31 January 2012

Martin Wolf: Europe is stuck on life support

The ECB has saved the eurozone from a heart attack, writes Wolf in his FT column. But its members face a long convalescence, made worse by the insistence that fiscal starvation is the right remedy for feeble patients.

A long-term transfer of resources to uncompetitive members would be a disaster, enfeebling recipients and bankrupting providers. But fiscal indiscipline is not all. Just as it was not the dominant cause of the collapse, but rather sloppy lending and improvident private borrowing, so fiscal discipline is not the cure. This attempt to vindicate the catastrophic austerity of Heinrich Brüning, German chancellor in 1930-1932, is horrifying.

The perspective embodied in the fiscal compact – itself an attempt to revive the failed stability and growth pact – lacks the necessary understanding of the dependence of output in one member country on demand in others, of the role of payments imbalances and of the fact that competitiveness is always relative. If Italy and Spain are to become more competitive within the eurozone, then Germany or the Netherlands must become less so.

Moreover, if the private sector is running a structural financial surplus to lower its debt, policymakers can eliminate structural fiscal deficits if and only if the country runs a structural current account surplus. Germany should understand this because that is precisely what it is doing. Countries hit by financial crises almost always have large structural private sector financial surpluses. If these countries are indeed to eliminate structural fiscal deficits, they, too, must run structural current account surpluses, just like Germany. Yet every country cannot run such surpluses, unless the eurozone as a whole is to do so.

It is impossible for individual countries to heal without offsetting changes elsewhere. As Ms Lagarde said in Berlin: “Resorting to across-the-board, across-the-continent, budgetary cuts will only add to recessionary pressures”. Fiscal tightening must be selective. More important, the indication that the adjustment process is working – so making unnecessary the long-term fiscal transfers Germany rightly detests – would be buoyant demand in the core of the eurozone, with inflation well above the eurozone average – a mirror image of what happened before the crisis.

The strongest note of optimism on the eurozone I heard in Davos rested on the dire results of a break-up. Yet desperate people do desperate deeds. Members now need the time and the opportunity to adjust. Strong firewalls should give the time, but only shifts in competitiveness will give the opportunity. Without both, the crisis will surely return.

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