Europe’s Real Problems
WHEN the history of the 21st century is written people will ask why it was that Europe was found wanting during its most intractable economic crisis.
They will ask why Europe slept as an undercapitalised banking system floundered, unemployment remained unacceptably high, and the Continent’s growth and competitiveness plummeted.
Worse still, if a reconstruction plan does not come soon, Europe’s leaders will be charged with “the decline of the West” and then face accusations for being, in the words of Winston Churchill about the 1930s, “resolved to be irresolute, adamant for drift, solid for fluidity and all-powerful for impotence.” There is, of course, no shortage of meetings.
Hardly a day goes by without a summit of European leaders discussing the latest crisis facing a member state.
But each time they talk as though they are dealing with a calamity confined to the nation in the headlines — the Greek problem, or the Irish problem, sometimes the Portuguese or the Spanish problem — without an agreement on the true nature of the emergency that is pan-European.
By wrongly analyzing Europe’s woes, they end up implementing the wrong remedies, too.
Because Europe’s deficit crisis, while a real concern, is just one of its concerns.
There are in fact three deep-rooted problems, each entwined with the others, and each reaching systemically into every corner of the Continent.
Alongside the deficit problem is also a banking problem — not confined to a handful of banks or countries — and a chronic growth problem.
I was present in Paris in October 2008 at the first meeting ever held of the euro zone heads of government.
The diagnosis of the banks I presented was of problems of liquidity but also of structure.
But most in Europe at the time believed they were dealing only with the indirect consequences, the fallout, from an “Anglo-Saxon” financial crisis, and of course thought that a wayward Britain had allowed itself to be locked into the American financial boom.
They did not then know that half the subprime assets had been bought by banks across Europe.
No one had yet fully appreciated the depth of the entanglements between European banks and other global financial institutions, or how big the banks’ exposure to falling property markets was.
I remember the shocked looks that passed along the table when I argued that European banks were even more vulnerable than American banks because they were far more highly leveraged — and indeed still are.
Even now a fundamental truth about the current state of European banks remains unspoken: German, French, Italian and British banks that have lent recklessly to the periphery are owed billions not just by the Greeks but by the Irish, Portuguese and Spanish, and have losses still to take from toxic assets and the real estate collapse.
When years from now people explain why Europe slept, they will also explain how, out of short-sighted self-interest, we treated the Greeks’ problems as if they were ones of liquidity (addressed by giving loans), not solvency, and how by short-term manoeuvres to delay the necessary denouement, we maximized the risk of a disorderly endgame.
Indeed with interest rates on the rise, capital outflows from all the periphery countries to the core are already making funding more difficult in each troubled country, dragging us into even higher interest rates, longer recessions and, possibly, higher deficits.
The third side of the triangle is, of course, low growth itself, which threatens to condemn the whole Continent to a decade of high unemployment.
The deficit reduction and bank stabilization we need to see cannot become entrenched without economies that generate trade, jobs and growth.
Yet, suffering from anaemic levels of growth, Europe is slipping further and further down the world league — not acutely but chronically, which is more serious and much harder to reverse.
Today European unemployment is stuck around 10 percent with youth unemployment rising above 20 percent and as high as 40 percent in Spain.
And it cannot come down fast.
Europe now has a trend rate of growth that is almost one half of the United States and one quarter that of China and India.
Once Europe represented half the output of the world.
By 1980 this had fallen to one quarter.
Now it is less than one fifth — just 19 percent.
Soon it will be little more than a tenth — 11 percent by 2030 — and then it will fall to 7 percent.
By 2050 — less than four decades from now — the European economy could be smaller than that of Latin America.
If European growth continues to run so far behind its competitors, then by midcentury it may be as small as Africa.
Yet Europe is only half as well equipped as America to export our way to growth.
Despite Germany’s success in China, only 8 percent of our exports (in contrast to America’s 15 percent) go to the eight fastest emerging market economies, what are now called the growth generators, that will account fort the majority of future growth.
It is clear that each of these three concerns — deficits, banking instability and low growth — is interwoven with the other in a way that makes policies designed to focus on only one issue much less effective than a comprehensive strategy aimed at simultaneously resolving all three.
A pan-European strategy is all the more necessary because the euro was constructed without any mechanisms for averting or resolving crises — and with no agreement on who is ultimately responsible for financing crisis costs.
While a strong and passionate pro- European, I stood out from conventional economic opinion in doubting whether Britain’s best interests lay in joining the euro.
The U.K. shadow chancellor, Ed Balls, led 19 separate assessments of the euro.
Our major finding was that inside the euro there was insufficient flexibility to achieve sustainable and durable convergence between nations.
But we also demonstrated that the euro had no crisis-prevention or crisisresolution plan in the event of convergence not being achieved.
For under a single currency no nation — even one completely uncompetitive with the rest of the euro zone — can adjust its exchange rate, or benefit from an interest rate tailored to its specific needs.
Nor had Europe adopted the U.S. crisisprevention model for damping down disparities in a single currency area — by labour mobility and wage adjustments, or by transfers to areas of need.
So, if I am right, we must now exchange panic-driven responses for a long-term reconstruction, or we will face a lost decade of high unemployment with social discontent, anti-immigrant feeling and secessionist movements.
We must now achieve for Europe the same “moment of truth” that the world found with the pivotal Group of 20 summit in 2009.
As happened with the G-20, Europe’s politicians should lead market sentiment by boldly and simultaneously agreeing on a Brady-bond style solution for Greece and a European bank recapitalization; a new euro area debt facility (responsible for, say, the first 60 percent of each country’s debt) as part of a coordinated fiscal and monetary policy that permits, like the U.S., fiscal transfers; and, above all, a pro-growth pro-enterprise strategy I call Global Europe: Europe’s energies redirected outward to exporting to the emerging economies — and re-equipping ourselves to do so with a clear timetable for — and inbuilt incentives and penalties to guarantee — labour, capital and financial market flexibilities Why would the Germans support this? Because far from being against their interests, they would now have a European reason to restructure their banks; they could set tough terms on economic reform; and, by acting now, they could avoid far bigger costs later.
Indeed I would argue that without my concurrent plan to restructure Europe’s banks and insurance companies and to go for growth, the status quo or even a Brady plan for Greece still risk Europewide financial contagion.
History books about the “decline of the West” are not inevitable.
But only a reconstruction that attacks deficits, banking liabilities and low growth together will avoid the deadening grip of an inward-looking protectionism — and barren but avoidable years of unemployment and wasted lives.
(Gordon Brown was Britain’s prime minister from 2007 to 2010).