Philippe Legrain, Senior Visiting Fellow at the London School of Economic’s European Institute, discusses the ongoing turbulence in the Eurozone in an interview with the School’s European Politics and Policy editor Stuart Brown.
Have the right lessons been learned from the crisis in the Eurozone?
The short answer is No. Catastrophic mistakes by Eurozone policymakers – primarily Angela Merkel’s government in Berlin, the European Central Bank in Frankfurt and the European Commission in Brussels – have transformed a financial crisis into a much deeper economic and political one.
More than seven years into the crisis, the Eurozone is doing much worse than the United States, worse than Japan during its lost decade in the 1990s, and worse even than Europe in the 1930s. The economy, which is still 2 per cent smaller than in early 2008, is stagnating. The least-bad performer, Germany, has grown by less than Britain over that period and less than half as much as Sweden, Switzerland and the US.
The worst, Greece, has shrunk by more than a quarter and is faring worse than Germany did during the Great Depression. Many people’s living standards have slumped and unemployment is painfully high: 11.4 per cent overall, much higher in Southern Europe, scarily so among young people. A lost generation is in the making. In a nutshell, the Eurozone is sinking into a deflationary debt trap, with tragic social consequences and unpredictable political ones.
Unsurprisingly, voters are fed up of years of seemingly unending misery. Social tensions within countries are multiplying, as are political frictions between them. Understandable anger at the injustice of bailouts for rich bankers and budget cuts for poor schoolchildren overlaps with a despicable scapegoating of outsiders, notably immigrants. Old stereotypes have been revived and new grievances created. Northern Europeans slander southerners as lazy good-for-nothings, while Greeks label Germans Nazis. Nasty nationalism is on the march again and support for the European Union has never been lower.
Most Europeans now associate the EU with austerity, recession and German domination, with undemocratic constraints on what they can do, rather than how we can all achieve more together. And they’re angry and resentful at incompetent and sometimes corrupt establishment politicians and EU technocrats who seem incapable of resolving the crisis and have imposed misery on ordinary voters (but not on themselves). In the absence of mainstream alternatives, voters are turning to radical and extremist ones: the radical left in Greece and Spain (and separatists in Catalonia), the far-right in France and Italy, Sinn Fein in Ireland.
Resentment of southern Europe is also boosting the anti-euro, far-right in the Netherlands, Finland and Germany. So politics may yet achieve what quiescent markets are no longer doing: with luck, force desirable policy change, but potentially break up the euro. That’s the big picture.
What were the key policy failures that brought us to this point?
As a result of these bailouts (of individual member states), the bad lending of private banks has become obligations between governments. And a crisis that could have united Europe in a collective effort to curb the banks that got us into this mess has instead divided it, pitting creditor countries – principally Germany – against debtor ones, with EU institutions becoming instruments for creditors to impose their will on debtors. The Eurozone has become, in effect, a glorified debtors’ prison.
It is tragic – but hardly surprising – that as a result Germany and EU institutions are now resented so much in debtor countries. It is also understandable that northern European taxpayers are angry at this. But instead of resenting southern Europeans, they should direct their anger at the banks that their loans, in effect, bailed out and at the policymakers who made it happen. And the upshot is that European taxpayers now have an incentive to resist the debt relief that Greece needs to recover. They would also lose out if the €64 billion bank debt unjustly imposed on Irish taxpayers were written down.
By putting the narrow interests of the banks ahead of those of ordinary citizens, Merkel and other Eurozone policymakers have set Europeans against each other. While governments bailed out the banks, first directly and then indirectly through the EU loans to southern European governments, they didn’t force them to clean up their balance sheets. As a result, the Eurozone now has state-sponsored zombie banks that use the cheap liquidity provided by the ECB to roll over their bad loans to zombie borrowers while denying credit to new ones.
And the flipside of failing to force banks to clean up their balance sheets is that households and companies still have huge, and often unpayable, debts …. Now that the panic that policymakers created has abated and austerity has been eased off, economies have stabilised. But they are not recovering, because the underlying causes of their weakness – the broken banks, the private-sector debt overhang and the shortfall of demand – have still not been tackled.
You’ve said that there is a false narrative which draws a parallel between Germany’s situation a decade ago and the Eurozone’s current problems. How damaging has this narrative been for the EU’s policy response?
Germany is trying to reshape the Eurozone economy in its dysfunctional image. Its mercantilist strategy of suppressing wages to subsidise exports is beggaring Germans as well as their neighbours. Don’t believe the hype about Germany’s success: its GDP growth ranks 15th among the 19 Eurozone economies since the euro’s launch. Once dismissed as the sick man of Europe, it responded not by becoming more dynamic, but by cutting costs.
Hobbled by a decade of underinvestment, its arthritic economy struggles to adapt: productivity growth averaged only 0.9 per cent a year over the past decade, less even than Portugal’s. And the brunt of this stagnation has been borne by German workers, who now earn less after inflation than 15 years ago, even though their productivity is 17.8 per cent higher. German policymakers claim that holding down wages is a good thing because it boosts the country’s competitiveness.
But countries are not companies. While it may make sense for an individual business owner to try to keep wage costs to a minimum, for society as a whole, wages are not a cost to be minimised. Provided they are justified by productivity, wages ought to be as high as possible. And since compressing wages suppresses domestic demand, Germany can only grow by exporting – and now that the rest of the Eurozone is stagnating and China is slowing, Germany is stagnating too.
German policymakers pride themselves on the country’s vast current-account surplus as an emblem of its superior competitiveness. But if Germany is so successful, why don’t businesses want to invest there? Its surpluses are in fact symptomatic of a sick economy – and that harms the rest of the Eurozone too. During the bubble years, Germany spread instability through its banks’ bad lending of its surplus savings. Now, it is exporting deflation through its wage stagnation, depressed domestic demand and opposition to debt restructuring.
Foisting the German model on the rest of the Eurozone is disastrous. Slashing incomes depresses domestic spending and makes debts even harder to bear. For struggling southern European economies whose traditional exports have been undercut by Chinese competition, the solution is not to try to produce the same old products at much lower wages, but rather to invest in moving up the value chain and produce new and better products for higher wages.
What is required to finally solve the crisis?
To solve the crisis decisively and fairly, the Eurozone ought to do what I advised President Barroso when I first met him back in 2010: restructure zombie banks; write down unbearable debts, both private and public; and support spending in ways that push the economy towards healthier patterns of growth, not least by increasing investment and lifting barriers to competition and enterprise, with Germany and other surplus countries playing their part by boosting domestic demand.
To work better in future, the Eurozone also needs institutional reform. Instead of a Eurozone caged by Germany’s narrow interests as a creditor, Europe needs a monetary union that works for all of its citizens. A genuine, comprehensive and robustly independent banking union, with a workable mechanism for bailing in the creditors of failed banks. The ECB’s role as a lender of last resort to solvent governments enshrined to avoid future panic. The no-bailout rule restored and with it much greater fiscal flexibility for democratically elected governments, constrained by markets’ willingness to lend and ultimately by the possibility of default.
And ideally, once it becomes politically feasible, we should create a Eurozone treasury accountable to both European and national legislators, with limited tax-raising and borrowing powers. Ultimately, the freer, fairer and richer Eurozone that would emerge is in Germany’s enlightened self-interest, too.
This interview first appeared on the LSE website as Five minutes with Philippe Legrain: ‘The Eurozone has become a glorified debtors’ prison’.
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