The crisis facing the eurozone looks at first sight as German efficiency clashing with Portuguese, Irish, Greek and Spanish sloppiness. But in many respects Germany has performed worse than the “peripheral” countries in the last decade. The largest economy of the eurozone has been marked by slow growth, poor domestic demand, weak investment, high unemployment, and minuscule productivity gains.
The only area in which Germany has excelled is exports, where it has chalked up large surpluses, while peripheral nations have had large deficits. But this imbalance is due to the skewed nature of the European monetary union. The eurozone has imposed a single monetary policy and tight fiscal policy. Member countries have applied systematic pressure on wages and working conditions across the zone; in Germany, wages have barely risen in real terms for 15 years, helped by the absence of unions in the old East Germany and easy access to the labour markets of other eastern countries.
However, German investment has been weak, and productivity generally rose less than in peripheral countries. In the past the exchange rates of these countries would have fallen, allowing them to improve their exports. But the euro makes this impossible.
In addition, during the 2007-09 crisis, European banks faced big problems because of speculative investments in mortgage-backed securities. The European Central Bank (ECB) provided abundant liquidity to banks and kept interest rates very low. But when countries faced heavy borrowing needs, it behaved very differently.
Public debt rose in 2009 mostly because states rescued the financial system and tax revenue collapsed as the recession unfolded. Profligacy and public inefficiency had little to do with it. But, unlike banks, countries were left to fend for themselves. The ECB simply watched as financiers proceeded to bite their saviour by speculating on public debt.
Dealing with the crisis so far has revealed policy chaos at the heart of the eurozone. Statements by the German chancellor, Angela Merkel, her finance minister and others are incoherent and vacillating, not to mention replete with moral posturing. Does the German establishment comprehend what is at stake?
The policy that has emerged almost by default is to impose austerity on the peripheral nations, while refusing to lend fresh money to ease the transition. This is unsustainable for Greece and possibly for Portugal, Spain and others. Greece has applied an enormous squeeze on its workers, exacerbating the recession. The state gathers money through new taxes and wage cuts, and uses it to pay exorbitant rates of interest to the financial markets. The eurozone, meanwhile, tells Greeks to liberalise and reduce bureaucracy. This has no prospect of leading to sustained growth.
A fundamental problem of the policy of austerity for the periphery is that it does not deal with the structural imbalance within the monetary union. As long as Germany stagnates and squeezes its workers, much of the eurozone will remain in trouble. Recent comments by the French finance minister, Christine Lagarde, indicate though that the French establishment has begun to sense the danger to its own interests.
And there are two strategic alternatives: the first is to aim for a “good euro”. Several steps could be taken, for example, restoring some fiscal freedom to member states, expanding the European budget, instituting fiscal transfers from rich to poor, and introducing a minimum wage and unemployment insurance. The ECB might also be allowed to buy state debt. The “good euro” relies on creating a radical cross-European political alliance, the prospects of which are slim. And it would probably weaken the international role of the euro.
The other strategy is “progressive exit” from the eurozone. This more radical approach would involve devaluation, restructuring of foreign debt, and capital controls. The productive sector would benefit but the initial shock would be substantial. To protect the economy there would have to be public control of banks and other key areas of the economy, including transport, energy and telecommunications. Peripheral economies might then be shifted in a more productive direction – for example, supporting the transition to low-carbon activities.
Finally, exit by the periphery might also help German workers appreciate the extent to which the eurozone has been tormenting them, leading to much-needed corrective action at the core.