Published in Business Spectator (Melbourne), 2 February 2012
The summit-less time is over and the professional euro rescuers are back at work. After the first crisis meeting of EU leaders this year, the future of Europe’s common currency is as uncertain as before. This is not despite the fiscal compact that was agreed but because of it. The Europeans are still trying to solve the wrong crisis.
For the time being, the German narrative has prevailed. In Chancellor Angela Merkel’s view, the crisis was caused by periphery countries not living within their means. Consequently she has pushed for stronger fiscal rules in return for continued funding of the various bailout schemes. Put simply, the Germans are not willing to pay for other countries unless they are prepared to become more German themselves.
There is only one problem with Merkel’s logic. It is based on a false premise. Public debt levels in the crisis countries are a symptom of a far more severe structural crisis but they are not the core problem.
The real issues are competitiveness differences and balance of payments imbalances. A sober look at the European crisis makes Merkel’s morality tale of the virtuous Germans versus the reckless rest collapse.
The Germans clearly feel good about themselves. Their budget may not be in surplus but at least the deficit is small. Treasurer Wolfgang Schäuble can borrow at miniscule rates. Unemployment is low.
German exporters are enjoying strong growth in emerging markets. If only the Greeks, the Portuguese and the Spaniards, and perhaps also the Italians and the French, could be a bit more like that, the Germans wish. At least then they would not have to pay for them.
What the Germans do not understand is that not everyone can be like them.
Part of Germany’s strength results from its neighbours’ weakness. The main reason for Germany’s ability to borrow as cheaply as it does is not its own debt-to-GDP ratio. Official government debt is 82 per cent of GDP and thus clearly above unproblematic levels.
Capital investors are only queuing up to lend to the German treasury because temporarily it looks like a safe haven, if only in comparison with countries like Greece and Italy. That is hardly an achievement Schäuble and Merkel could be proud of.
The strength of the German economy is also questionable. It is true that small steps had been undertaken to liberalise the labour market in the early years of the century. However, what really boosted German growth was its decade-long policy of wage restraint, coupled with a weak euro exchange rate that no longer reflected German export strength but periphery weakness.
Together, these conditions produced a mercantilist framework in which Germany flooded world markets with high-quality products at über-competitive prices while also providing credit to its international customers. Successful all of this may have been; sustainable it is not. Nor is it plausible that as taxpayers the Germans should be asked to continually bail out the periphery while as workers their low unit-cost wages caused some of the periphery’s problems in the first place.
To be clear: to bring Europe back into balance Germany needs an appreciation of its exchange rate as much as Greece needs a currency depreciation. Berlin is as much a problem as Athens. The two countries are two sides of the same euro coin.
And this is where the whole German narrative about euro sinners and saints breaks down. It is not enough to force Greece and others to implement strict austerity programs. Cutting the public deficit does nothing to solve Greece’s more fundamental problems. Even if the Greek government somehow managed to balance its books, the Greek economy would still remain moribund and dependent on international capital transfers ad infinitum.
Put simply, the result of a German-mandated austerity drive would be a crippled Greek government running a crippled Greek economy. The only winners in such a scenario would be the Germans, who could remain Europe’s export steamroller.
What would really help Greece is an environment in which its companies could once again compete with their European peers. At Greece’s poor productivity levels this is unlikely anytime soon. It could only happen if one of two things occurred: a Greek deflation (the so-called ‘internal devaluation’, achieved through wage cuts) or a German inflation (for example by substantially increasing German wages).
Since Greece cannot deflate and Germany does not want to inflate, there is no solution to the crisis – no matter how much the Greek government cuts spending, no matter how tough Angela Merkel talks about fiscal discipline. That is because the fiscal problem is only the visible symptom of an underlying misalignment of competitiveness differentials within the eurozone.
For the same reasons, the Germans have no interest in Greece departing the eurozone or leaving the zone themselves. Both ways of action would be disruptive to their business model.
Perversely, Germany only does well as long as its European neighbours are struggling. The moment the European periphery recovers, Germany will lose its ultra-low borrowing costs and its export advantages. The German export boom would be over immediately while Germany’s substantial public debt burden would suddenly require more realistic servicing costs.
This means that Germany will try to prevent a Greek exit from the eurozone as it runs against German interests. And of course the same logic stops Germany from departing the eurozone itself. The only thing that could change this would be a revolt of German taxpayers once the first German guarantees towards the eurozone are triggered. For the time being, however, Germany is even benefitting from its emergency loans to Greece, since Greece pays an interest rate higher than Germany’s borrowing costs.
Solving the European crisis would take more than fiscal adjustments. Unfortunately, recalibrating the European economy requires the Germans giving up their economic model. It would also mean rezoning the euro area, either by pushing Germany out or letting Greece depart.
Berlin is only focussing on the fiscal crisis since it does not want to change its own ways. But as long as the Germans are unwilling to accept that they are part of the problem they cannot offer workable solutions to others.