The eurozone crisis: end, middle or just the beginning?
By Roberto Foa
In the wake of failure to agree treaty-change at the December 9 summit, is the eurozone now on the verge of imminent ‘collapse’? Comparing the Anglo-Saxon and the continental newspapers over the past several weeks has revealed a massive discrepancy in coverage, both in tone, and diagnoses. With debt contagion approaching the eurozone core, Joseph Stiglitz publicly raised the spectre of the ‘end of the eurozone’, while Lawrence Summers stated that the European Union ‘risks catastrophe’. And yet, to judge from the calmer commentary found in the Frankfurter Allgemeine Zeitung or Le Figaro, there was always the luxury of time to first negotiate a new EU treaty – and perhaps still is.
This discrepancy, I think, reflect a deeper ideological difference. Neo-Keynesian economists such as Stiglitz or Summers see the eurozone crisis as a technical, macroeconomic difficulty, a problem of liquidity rather than solvency. They have therefore proposed large-scale, ‘technical’ solutions, such as a joint Eurobond – or a Euro-TARP, as suggested by US Treasury Secretary Geithner, during his intervention at the September eurozone summit. They are perplexed that the European Union cannot instantly implement what they feel is an obvious policy fix.
If continental, and in particular, German commentators have not thus far shared their sense of urgency, it is not because of complacency, but due to a different diagnosis. Those who currently advise the German government prefer to point to failings of institutions and incentives: decades of poor fiscal management in the Mediterranean countries, and irresponsible corporate governance in the eurozone banking sector. Correspondingly, they have favoured solutions that are partial, disciplinary, and gradual: IMF programmes in periphery, financial regulation in the core, and above all, a new EU treaty framework to ensure collective debts are matched by collective obligations.
Why this extreme divergence of perspectives? While it is easy to see nothing more than a technical discrepancy, a difference in economic schools of thought, I think there is a more profound disagreement at work, concerning views of agency and trust. US public intellectuals assume politicians and businessmen to be the responsible agents of their citizens or shareholders. Thus they have faith that the managers at Bank of America or Italy’s politicians would deleverage, if given access to easier terms of credit, rather than reward themselves and their supporters. That is why they favour immediate and unlimited liquidity, at home and abroad.
European commentators, by contrast – whether they are situated on the socialist left or the neoliberal right – tend to suspect that elites will place their own short-term interest above that of their constituents, unless compelled. It is no surprise, for example, that many Italian economists – including the new European Central Bank president Mario Draghi – are among the more enthusiastic proponents of the view that Italian governments function best when placed under the boots of their northern neighbours. That is why having a new treaty framework, with monitoring of national budgets, is so necessary before enlarged bond purchases can be taken on by the ECB.
Whether we believe institutions or policies are at fault, however, has implications not only for how we think about the resolving the eurozone crisis – but even whether we seek resolution at all. For example, commentators in London and New York highlight with alarm that, in the absence of urgent action, the eurozone’s banking sector is now on the verge of collapse. If we see this as a ‘technical’ problem of liquidity, then the solution proposed by Timothy Geithner at the September eurozone summit is not only reasonable, but necessary: the banks must be recapitalised, and urgently.
Yet seen as a problem of poor corporate governance and excessive risk, the provision of unconditional liquidity now will do little to address root causes. The current weakness of the eurozone banking sector reflects years of misaligned incentives, excessive staff remuneration, and leverage above tolerable risk thresholds. Dexia, which increased its CEO salary by 30 per cent after receiving a public bailout in 2008, was symptomatic of this rot.
Other eurozone banks are little better, having increased their leverage since the crisis of 2007-8, such that they are now far more exposed to risk than in the United States (see chart). French banks are the worst perpetrators, having increased from a ratio of 17 to 24 times assets to capital, and several may need to be nationalised. Yet if minor credit events now cause insolvency, the market is only delivering discipline where regulators have failed.
What applies to eurozone banks, applies equally well to eurozone sovereigns. We all know the argument, often restated by Keynesians, that the eurozone crisis is a currency crisis, and not simply a debt crisis: peripheral sovereigns were able to run up debts, in part, due to flows of easy capital from the surplus countries at the core.
Yet if the shoe and the foot do not fit, we have a choice about which we adjust. That is, one option is to re-tailor the shoe, by remoulding Europe into a fiscal union and cover deficits by fiscal transfers. The other is to reshape the foot, by making eurozone sovereigns more similar to one another. Realistically, we are going to need some combination of each. A sensible debate has to be about what proportion of either is feasible.
Critics of the austerity programmes in Greece, Portugal, and Spain miss the extent to which IMF and ECB support is not merely technical assistance, but a long-term institutional and administrative revolution, similar to that undertaken by post-socialist Europe after 1989. In short, the goal is to complete in the economic domain what EU accession accomplished in the political sphere: harmonising the South with the North, not only in democratic politics and rule of law, but in building effective tax systems, open markets, and competitive industries.
Can this succeed completely? Of course it cannot. But it must succeed in part. Even if the Greek government is still running a 6.8 per cent deficit next year this will be a real deficit, audited by European and International Monetary Fund officials, and not the phony figures and off-balance sheet accounting of the past. Even if the fiscal reforms implemented by Athens have fallen short of a fair and comprehensive tax system, they lay the basis for further rounds of reform.
Those calling for immediate comprehensive action see the eurozone crisis as merely one of confidence: to restore faith in eurozone banks and sovereigns, and allow each to reduce its burden of debt as borrowing terms improve. Yet from a classical perspective, the crisis is a part of the solution. As long as it continues, incompetently-run banks will be forced to insolvency, and irresponsible sovereigns into international administration. The challenge is one of containment, until the adjustment has run its course. And whether it can be contained, is what we shall shortly see.