The eurocrisis can still be solved. If we want to
The solutions to the European crisis are surprisingly simple, well-known and increasingly gaining support even from sceptical economists. The solution would be imminent if the politicians opened their eyes and pulled their heads out of the 1980s’ paradigm. Whether it can happen is a different question.
The European crisis is a consequence of two and practically only problems: the cyclical crisis of demand and the systemic crisis of eurozone institutions. The debt and financial crises are mere symptoms. If we solve the demand-led vicious circle and rectify the institutional set-up of the common currency, the debt and financial crises will cease to be an issue.
Companies all over Europe are afraid to borrow, invest and hire, because they expect a further stagnation or a downturn, while their cash reserves grow. They adjust to lower turnovers in next months and years. Households are saving more and spending less out of the same fear. Record high numbers of unemployed have little or nothing to spend. There’s no growth, many sectors are shrinking, far too many are unemployed, government income falls despite tax hikes and its debt soars. Central banks pumps money into the economy, but the economy is unwilling to take it.
The diagnosis is a textbook case. Very simply put, the masses of unemployed Europeans spend too little and thus don’t allow companies to hire them, produce, pay salaries and sell their products. The society suffers huge dead-weight losses, although the economy is able to function under higher employment and therefore create greater added value.
This situation is nothing new. It is a vicious circle, which materialises during most of the crises. It is called the crisis of demand and it can persist for many years without any significant progress. In such situations, there are two things that a government should avoid at any cost: raising taxes on consumption and reducing deficits unless it urgently has to. Most of European countries are sadly doing both.
Moral economists say that during a crisis, the weak will fall, the system cleans up and the growth will recover all the more. This is an illusion. Long-term cyclical unemployment destroys human capital, subverts society and individuals, liquidates otherwise healthy companies, and favours monopolies. Operating so far above structural unemployment – as it is the case practically everywhere in Europe – creates long-term and irreversible damage.
Crisis of demand
There is just one solution to such a crisis: fiscal stimulus. It’s simple and straightforward, despite the bad reputation such interventions gained during the last years of reckless public deleveraging. The state temporarily creates demand, companies stop fearing the future and hire. Consumers see light at the end of the tunnel, they stop saving too much, economy starts to recover, unemployment falls, the tax income increases, expenditure falls, and debt burden loosens. Much more efficiently than under panic-stricken fiscal retrenchment in the midst of a recession.
We probably can’t ask Greece to intervene with fiscal stimuli. But we can ask most of European countries and Europe as a whole to do so. Many European governments are borrowing at lowest rates in history of their countries. Sometimes they get paid for borrowing. We should take it as a sign.
Fiscal stimuli of these countries should be a first step out of the crisis. They can be undertaken immediately. In the long term, it is necessary to create an equivalent of US treasuries on the European level with some degree of conditionality. This would ensure that volatile market psychology won’t chaotically decide on the destiny of whole countries.
Crisis of the euro
A big part of the pressure on European periphery comes from the fears that member states won’t be able to guarantee the banking system in a case of a collapse. It is therefore necessary to implement the banking union as soon as possible. Only then will we have time to talk about making the stockholders pay, about modalities of bail-ins, bank nationalisation, or moral hazard.
On the other hand, the capital flee from Greece is underpinned by a fear of euro exit. There is one direct solution: Implement a European-wide deposit insurance in euros and euros only. Depositors would calm down, the convertibility risk would effectively disappear, and the exposure of member states would get so big that investors would never suspect them of conspiring about a Grexit. Investors wouldn’t be afraid of huge losses in the medium-term due to potential exit and a lot of money would be saved. Greece could start to recover.
Furthermore, the ECB should have the option under special circumstances to buy debt directly from states. The current situation, when the cash to stabilise public finance has to go through financial markets is scandalously inefficient and lossy. The ECB should also – at least temporarily – commit to a higher inflation rate (publicly or privately) so that the savings bubble bursts and consumers spend as much as during normal times. The ECB has to become a true lender of last resort, since there is nobody else who can fit this role.
It is also necessary that creditor countries absolve a bigger part of the debt held now by the EFSF, so that economies in difficulty could start to grow again. As we know from real life, it’s sometimes better to get your debtor a shower, buy him a tie and send to a job interview rather than to beat him up, pee on him and steal his wallet with nothing but nickels.
In the long term, member states have to accept the fact that those who profit from the existence of the common currency more than others will send – directly or indirectly – some cash to those who profit less. This does not have to have a form of regular and too obvious fiscal transfers; a pan-European unemployment fund of few percentage points of European GDP could be enough. Similar mechanisms would solve the shortcoming of the common currency without a common state, as they will shrink the imbalances piled up before and during the crisis. The current crisis would be over and, more importantly, it wouldn’t return.
Why it won’t happen…
There are many more steps that might be necessary. Especially in terms of politicising and democratising Europe in order to make the common currency legitimate and controlled by European citizens. However, avoiding the immediate crisis of demand and resolving the major loopholes of eurozone institutions would be enough to get us out of the worst.
Suprisingly, politicians know how to get the crisis solved. Some of them just prefer to please short-sighted and increasingly nationalistic and self-righteous voters by reinforcing primitive but popular narratives, such as the stereotype of lazy southerners living at the expense of hard-working northerners. This is why the solution to the crisis is tougher than it could be. Not because simple and efficient solutions don’t exist, but because politicians fear unorthodox measures and unpopularity. If they had the courage to explain why such solutions are important and why they must be undertaken as soon as possible, the crisis would be over. But since they don’t, we have still some hopeless months and years ahead.
Published in Hospodářské Noviny (24/9/2012)