The economic downturn that began in 2007 in the United States generated by a fall in property prices and the subsequent sub-prime mortgage crisis ultimately lapped over into secured loans. It went global after the failure of Lehman Brothers a year later. The financial emergency forced many governments, though not Italy’s, to intervene with public bank financing in an effort to stave off the collapse of domestic financial systems. Many European countries saw their debt increase massively as a result of these efforts, including Ireland, Britain, and Spain.
At the same time, the new Greek government publicly announced that its real debt was far greater than official figures had suggested, plunging Europe and the euro into the sovereign debt crisis. Increases in national debt outside the euro zone doesn’t by itself explain what happened to the common currency. In reality, the eurozone debt as a whole represents 88% of GDP, which is lower than the 100% rate in the US and isn’t much higher than the 76% the UK, a non-euro state. Market reservations are due mostly to ongoing doubt about the sustainability of the single currency in the face of systemic crises like the one that continues to dog the continent. Four conditions determine the sustainability of a single currency: price and wage flexibility, mobility of means of production, unity among fiscal policies in terms of redistribution, and the convergence of inflation rates.
The recently signed Stability and Growth Pact succeeds, at least in part, in obtaining the convergence of public debt and inflation rates, but it falls short of integrating national policies. On the other hand, French Foreign Minister Robert Schumann, whose Schuman Plan laid the groundwork for political cooperation, insisted in 1950 that “Europe cannot be made all at once and all together, but will be built through concrete and progressive measures.” Former Italian Prime Minister and European Commissioner Romano Prodi told the Economist in an interview that “the monetary union was like an unfinished building that would be completed when conditions were ripe or a crisis imposed its completion". The lack of strategic vision among European leaders in recent years suggests the correctness of Prodi’s characterisation.
In Chinese, the word “crisis” is composed of two characters: the first one suggests the concept of “imminent danger,” the second “opportunity.” Focusing on the second aspect permits a realistic assessment of where Europe might stand two years hence. First comes banishing the idea of expelling Greece from the eurozone as a means to solve the sovereign debt crises. A study by the Swiss bank UBS quantified the cost of a Greek exit from Europe at about 10 times the total amount of the plans developed so far to ensure it remains within the fold. National currency devaluation, tariff barriers and debt (which would remain in euro) would cause a chain of banks and companies to default, plunging the country into the kind of chaos endured by Argentina in 2001.
The UBS study suggests that German citizens, in that event, would have to pay about €10,000 a head, compared to the €1,000 a head they will be forced to contribute to the combined “rescue” of Greece, Ireland and Portugal. To avoid the political costs of the common currency’s collapse means making profound changes to institutional architecture of the EU and pressing for greater integration of economic and fiscal policies. What this in turn demands is the overcoming domestic political reluctance, which is locally oriented but desperately shortsighted.
The Fiscal Compact and the European Stability Mechanism (ESM) are the latest emergency measures. While are to be applauded, their success depends on ESM support funding rising to a trillion euros and its ability to intervene directly in support of banking groups in crisis, and not only through governments, which is the norm now.
A medium term relief instrument, while awaiting real tax integration, could be so-called eurobonds, or bond issues common to the eurozone’s member states. Such bonds could become an accepted means to help manage public debt. National debts would be in part replaced by eurobonds (with limit based on percentage of GDP). At the same time, states would continue issuing national bonds to help with financing. Other member states would serve as eurobond guarantors. But calming markets and drawing up the future of a federal European Union also means centralising fiscal policy and gradually increasing both resources and that which falls under EU governing competence.
The Delors Report of 1989 argued that “in all federations, the way fiscal policies are combined have a powerful effect in terms of shock absorption, reducing sudden surges in economic hardship or prosperity among individual states.” The 1977 McDougall Report determined that a federal budget (excluding defence) should reach 2-to-2.5% of GDP, and that “common EU fiscal policy was a key ingredient toward any European Monetary Union integration.” But half the current 1% figure is dedicated to agricultural subsidies instead of strategic matters such as energy, defense, and foreign policy and security. Europe has two years and the clock is ticking.
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