robust enforcement procedures, more vigilant
bond markets, and a more activist central bank. With such a system in
place, and with their commitment to fiscal discipline established, EU
leaders will now face the slow, difficult tasks of adjustment and
structural reform. And those burdens must be shared by all. It is
understandable that Germany and the ECB initially demanded austerity as
the condition for bailouts, but this one-sided approach has driven
peripheral economies deeper into recession. Moving forward, austerity,
wage reductions, and structural reform on the periphery must be comupled
with public spending and wage increases in Germany, which will boost
demand. There will be no quick fix, but the eurozone will recover,
slowly but surely.
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