23 January 2014

Katinka Barysch: Europe's top-down myopia

Writing for Project Syndicate, Barysch argues that the eurozone does not need fiscal or political union; the institutional framework just needs to be strong enough to enable markets to (re)act, while offering real help to countries that find themselves temporarily in trouble.

Europe’s obsession with large-scale top-down reforms is rooted in prevailing analyses of the causes of the euro crisis. Most people in Germany, the Netherlands and Finland blame excessive public spending and inadequate regulation in countries like Greece, Spain, and Cyprus for destabilising the eurozone and, in turn, the EU.

A somewhat more nuanced analysis holds that the European Central Bank’s one-size-fits-all monetary policy created destabilising imbalances in the eurozone. Interest rates were too low in Southern Europe, where governments and households binged on cheap loans, and arguably too high in Germany, which was already held back by the economic burden of reunification. If the euro generated these imbalances, the argument goes, country-level solutions are inadequate. Europe’s only option is to repair and strengthen the currency union through banking, fiscal and political union.

A Banking Union really is needed to break the vicious cycle of weak banks and debt-laden governments. The good news is that its contours are fairly clear, and the process of constructing it is already underway, though the pace is very slow. But the logic behind fiscal union is muddier – the implication is that it would entail a much larger EU budget, presumably financed by some kind of EU-wide taxation, as well as eurozone-backed unemployment insurance and a debt-mutualisation mechanism like Eurobonds.

The centralisation of financial and fiscal powers would demand increased accountability at the European level. For that, a political union – with directly elected European officials and a significantly more powerful European Parliament – would be needed. This is unlikely to happen, at least in the foreseeable future. But that probably does not matter as much as many people claim.

The imbalances generated during the euro’s first decade are already being resolved. Indeed, the painful adjustments that southern European countries (and Ireland) have endured have led to substantially smaller external deficits and declining unit labour costs. These improvements will put increasing pressure on France and Italy to follow suit, which could make Europe as a whole more competitive.

If past problems are already being corrected, and future problems will be of a different kind and magnitude, then perhaps there is no need for eurobonds or EU taxes. And, without debt mutualisation or large-scale redistribution of wealth, political union becomes unnecessary – at least for now.

The eurozone’s new institutional framework does not have to direct 18 countries’ fiscal and economic policies. It just needs to be strong enough to enable markets to recognise and react to worrying developments, while offering real help to countries that find themselves temporarily in trouble. This is not only doable; it is being done. Now European countries can turn to the challenge of becoming more flexible and productive so that they can be more competitive in the future.

Full article

© Project Syndicate