Once, more than half a century ago, the Social Democrat Kurt Schumacher said: “Politics begins with reflection on reality.” The reality of the European Union today is that the economy, foreign trade and capital markets all form a web of constraints that it is impossible to escape. The debt crisis in the euro area demonstrated that and what is more it did so with massive and uncompromising force. From a purely economic point of view there would be one simple and tidy solution: an overindebted nation state that is insolvent should simply cease servicing its debts. The debtor’s “default” is then followed by a swift and brutal “haircut”, an agreement with creditors to forego interest payments and part of the debt or to postpone repayment of the debt. Subsequently life returns to normal and everything carries on as before with adjusted balance sheets. But what do we mean by “normal”? This is precisely the problem, because the economic normality after a “default” is capital flight, extremely high interest rates, collapsing banks and a macroeconomic crisis that causes a dramatic loss of income and jobs. Such a situation can only be alleviated by a drastic currency devaluation and strict controls on the movement of capital. Neither of these is possible in the euro area. That leaves only two alternatives: leaving the currency union or massive aid packages to stabilize the euro.
The former is certainly possible in financial terms – by means of a currency reform combined with the introduction of a national currency. In economic and political terms, however, this would be a national disaster for any country because it would lead to total ostracism by the markets. Any increase in political leeway would be practically worthless because a drastic devaluation of the new currency would massively increase the real burden of foreign debts. And it would drive pay levels down so far in the inner-European ranking that qualified personnel would emigrate en masse – to the then far richer countries of the EU.
Behind this lies a fundamental problem that has received too little attention until now: the mobility of young high performers and the growth of a globalized generation that not only speaks good English but is also ready to build a future in another country at any time. Freedom of movement across national frontiers within the EU means it is no longer possible to secure economic competitiveness on a long-term basis using international pay differentials. This is all the more the case when skilled employees are becoming increasingly scarce in the healthy economic centres of highly industrialized countries – a situation caused not least by demographic trends. The situation is beginning to resemble that of the 1960s. This time, however, it involves highly qualified, largely academically trained specialists and is a Europe-wide “brain drain”. The only means left to actually prevent this would be to leave the EU itself in order to effectively push through the necessary compulsory measures on capital and labour markets. The political price for Europe would be disastrously high. It would be all too reminiscent of the 1930s, when the beginnings of a liberal world economic order came to nothing due to the resistance of the large countries, a situation which eventually resulted in the whole world falling into the abyss. After the Second World War, on the other hand, the United States astutely assumed responsibility as the hegemonial power. This had positive developments, namely the integration of the world economy and global growth.
In today’s euro area this role is played – nolens volens – by Germany and its stable neighbours. The message to the financial markets must therefore be: we remain willing to do everything to stabilize the situation in the problem countries, which means a watertight rescue facility, no matter what it costs or how large it is. This message has to be totally credible, but at the same time totally non-specific – in a similar way to statements about combating terrorism. Nevertheless, the main elements are clear to everyone: liquidity and guarantees measured in breathtaking billions and in return an extremely harsh austerity policy in the countries that receive support. Of course, all this is a bitter experience. It shows how harshly economic reality overrules the law in crisis situations. The “no bailout clause” in the European stability pact, which stipulates that no country is liable for the debts of another, is and remains dead. However, that does not mean that the euro area will fall into a quagmire of financial crises. On the contrary, the events that have been affecting the Greeks, Irish, Portuguese and Spanish in the last few months represent turning points that will burn themselves deep into the collective consciousness. They will change these countries and their people in the same way that the hyperinflation of the 1920s and two currency reforms have permanently made the Germans a nation for whom the goal of price stability plays a paramount role.
That is why the new situation also represents an opportunity for serious reform. It can, however, only be effective by going to the root of the problem – in other words, national finance policy. A constitutional debt brake, as exists in Switzerland and now also in Germany, could become a political goal for all the nations of the euro area. It would mobilize the political forces that are required for a permanent return to financial discipline and thereby – at least in the long term – to a path of real economic growth. This requires a regional structural policy that would get the catching-up process in the southern and eastern European countries moving forward again – furthermore, on a sound basis, ongoing and sustainable, without real estate bubbles or consumer spending sprees. In fact, looking at the last ten years it becomes clear that there was only an illusion of convergence, which the financial crisis brought to an abrupt end. The lesson today must be that even a country as successful as Spain does not yet have the industrial innovative force that distinguishes German and Austria or Finland and Sweden. What is true of the southern European EU partners, also applies to our central European neighbours, who were only really able to start the catching-up process in 1990. A new policy emphasis is therefore required on both the European and national level, one that involves a shift away from numerous small support programmes, which frequently do nothing more than increase local consumption, and towards a comprehensive industrial policy that helps peripheral regions to become independent centres of innovation within a new global division of labour. This will take time and also cost money. Above all, it will place a financial burden on Germany. Yet that is the only way it will be able to create a continent in which economic strength is not concentrated solely on the western centre, but also takes in large parts of the EU in the east and south. This remains a major political goal – and, to a certain extent, also a moral obligation, especially in Germany, whose western part received a – second – chance to integrate into the new world economy after the Second World War. This second chance is precisely what the others now also deserve.////
Karl-Heinz Paqué is professor of international economics at Otto-von-Guericke-Universität Magdeburg. His latest book “Wachstum! Die Zukunft des globalen Kapitalismus” (Growth! The Future of Global Capitalism) was published in September 2010.
A Path to Long-Term Stability
At the end of 2010 the heads of state and government of the European Union agreed on a permanent crisis mechanism, the European Stability Mechanism (ESM). It is intended to make the euro more secure if individual countries face financial difficulties. This permanent mechanism is scheduled to replace the present European Financial Stability Facility (EFSF) from 2013. The “emergency parachute”, as it is often known, was set up temporarily when the Greek financial crisis developed into a euro crisis in 2010.
The Treaty of Lisbon will need to be amended to establish the permanent European Stability Mechanism. This EU treaty forms the basis for cooperation between the EU member states and actually forbids mutual financial assistance by EU countries. The government leaders therefore agreed to expand the treaty by one paragraph that permits such intervention to safeguard the stability of the euro. This minor addition to Article 136 of the EU treaty has to be ratified by all EU countries by the end of 2012 so that the permanent European Stability Mechanism can supersede the current “emergency parachute” in mid-2013.
The current facility has a total volume of 750 billion euros. Member states can receive 60 billion euros from the European Union budget itself in the event of a debt crisis. A total of 440 billion euros can be made available by the European Financial Stability Facility (EFSF), which refinances the loans by issuing bonds on capital markets. The EFSF is a specially founded single-purpose enterprise for which all member states of the euro area share liability (see our interview with EFSF CEO Klaus Regling on page 18). The International Monetary Fund (IMF) can provide additional loans worth up to 250 billion euros. In any event, these are loans that the countries concerned eventually have to pay back with interest.
What is new about the European Stability Mechanism it the fact that countries’ private creditors, such as banks and funds, can also be compelled to assume liability. The EU has taken this step to counteract speculation aimed against individual countries. It is also planned to involve the International Monetary Fund (IMF) in this.
