The eurozone’s sovereign-debt crisis represents a significant challenge for Europe and the global economy. But it is also an opportunity: overcoming the challenge will not only contribute to a sustained global economic recovery, but will also test our capabilities to control the dangers of globalization.
The integration of markets in recent decades, coupled with enormous technological progress in communications and transport, has diffused growth to regions that for centuries lagged behind the dramatic rise in living standards witnessed in Europe, North America, and Japan since the Industrial Revolution. More efficient use of global resources allowed productivity to grow, lifting billions of people out of poverty and into the modern world.
The downside is that national control over economic policy has been significantly diminished, while international economic governance confronts new problems. As markets integrate and systems converge, addressing imbalances in either the real economy or the financial sector becomes increasingly difficult, owing to the constraints on multilateral policy cooperation built into institutional arrangements designed for nationally-bounded economies.
Over the last decade, large external imbalances were allowed to emerge within the eurozone. The competitive position of peripheral member countries – particularly Greece, Spain, Portugal, Ireland, and Italy – deteriorated sharply vis-à-vis the core countries. Governments in the periphery turned a blind eye to credit-fueled bubbles and public or private debt, and failed to adopt counter-cyclical fiscal measures or promote structural reforms to improve competitiveness. Large external deficits were matched by surpluses in core countries, whose excess savings then flowed back to the periphery, in turn permitting excessive borrowing and leading to fiscal blowouts.
Greece was the first country to seek financial assistance from the European Union and the International Monetary Fund, with a bailout program negotiated in May 2010. Exceptionally harsh austerity measures included sharp tax increases and cuts in public-sector salaries and pensions. Structural reforms – particularly privatization, market liberalization, opening up closed professions, and downsizing the government sector – were either neglected or poorly monitored. The result was a deep and prolonged recession, limited gains in competitiveness, and missed fiscal-deficit targets
Poor design and implementation of the adjustment programs undoubtedly has contributed significantly to the persistence of crisis conditions. However, debt growth exposed a critical flaw in the eurozone’s economic constitution: national debts are member countries’ responsibility, but the common currency lacks a sovereign. Unlike most monetary authorities, the European Central Bank cannot act as a lender of last resort, which, together with the absence of common bonds (Eurobonds), induced large-scale speculation on member states’ national debt, reflected in widening interest-rate spreads.
Resolving the crisis inevitably includes action on two fronts. The over-indebted countries must address the causes of the persistent imbalances by implementing structural reforms that liberalize markets and encourage wage flexibility. At the same time, the eurozone must be equipped with the instruments needed to restore stability and prevent crises from recurring.
Given its specific history, Europe cannot emulate the United States’ model of a functioning economic union. Nonetheless, in order to make the currency union work, Europe should take decisive steps in that direction. This means centralizing European debt through Eurobonds, mobilizing sufficient rescue funds, allowing the ECB to intervene in the primary bond markets, and establishing both a fiscal and a banking union.
However, the unification agenda lacks universal support. The issuance of Eurobonds would imply subsidizing debt-service costs for less creditworthy countries, raising the specter of a “transfer economy” – poorer countries’ permanent dependence on rich countries’ assistance – which Germany strongly opposes. Fiscal union would also include common taxation, implying a loss of sovereignty.
Such fears are reinforced by the prospect of extending unification to the political sphere in order to give supranational governing institutions sufficient democratic legitimacy. This could involve popular election of the European Commission president and strengthening the European Parliament’s powers while diminishing those of the intergovernmental European Council.
Until then, “too little, too late” and “muddling through” will continue to characterize EU and eurozone policymaking. This, coupled with weak reform efforts in the over-indebted countries, goes a long way toward explaining Europe’s inability to overcome the crisis and set a course for economic recovery and steady growth.
But the eurozone crisis is also a globalization crisis. In an open, globalized economy, the gap between winners and losers widens as competition intensifies. And, as markets integrate and become more interdependent, the need for policy discipline and international cooperation increases.
A key task is to prevent the emergence of excessive current-account imbalances, which means supporting exchange-rate realignments and appropriate adjustments in fiscal policies. A new global financial-services rulebook, including tougher regulation and strengthened supervision, as well as trade liberalization and higher volumes of appropriately targeted development assistance, would also contribute decisively to raising the standards of international economic governance.
The challenge for political leaders is to ensure that the current era of rising and more widely diffused prosperity endures, so that humanity’s poorest eventually share the benefits of modern civilization. This requires reinforcing international governance institutions, such as the G-20. It also requires that the outcome of Europe’s struggle to establish effective institutions offers grounds for hope, not despair.