The Open Forum panel on the Eurozone started with an expression of optimism and relief. Despite recent drawbacks, the Eurozone is out of the emergency room after years of trials and tribulations. While the recovery was still in doubt at the previous World Economic Forum, the illustrious panel of national ministers and think tank directors at WEF 2013 unanimously agreed with the aforementioned assessment. Though the latest report by the European Commission throws some doubt on this assessment, it is clear that the Eurozone has issues to tackle that are beyond the immediate economic collapse of some of its members. With some countries still in recession, an average unemployment rate of over 11%, and an increasing lack of popular support, it is clear that the status quo is unsustainable. Two questions then need answering now: where to go and how to get there?
From Fiscal Responsibility to Economic Growth
As the Eurozone is slowly and painfully dragging itself out of the sovereign debt crisis, European leaders have been criticised for the manner and speed with which austerity had been imposed on some countries such as Greece, Spain, and Italy. Along with other prominent economists, Joseph Stiglitz called the measures a ‘suicide pact‘, highlighting the potentially self-defeating nature of austerity. He warned that cuts in government spending equal demand shocks that could slump an economy back into recession and thus dry out revenues streams that are needed to repay sovereign debt. As the recession persists, a country is forced to borrow more to service its existing liabilities; this leads to an increase, not a decrease, in overall debt. The UK has turned out be an unfortunate example of this process. The coalition government’s austerity programme of 2010 contributed to the current threat of a triple dip recession, and even more recently, the loss of the country’s top credit rating.
Although there is a trade-off between austerity and economic growth in the short run, the relationship between the two has proven to be more complex. The simple fact that markets were increasingly unwilling to lend money to some governments in the Eurozone – as evidenced by surging yields on national bonds – made it abundantly clear that public spending could not continue as it had for the past two decades. In the absence of alternatives, and in order to withstand market pressure, states needed to develop a credible reputation for fiscal responsibility, and thus, in a very short period of time, balance their budgets and cut governmental spending.
Sometimes credibility and reputation matter even more than actual economic performance. Steven Vanackere, the Belgian Finance Minister, explained how in 2011 the interest rate for Belgian 10 year bonds surged to 5.8% because the government was perceived to be inactive and incapable of fiscal adjustment at a time when Belgium had to refinance €18 billion, or 3.5% of its GDP. Only after taking decisive action to curb the governmental budget, trust returned and yields dropped from 5.8% to 2.2%. It is important to note that the bond yields did not reflect economic fundamentals as Belgium’s economic performance had remained fairly constant during this time period. Fiscal responsibility is thus a precondition for national governments to borrow and invest under reasonable terms, whilst also being a way to lessen the dependency on financial markets. As remarked by Angel Gurria, the Secretary-General of the OECD, it also works as a shield against excessive financial punishment of economically weak members of the Eurozone.
Beyond The Crisis
As the crisis slowly blows itself out, the Eurozone will have to tackle an ambitious set of reforms. First, it will have to make sure that legislation governing the spending limits of countries can be enforced. This has been made more likely by the enactment of the European Fiscal Compact in March 2012, which defines minimum standards for national deficits and debt as well as penalties for the failure to meet them. In addition, the crisis has also demonstrated that national decisions will have to be increasingly analysed in their consequences for the EU as a whole. As the Spanish Finance Minister Luis De Guindos Jurado pointed out, Germany’s and France’s decision to breach the rules of European Fiscal Stability and Growth Pact made it effectively impossible to impose fiscal discipline on other countries, as they were in many ways “the anchors and referees of the European Union”.
Beyond fiscal responsibility, the success of the European recovery will depend on the Eurozone’s ability to generate real economic growth as a result of structural changes that enhance its global competitiveness. Robin Niblett, the Director of Chatham House, argued that this calls for reforms along several dimensions. It entails improving the environment of doing business, including developments in infrastructure, energy consumption, education, and labour laws. It entails improving the ease of doing business and thus, the rectification of corruption and the dismantling of large chunks of inefficient bureaucracy. And finally, it entails enlarging the scope of doing business, which implies an honest acknowledgement that only 20% of the service sector, which constitutes around 70% of European GDP, is open for competition.
Regaining competitiveness implies changing the structure of society itself in some countries. This would mean altering the relationship between the private and public sector, proceeding to a pan-European integration of the service sector and tackling demographic and unemployment challenges increasingly on a supranational level. Europe is, in this sense, as much about well-understood self-interest as it is about solidarity. Countries will continue to make their own policy choices but a deeper European integration will increase the spill-over effects of sovereign action. Spain profits from Italian fiscal responsibility and vice versa, as does Germany and the Eurozone as a whole.
Seen from the other side of the world, European countries have much more in common with each other than what sets them apart. Europe is united in its affinity for representative democracy, pluralism, and coalition type politics as well as its emphasis on the rule of law and the stability of its political systems. As the German Foreign Minister Guido Westerwelle remarked: “in an increasingly globalized world, where different value systems collide and compete, the Eurozone is each member’s best bet to preserve their cultural identities and their liberty.” The most accurate characterization of European relationships should thus neither be solidarity nor domination, but a sense of a common interest, common will, and maybe even a common destiny.
Feature image: Vittorio Grilli, Minister of Economy and Finance of Italy,World Economic Forum in Davos; Source: Nikolaj Fischer