NEW YORK –
Like an inmate on death row, the euro has received another last-minute stay of
execution. It will survive a little longer. The markets are celebrating, as
they have after each of the four previous “euro crisis” summits – until they
come to understand that the fundamental problems have yet to be addressed.
There was good news in this summit: Europe’s leaders have finally understood
that the bootstrap operation by which Europe lends money to the banks to save
the sovereigns, and to the sovereigns to save the banks, will not work.
Likewise, they now recognize that bailout loans that give the new lender
seniority over other creditors worsen the position of private investors, who
will simply demand even higher interest rates.
It is deeply troubling that it took Europe’s
leaders so long to see something so obvious (and evident more than a decade and
half ago in the East Asia crisis). But what is missing
from the agreement is even more significant than what is there. A year ago,
European leaders acknowledged that Greece
could not recover without growth, and that growth could not be achieved by
austerity alone. Yet little was done.
What is now proposed is
recapitalization of the European Investment Bank, part of a growth package of
some $150 billion. But politicians are good at repackaging, and, by some
accounts, the new money is a small fraction of that amount, and even that will
not get into the system immediately. In short: the remedies – far too little
and too late – are based on a misdiagnosis of the problem and flawed economics.
The hope is that markets will reward
virtue, which is defined as austerity. But markets are more pragmatic: if, as
is almost surely the case, austerity weakens economic growth, and thus
undermines the capacity to service debt, interest rates will not fall. In fact,
investment will decline – a vicious downward spiral on which Greece
and Spain have
already embarked.
Germany
seems surprised by this. Like medieval blood-letters, the country’s leaders
refuse to see that the medicine does not work, and insist on more of it – until
the patient finally dies.
Eurobonds and a solidarity fund could
promote growth and stabilize the interest rates faced by governments in crisis.
Lower interest rates, for example, would free up money so that even countries
with tight budget constraints could spend more on growth-enhancing investments.
Matters are worse in the banking
sector. Each country’s banking system is backed by its own government; if the
government’s ability to support the banks erodes, so will confidence in the
banks. Even well-managed banking systems would face problems in an economic
downturn of Greek and Spanish magnitude; with the collapse of Spain’s
real-estate bubble, its banks are even more at risk.
In their enthusiasm for creating a
“single market,” European leaders did not recognize that governments provide an
implicit subsidy to their banking systems. It is confidence that if trouble arises
the government will support the banks that gives confidence in the banks; and,
when some governments are in a much stronger position than others, the implicit
subsidy is larger for those countries.
In the absence of a level playing
field, why shouldn’t money flee the weaker countries, going to the financial
institutions in the stronger? Indeed, it is remarkable that there has not been more
capital flight. Europe’s leaders did not recognize this
rising danger, which could easily be averted by a common guarantee, which would
simultaneously correct the market distortion arising from the differential
implicit subsidy.
The euro was flawed from the outset,
but it was clear that the consequences would become apparent only in a crisis.
Politically and economically, it came with the best intentions. The
single-market principle was supposed to promote the efficient allocation of
capital and labor.
But details matter. Tax competition
means that capital may go not to where its social return is highest, but to
where it can find the best deal. The implicit subsidy to banks means that
German banks have an advantage over those of other countries. Workers may leave
Ireland or Greece
not because their productivity there is lower, but because, by leaving, they
can escape the debt burden incurred by their parents. The European Central
Bank’s mandate is to ensure price stability, but inflation is far from Europe’s
most important macroeconomic problem today.
Germany
worries that, without strict supervision of banks and budgets, it will be left
holding the bag for its more profligate neighbors. But that misses the key
point: Spain, Ireland,
and many other distressed countries ran budget surpluses before the crisis. The
downturn caused the deficits, not the other way around.
If these countries made a mistake, it
was only that, like Germany
today, they were overly credulous of markets, so they (like the United
States and so many others) allowed an asset
bubble to grow unchecked. If sound policies are implemented and better
institutions established – which does not mean only more austerity and
better supervision of banks, budgets, and deficits – and growth is
restored, these countries will be able to meet their debt obligations, and
there will be no need to call upon the guarantees. Moreover, Germany
is on the hook in either case: if the euro or the economies on the periphery
collapse, the costs to Germany
will be high.
Europe has
great strengths. Its weaknesses today mainly reflect flawed policies and
institutional arrangements. These can be changed, but only if their fundamental
weaknesses are recognized – a task that is far more important than
structural reforms within the individual countries. While structural problems
have weakened competitiveness and GDP growth in particular countries, they did
not bring about the crisis, and addressing them will not resolve it.
Europe’s
temporizing approach to the crisis cannot work indefinitely. It is not just
confidence in Europe’s periphery that is waning. The
survival of the euro itself is being put in doubt.
Joseph E. Stiglitz, a Nobel laureate in economics, has pioneered
pathbreaking theories in the fields of economic information, taxation,
development, trade, and technical change. As a policymaker, he served on and
later chaired President Bill Clinton’s Council of Economic Advisers, and was
Senior Vice President and Chief Economist of the World Bank. He is currently a
professor at Columbia University, and has taught at Stanford, Yale, Princeton,
and Oxford.He is the author of The
Price of Inequality: How Today’s Divided Society Endangers our Future.
