Europe’s self-inflicted crisis

Published in ABC – The Drum Unleashed (Sydney), 16 December 2010

To superficial observers, this week’s European summit in Brussels will look like any other high-level conference.

Prime ministers, chancellors and presidents will rub shoulders, pose for photographers, and dally with waiting journalists. Once again it will all seem a bit like a school reunion. But the pretty pictures of smiling politicians cannot conceal that the continent is in crisis and the European Union is falling apart.

It was a horrible year for Europe. In May, Greece narrowly escaped bankruptcy by receiving emergency loans from other European countries. In October, France came to a standstill over President Sarkozy’s pension reforms. In November, Ireland was forced to accept help from a trillion-dollar fund meant to stabilise the common European currency, the Euro. To make matters worse, speculations are growing that further countries will soon need vast amounts of money to prevent them from crumbling under their debt loads. And we haven’t even mentioned the ongoing soap opera around Italian prime minister Silvio Berlusconi’s affairs.

As we are watching the European crisis from afar, questions need to be answered. How did Europe get into this mess? What will the fallout be for Australia? And finally, are there any lessons for us to learn?

What is surprising about Europe’s decline is the fact that it took international experts so long to detect it. Not long ago, there were books predicting the beginning of a new golden age for Europe.

There was The European Dream: How Europe’s Vision of the Future Is Quietly Eclipsing the American Dream by US sociologist Jeremy Rifkin; Why Europe Will Run the 21st Century by British foreign policy expert Mark Leonard; and The United States of Europe: The New Superpower and the End of American Supremacy by US publicist T. R. Read. Now available at heavily discounted prices, such overly-optimistic accounts of Europe appear completely outdated, though they are only a few years old.

It would be easy to blame Europe’s sudden decline on the fallout from the global financial crisis. Such scapegoating would be convenient, but it is inappropriate. The economic crisis only brought to the fore a number of developments that started long before Lehman Brothers collapsed.

In most European countries, government spending grew rapidly after World War II. In 1960, government spending as a share of economic output was around the 30 per cent mark in most European countries, even in Sweden. In Switzerland, it was as low as 17 per cent.

By the year 2000, the state had grown dramatically across Europe. In Spain, it accounted for 39 per cent of GDP, in France it was 52 per cent and in Sweden it was 55 per cent. In the case of Sweden, this was actually a slight improvement because the Swedish state had consumed more than 60 per cent of GDP in 1980.

In order to finance such excessive public spending, taxes were no longer sufficient. Budget deficits became the normal state of affairs across the continent.

For a while, this seemed to work. European countries could offer generous benefits, pensions and public services. No wonder American authors looking at Europe were impressed. However, European spending levels were not sustainable as the financial crisis revealed.

On top of the results of irresponsible government spending, Europe now suffers from the attempt to unite countries in a monetary union. The export-dependent German economy, the Celtic tiger Ireland and the sluggish economy of Greece were too different for a single currency to work. These countries would have required different interest rates. Instead, they were subjected to a one-size-fits-none monetary policy. Now that this experiment has failed, the struggling members of this monetary union are neither allowed to leave the Euro zone nor to default on their debt.

For Australians, there is no reason to watch this unfolding tragedy with schadenfreude. Europe is still one of Australia’s most important trading partners. If it continued its way into financial meltdown, we are bound to feel it here, too. Capital markets are highly connected, as we found out in the GFC. A series of sovereign defaults of European countries would surely affect Australia.

There is another reason why Europe’s decline should make us worry. It demonstrates all too clearly what can happen if you put off good economic policy making for too long.

If you went to Ireland or Spain in 2005, you would have experienced countries that were overwhelmingly optimistic. Government finances looked fine. House prices kept going up. Unemployment was low.

If all of this reminds you of Australia, it should. At the same time that dark clouds were forming on the horizon, Europe celebrated its last big party. By the time the clouds burst, it was too late to stop the deluge.

Above all, Europe’s crisis is a warning against political complacency. Australia should take notice or risk falling into the same trap.