July’s EU/IMF plan , created to calm the waters, involve private investors and allow the European Financial Stability Facility (EFSF) to buy debt in secondary markets , is a big step in averting widespread sovereign defaults and a near-term implosion of the euro.
However, while it placates the symptoms, it does little to solve the cause – disparate competitiveness in a monetary union that has some political union but not enough economic union. And, even if fully implemented, it offers little more than returning the zone to its pre-crisis position.
Learning curve
So, what can countries learn from the crisis? To highlight its origins, we map out the zone’s economic convergence so far.
First, the zone has achieved its primary objective of controlling inflation under a fixed exchange rate regime. Since its inception, the zone’s CPI inflation has averaged 2% year-on-year, exactly the ECB’s medium-term ceiling. In addition, almost all members have seen their inflation fall, which owes more to the ECB than governments. Nominal exchange rates are thus far intact (though members’ real exchange rates of course adjust to how their relative unit labour costs shift).
Second, the cost has been lost growth and employment that lies at the heart of the eurozone’s problems. Members have across the board suffered slower GDP growth since 2000. This growth forgone has deprived those that need it most – the high-debt sovereigns under attack by the bond vigilantes and rating agencies.
What’s worrying is that the sharpest job losses have been in the least competitive countries such as Greece and Spain – they have seen their relative unit labour costs grow 12% and 26% respectively since 2000. Germany’s unemployment rose from 9% in 2001 to over 12% by 2005, but this pain reaped dividends as it translated cost control into a current account improvement. Other countries must now replicate this, which means even slower growth going forward.
Fiscal strife
Third, this slower growth could again hamper members’ ability to improve fiscally. There has since the euro been a near across-the-board deterioration in fiscal balances and government net debt positions as a share of GDP.
These highlight Germany as the winner, the only member managing to get its unemployment and relative unit labour costs down while growth slows – and the uncompetitive countries as the relative losers. That is, countries less successful than Germany in controlling costs and/or improving productivity have proved less able to adjust to the slower growth of the eurozone.
With currency devaluations closed off and inflation capped by the ECB, their main pressure release has been fiscal expansion – exacerbating the deficit-hit from lower tax revenue. Little wonder, it’s been these, fiscally-erring countries’ bond spreads that have widened most during the malaise. Then there’s the hope that the bigger countries can pull the debtors out of trouble, which our Misery Index analysis of inflation and cyclical unemployment questions.
So, if they can’t adjust and wish to stay in the euro, they will not only again increase their fiscal strains and bond spreads, but place an increasing burden on the core countries, such as Germany and France, trying to fund them. In which case, the cost of keeping inflation down, in terms of lost growth, jobs, tax revenue and credit ratings could become even higher. And, contrary to Merkel’s wishes, they’ll be no better off than before the crisis.
