The True Finns are widely reviled in European circles for threatening to pull the plug on support for Portugal and, more generally, articulating the sentiments of narrow, nationalistic and selfish voters in wealthy countries. While I share this revulsion it is important to recognize that they are right about one thing:
Something new is going to happen and that’s very good because these bail-outs clearly have not been working. (Timo Soini, quoted in the Financial Times, 18 April)
I almost entirely agree. The bail-outs – actually an inappropriate term – are indeed not working. The deficit countries in particular and the euro area in general are heading inexorably towards the precipice of default, recession (or even depression) and, probably, the break-up of the euro area. This is widely recognized, even, belatedly, by those policymakers responsible for the failed strategies. And so “something new” is indeed going to happen. The only question is whether that is “very good” or not. And that depends on what the something new turns out to be.
Why we are heading towards crisis is – or at least should be – too obvious to require spelling out in detail. The short answer is that the bail-out packages were not real bail-outs (as was pointed out at the time: Greece, Ireland). A genuine bail-out removes so much water from the holed ship and offers sufficient protection against heavy seas that repairs can be made and it can soon sail under its own steam. Moreover, bailing out one ship also should have a calming effect on the sea and reduce the chance of other ships capsizing. (Yes, I am aware that extending the metaphor in this way takes liberties with the laws of physics.)
Instead, the euro zone’s holed ships have been lent pumps that more or less only pump out as much water as is currently flooding in. Worse the pumps are heavy (costly), weighing the ship down. And, much worse still, in return for the loan of the pumps the activities of the crew are subject to limitations (austerity policies) that weaken the hull, instead of enabling them to strengthen. And (again, with apologies to the literal-minded) the sight of one floundering boat ‘encourages’ the waves to pound all the more fiercely against other, currently intact, vessels.
Returning to the physical world, what has been the result? Portugal has been swamped and will be treated to a ‘bail-out’ on the Greco-Irish model. Growth forecasts in Greece and Ireland are continually being revised down (or rather the rate of contraction up), and as a result the concerns about debt dynamics worsen more or less daily. The interest rate on their outstanding government debt goes up and up. This causes citizens to transfer their money out of domestic banks, weakening them further and squeezing lending and economic activity yet more. The rating agencies helpfully downgrade the sovereign debt and/or the bank debt of the countries concerned, which drives up spreads further making recovery yet more difficult. And speculation mounts as to which country will be next. As if this were not enough the ECB, exacerbates the pressures by raising interest rates.
Which brings us back to the True Finns and, more generally, to resentment in core euro area countries about taxpayers’ money in allegedly well-behaved countries allegedly being sent to allegedly bail out allegedly profligate governments for allegedly selfless reasons. The circle closes. Not only are populations in the periphery saying ‘we can no longer pay back’, populations in the core are saying ‘we can no longer pay in’.
It matters little that all the above-mentioned allegations are in fact incorrect. It is not ‘well-behaved’ to drive other parts of the euro area to the wall with beggar-thy-neighbour wage competition. Taxpayers’ money is not being ‘sent’: rather the money is being raised cheaply and lent dearly. There is, as we have seen, no genuine bail-out. While policy mistakes were certainly made in peripheral countries, fiscal profligacy, with the partial exception of Greece, was not the key issue. And finally, the support offered is very largely used to protect the interests of banks in core countries with heavy exposure to the periphery, not to mention to serve the common interest of all euro area countries in avoiding a break-up of the euro area. Similarly, it also matters little whether the politicians concerned are ignorant of these facts or whether they are, while knowing better themselves, cynically stirring up popular resentment.
The result is the same, and the fact is that the current efforts to save the euro area are quite simply failing.
What is to be done?
A while back I proposed a six-point ‘blueprint’ for growth, consolidation and convergence in the euro area. It set out a package of measures to:
- arrest the deflation of demand and boost output growth in the periphery
- boost growth (and render it sustainable) across the euro area as a whole,
- address macroeconomic imbalances in a symmetrical way,
- bring public finances back into a position of long-run sustainability and safeguard future fiscal revenue sources,
- ensure greater fairness and equality, and
- ensure financial-sector stability.
Had European policymakers had the economic understanding and the political vision to clearly articulate the need for and begin implementing a package along these lines I firmly believe that both the economic and political outlook in Europe would today look very different.
Clearly this is a medium-run agenda. The situation has since worsened considerably and emergency measures are needed. They include: an announcement by the ECB of no further interest rate rises and its willingness to purchase bonds on secondary markets to dramatically reduce interest rate spreads; a substantial reduction in the rate of interest charged on the loans to Greece and Ireland and similar conditions given to Portugal; the suspension of demand-deflating austerity measures in the peripheral countries, until output begun to grow once more; expansionary policies (including faster wage increases) in those surplus countries with fiscal room for manoeuvre; and the launching of a European investment offensive with a focus on peripheral countries.
The alternative is a huge crisis, default and the break-up of the euro area. Many on the Right and some on the Left welcome this. The former never liked the euro because it was part of a broader European integration process that they rejected. In the case of critics on the Left, the ‘default and devalue’ option results from a conviction that the euro area architecture is so fundamentally broken that only a crisis offers a chance of renewal. My friend and colleague Dean Baker is one who has recommended this course. We agree entirely on the perversity of current policies and that an integrated policy response would be the first-best solution. Dean and others are more skeptical of the chances of this happening; I have to admit that they may well be right. More importantly, I think, such commentators are more sanguine about the likely costs of the default and devalue option. I fear not only that the price would be extremely high, it is still not clear what should replace the euro under this conception. (This is one reason why I find the comparison with Argentina, while clearly informative, not ultimately persuasive.) Floating exchange rates? A minimalist euro area? All such exchange rate regimes have costs and drawbacks of their own, as past experience has shown. One needs to be careful what one wishes for.
In any case the key point is that, in terms of the economics, there is absolutely no barrier to saving the euro area using the measures indicated. It is a question of the politics. In my view it is too early to give up trying to argue for an integrated European policy response. If it does not materialize then default and devaluation may well happen, at which point the academic argument stops and we will see how costly the short and longer-run costs are.
One thing, at least, is already clear: The True Finns and other reactionary forces in Europe get almost everything wrong about the euro area crisis, but something will indeed have to happen.
 For a similar view of this vicious circle German-speaking readers may like to consult Gustav Horn’s recent column.