Quo vadis, Euro?
This is a guest post by Thiess Petersen, who also works with the future challenges team in Gütersloh. Thiess’s research is primarily concerned with questions of globalization and the current international financial crisis. He leads seminars and lectures at several universities and is currently occupied by the production of textbooks on economics. Five years ago, our team had already warned of an impending economic crisis in which sovereign debt would figure prominently; this scenario is now coming to pass in more and more Western countries. In the future, Thiess plans to write for us more frequently on the topic of the financial crisis and how it serves to illustrate the complexities of political economics and the interconnected nature of our world. Please take also a quick look at our discussion papers about Economic Governance Reform as well as Economic Governance and Crisis Prevention.
Quo vadis, Euro?
1992 brought us the Treaty on European Union (TEU) better known as the Maastricht Treaty. In 2002 the first euro bank notes and coins came into circulation. So what does 2012 hold in store for Europe and the euro? It looks extremely likely that 2012 is going to be a make-or-break year for the euro.
What is absolutely certain is that the euro is now facing its stiffest test ever. The enormous mountains of debt accumulated by eurozone countries are causing the confidence of international capital markets in the euro to evaporate. In 2012 it’s estimated that the countries and banks of the eurozone will need something in excess of 2,000 billion euro just to refinance their expiring credits. At the moment it’s still not certain whether private investors will put forward such sums at reasonably affordable conditions. Yet if states like Italy, Spain or Portugal can no longer cover their need for capital on the private credit markets, state bankruptcy looms large and with it the end of the eurozone.
At first glance the present crisis appears to stem from the unsound methods of budgetary management pursued by many eurozone countries. Yet the fact is that basically the euro crisis is less a crisis of state finances than the consequence of the failure of individual countries to achieve competitiveness. It can be traced back to when national economies with different levels of productivity came together in a single monetary union. This meant that economically weak countries lost a vital instrument for keeping their competitiveness on international markets on a steady keel. Because beforehand when they had their own currency, countries with slow rises in productivity could always devalue it to lower the price of their goods in the rest of the world – if, for instance, German goods became 8 percent cheaper after a productivity rise while the prices for Greek products only fell by 2 percent, a six percent devaluation of the drachma would still keep Greek products competitive on international markets.
Since the introduction of the euro this is no longer possible. The follow-on effects are less effective international competitiveness for economically weak countries and a fall in production. And a fall in production fuels unemployment. For the government this means lower tax revenue combined with ever higher expenditure to buffer the effects of unemployment – in short, an increase in sovereign debt.
A common currency can only be sustained in the long-term when all the countries participating in it display similar levels of productivity. Should this not be the case, those countries with an insufficient level of productivity must lower the costs for their production factors – which at the end of the day means wage cuts. Alternatively, there is the possibility that workers who lose their jobs due to a lack of international competitiveness migrate to countries with higher productivity levels. Yet in practical terms neither of these two adjustment mechanisms will work in the European Monetary Union. And this is hardly surprising, considering the very poor track record both these mechanisms have had in post reunification Germany.
A monetary union, however, can only survive in the long term if the economically strong countries make transfer payments to the economically weak – as Germany did within the framework of the Länderfinanzausgleich – the financial equalization scheme between the Federal Government and the Länder. Thus fiscal transfers between the countries of the eurozone are a substitute for the lack of labor mobility and the lack of flexibility in price factors. They need to be predicated on much greater integration of economic policies which also includes tax equalization payments and redistribution within the framework of a collective social insurance system. Whether economically powerful nations like Germany are ready to make such a move, however, is more than doubtful.