The three deadly sins of the euro protagonists
Much burden-sharing still lies ahead
by David Marsh
Tue 4 Jan 2011
André Szász, long-time board member of the Dutch central bank responsible for international monetary affairs, has witnessed all the major ups and downs of European money during a career that started in the 1970s. Referring to the treaty that set down the path towards economic and monetary union (EMU), he once opined: ‘Not one of the politicians who agreed the Maastricht treaty in 1991 understood what they were doing.’
Szász, who retired in the early 1990s, has a point. Confronted with the plethora of challenges piling up around the euro, Europe’s politicians have looked overwhelmed for some time.
What were the cardinal errors – the deadly sins? Let me list three decisive miscalculations, all ultimately self-reinforcing, all contributing to the slow-burn euro crisis.
First, the belief that the ‘one size fits all’; monetary policy would lead to a symmetrical distribution of pain and gain turned out to be illusory. It was clear that faster-growing countries with above-average inflation and low interest rates at the beginning of EMU would gain transitory benefits – but would suffer negative effects through reduced competitiveness that could no longer be offset by devaluations. The hope was that compensation would come from the disadvantage faced by low-inflation, low-growth countries such as Germany, which was held back at the beginning of the 2000s by interest rates that were too high for its own economic situation. We now know that the distribution has been asymmetric. At the start of monetary union, Germany used years of subdued growth to strengthen fundamentally its economic structure, and is now reaping the rewards. Other countries enjoyed low interest rates and shortlived expansion without addressing structural reforms - and are now paying the bill.
The second error related to the distortions in competitiveness that inevitably build up in a fixed exchange rate system uniting countries with different developments in prices and productivity. The idea was that these distortions could be reversed relatively easily. Not so. According to OECD statistics, Germany’s competitiveness measured by unit labour costs has improved by 10% globally since the start of EMU, whereas countries like Spain and Italy have suffered losses of 20%. As a consequence of austerity in the southern countries, and the present above-average growth in Germany, the competitive gap between the better- and worse-performers will fall – although nothing like fast enough to make good the disparities advantages. Those who look to higher inflation in Germany to rescue the south will end up disappointed.
Third mistake: that trouble-free financing could be arranged in perpetuity for EMU members’ extreme current account surpluses and deficits caused by these competitive variations. Politicians and technocrats knew EMU would be immune to currency crises. Yet they overlooked that the system could be prone to credit crises, as lenders demanded higher interest rates on debt perceived to be increasingly higher risk - even (and especially) after years of apparent convergence on the bond markets.
We should not expect too much from the self-healing power of economic developments. Large imbalances between creditor and debtor nations are falling, but they are still there, and they still need to be financed. The OECD estimates that in 2012 Germany and the Netherlands will still be running current account surpluses amounting to 7% of GDP, Spain, Greece and Portugal will have deficits between 5 and 8% of GDP. Taxpayers in creditor countries are right to be wary. A great deal of burden-sharing lies ahead.
Tell a friend