Angela Merkel’s remarkable election result confirms her position as the dominant politician in Germany and so also in Europe. It is assumed she will get the eurozone she wants: Germany writ large. That may prove right. Alas, if she does, it is going to be a deeply depressing spectacle.
Wolfgang Schäuble, Germany’s finance minister, laid out the view on which Berlin’s current policy is based, with sobering clarity, in the Financial Times last week. The doomsayers, he argued were wrong. Instead, “the world should rejoice at the positive economic signals the eurozone is sending almost continuously these days”. If depressions and mass unemployment are a success, then adjustment in the eurozone is indeed a triumph. Schäuble accuses his critics of living in a “parallel universe”. I am happy to do so rather than live in his.
Ambrose Evans-Pritchard of The Telegraph has provided a colourful rejoinder. Kevin O’Rourke of Oxford and Alan Taylor of the University of California, Davis, offered a sober assessment, concluding that a break-up is not unthinkable.
So where is the eurozone? Its unemployment is 12 per cent. Its gross domestic product in the second quarter was 3 per cent below its pre-crisis peak and 13 per cent below its pre-crisis trend. In the most recent quarter, Spain’s GDP was 7.5 per cent below its pre-crisis peak; Portugal’s, 7.6 per cent; Ireland’s, 8.4 per cent; Italy’s, 8.8 per cent; and Greece’s, 23.4 per cent. None of these countries is enjoying a strong recovery. The latest unemployment rate is 12 per cent in Italy; 13.8 per cent in Ireland; 16.5 per cent in Portugal; 26.3 per cent in Spain; and 27.9 per cent in Greece. These would be higher without emigration. Ireland’s plight is a warning: it has long since restored its competitiveness and is running a large current account surplus. Yet its GDP has stagnated for four years.
Similar stagnation may be the fate of others. Why? To understand this, one needs to understand why the parallels drawn by Schäuble between Germany’s reforms in the 2000s and the position of today’s vulnerable countries are absurd.
Germany experienced a mild recession in 2003; today’s vulnerable countries are suffering depressions. Germany’s largest current account deficit was 1.7 per cent of GDP in 2000; those of today’s crisis-hit countries were far larger, with those of Greece, Portugal and Spain more than 10 per cent of GDP. Germany did not have huge debts and had no difficulty in financing itself; today, the vulnerable countries have huge debt overhangs and much difficulty in financing themselves.
Before the crisis, the world and eurozone economies generated strong demand for German exports; today’s vulnerable countries are pursuing adjustment in a period of chronically weak demand. In the pre-crisis boom, Germany’s partners found it hard to avoid high inflation; in today’s weak economy, Germany has no difficulty in keeping its inflation low.
The difficulties confronting the vulnerable eurozone countries reflect these conditions. They have to improve their competitiveness. But the only one in which nominal wages have fallen substantially is Greece. Elsewhere, it is rising productivity that has improved competitiveness. But that is the other side of the coin from the unemployment. Moreover, if prices and wages did fall, the real burden of debt would rise. High nominal interest rates relative to the growth of nominal incomes also raise the debt burden. All these countries are going to end up with gross public debt at more than 100 per cent of GDP. This will be hard to manage.
In the terrifying summer of 2012, the European Central Bank promised to do “whatever it takes” to save the euro. The ECB then announced its Outright Monetary Transaction program of support for bonds of beleaguered sovereigns. This assuaged the markets’ alarm without any need (so far) to fire a shot in anger. This has given the eurozone time. But it has not solved the underlying problems.
What are those problems? The first is to get out of the current mess. The second is to achieve the reforms needed in the longer run. Ongoing fiscal transfers seem neither desirable nor feasible. But better insurance mechanisms for sovereigns and banks are needed in the long run. Yet all this will be academic if the eurozone does not allow its members to return to economic health over a reasonable time period.
Can that be done? Without a change in Germany’s philosophy, the answer is No. As Schauble’s piece makes quite clear, demand does not appear in the analysis. Yet a large country with a huge structural current account surplus does not just export products. It also exports bankruptcy and unemployment, particularly if the counterpart capital flow consists of short-term debt. That the new macroeconomic imbalances procedure avoids recognising the role of Germany’s shortage of domestic demand is most revealing. The benchmark for concern over a current account surplus is 6 per cent of GDP, regardless of the size of the country. Germany’s average turns out to be exactly 5.9 per cent.
So what is actually happening? The answer is that the eurozone is trying to become a bigger Germany. A mixture of rising productivity and collapsing demand has driven vulnerable economies into external balance.
Meanwhile, Germany is redirecting its surpluses outside the eurozone. Overall, the shift in the eurozone’s current account balance towards surplus between the fourth quarter of 2008 and the second quarter of 2013 is €340 billion. To the extent that this helps solve the eurozone’s internal problems, it does so by exporting bankruptcy elsewhere. This attempt to export its difficulties via beggar-my-neighbour policies is inconsistent with the eurozone’s obligations inside the Group of 20 leading countries.
But it also will not work, for two reasons: first, the eurozone is far too big to achieve export-led growth, as Germany has done; and, second, the currency is likely to appreciate still further, thereby squeezing the less competitive economies all over again.
None of this, so far as I can judge, even appears relevant inside Schäuble’s universe. In that universe, pursuit of competitiveness is never recognised for the zero-sum game it is if demand is completely ignored.
The eurozone could be a success, but not under such a philosophy. Will it survive? Nobody really knows. Is this how Europe’s most ambitious project should be run? No.
Copyright The Financial Times Limited 2013.