It has been three years since the outbreak of the euro crisis, and only an inveterate optimist would say that the worst is definitely over. Some, noting that the eurozone’s double-dip recession has ended, conclude that the austerity medicine has worked. However, try telling that to those in countries that are still in a depression, with per capita GDP still below pre-2008 levels, unemployment rates above 20 percent and youth unemployment at more than 50 percent. At the current pace of “recovery,” no return to normality can be expected until well into the next decade.
A recent study by Federal Reserve economists concluded that the US’ protracted high unemployment will have serious adverse effects on GDP growth for years to come. If that is true in the US, where unemployment is 40 percent lower than in Europe, the prospects for European growth appear bleak indeed.
What is needed, above all, is fundamental reform in the structure of the eurozone. By now, there is a fairly clear understanding of what is required:
‧ A real banking union, with common supervision, common deposit insurance and common resolution; without this, money will continue to flow from the weakest countries to the strongest;
‧ Some form of debt mutualization, such as Eurobonds: With Europe’s debt/GDP ratio lower than that of the US, the eurozone could borrow at negative real interest rates, as the US does. The lower interest rates would free money to stimulate the economy, breaking the crisis-hit countries’ vicious circle whereby austerity increases the debt burden, making debt less sustainable by shrinking GDP;
‧ Industrial policies to enable the laggard countries to catch up; this implies revising current strictures, which bar policies such as unacceptable interventions in free markets;
‧ A central bank that focuses not only on inflation, but also on growth, employment and financial stability;
‧ Replacing anti-growth austerity policies with pro-growth policies focusing on investments in people, technology and infrastructure.
Much of the euro’s design reflects the neoliberal economic doctrines that prevailed when the single currency was conceived. It was thought that keeping inflation low was necessary and almost sufficient for growth and stability; that making central banks independent was the only way to ensure confidence in the monetary system; that low debt and deficits would ensure economic convergence among member countries; and that a single market, with money and people flowing freely, would ensure efficiency and stability.
Each of these doctrines has proved to be wrong. The independent US and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility.
Likewise, Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. The crisis caused the deficits and high debt, not the other way around, and the fiscal constraints that Europe has agreed will neither facilitate rapid recovery from this crisis nor prevent the next one.
Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. However, migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialized), has been hollowing out the weaker economies. It can also result in a misallocation of labor.