Europe is playing for big stakes at the G20. This new global governance format has often been seen in terms of opening up to major emerging economies, or through the constant mix of interdependence and infighting that characterises Sino-American economic relations. But even though practical outcomes from the G20 are severely constrained by the disagreements among participants, a lack of outcome from this G20 would still have serious consequences for Europe. At this point, Europe has losses to count, but does not have tangible gains to balance the scale.
The Seoul summit was preceded by months of sparring and fencing about Europe’s diminished economic weight, its over-representation in international financial institutions and at the G8, and the need to downsize. There was also acid comment about the risks that Europe’s new budget austerity were creating for the world – deflation, a turn inwards of world economies and protectionism were said to be the obvious if unintended consequence of Europe having to slash its public spending.
These last arguments would have seemed more valid if European governments hadn’t been under attack at the same time in the markets for their past public debt. It is not only the real or potential cracks in Eurozone solidarity which have been probed and will be tested again in the future. Europe was asked in the same breath to spend, and not to spend. Of course, rational economists will say that both are possible and necessary – you can invest in efficiency-enhancing and at the same time trim down on other public expenses. Given that the time horizon of markets – and of politicians who are liable to elections – is very short, this combination of a Keynesian and a Friedman-like policy was unlikely to happen. One after the other, European member-states have adopted tough – or tougher – austerity packages, with the nagging fear that they’d be spotted and preyed upon by the market if they acted differently. That the country with the only truly independent currency in Europe, the United Kingdom, went further than any other in budget-cutting is further proof that in the grip of uncertainty, standing alone is in itself a further hazard. Germany was the only economy which, in principle, might haved acted differently. That’s if you discount the risk of a run on the European banking system however. Only Germany, and very few others, has kept a capacity to counter such a market event. To do so, its political leaders must persuade their voters that there is no better way out, and that the short-term risks are worth taking. This would be infinitely harder if Germany had already expended its ammunition on a policy of deficit spending designed to help its neighbours. And so, Europe has kept its foot on the brake, while others – America, China, Japan – have spent liberally or created mountains of paper money to keep the system properly inflated.
Could it have been otherwise ? One would need to assume a further degree of integration and in fact, federal decision-making at the European level. The European Union and its 27 states are in the structural situation where automobiles were before unibody construction prevailed. You can bolt on, or even weld, as much as you like, the result will never be as roadworthy as a unitary chassis, which is going to be both lighter and more rigid.
That’s why Europe would find it very risky to implement the kind of daring Keynesian budget deficit policy that’s really needed to jumpstart our continent, starting with major infrastructure investments which would further integrate Europe’s new members with its core. Instead, some of our member states are selling infrastructure to outsiders – lately that means China more often than not – bridging public deficits through the sales. The new capital investors then put their own money into the projects – but it will be their money and their companies, not ours.
Strikingly, the United States with its federal system and its role as global currency printer could have taken the risk that Europe cannot take: expanding further the federal budget and its deficit as a stimulus to economic growth. Instead, it is choosing to use the printing press for money – in effect exporting America’s deficit to all holders of US dollars and creating bubbles wherever the cash finally ends up. Not even counting the risk of a further currency re-evaluation for Europe (we should count our blessings that we have our own big public spenders who make such a move upwards unlikely in a currency war), the risk we run is stagflation. Stagnation would come from our declining public expenses, coupled with our exports being chipped away by competitors with lower currencies on third markets. Inflation would be fuelled both by the Fed’s money creation and by raw material and energy inflation. China, hugging close to the dollar as it declines, is taking care of that last point.
On the other issue – that of representation – Europe did the unexpected. The pundits for the new world order had been gaggling at Europe’s conceit in keeping an oversize contingent of seats and voting rights at the IMF and other bodies, at its incapacity to reform and make room for newly emerging or emerged partners. Europe was the Titanic with pessengers asleep in their armchairs, one critic said. Instead, at the preparatory meeting of the finance ministers before the G20 summit, Europe quietly performed what is an act of collective, or should one say multilateral, seppuku or self-immolation. Without so much as a riddle among member states, it cut by two seats its representation on the IMF board and agreed to diminished voting rights in the near future. Not only has Europe given up those seats, but its voting rights will decline much more significantly than those of the United States. If one was searching for a proof that European nations could look beyond immediate national self-interest and contribute to a liberal order, the sacrifice by two European nations is this proof.
But the question is, how useful will the budgetary sacrifices be, how will Europe leverage its reduced representation towards favourable policy outcomes ? In the run-up to Seoul, Europe looked very much like a canary wedged between two elephants, the US and China. The canary is singing about financial regulation, curbing blind monetary creation and the need for a realignment of currencies. The elephants are trampling the grass without regard for their partners.
There are two lessons from this story. One is that Europe would obviously do better with a further leap ahead in federal decision-making – which of course requires major political adjustments. Mrs. Merkel’s request for a Treaty change on the issue of public deficits and sanctions is indicative of the needs ahead. The second lesson is that Europe should not only play the gracious host in the coming French presidency for the G20. It must assert its own interests – and that will require both assertiveness towards China on the currency issue and a strong representation to the United States, which may be sowing the seeds of the next crisis by its present actions.
The European Council on Foreign Relations does not take collective positions. ECFR publications only represent the views of their individual authors.