Fire and ice on Europe’s debt march

Published in Business Spectator (Melbourne), 25 April 2013

For those eternal optimists always looking for green shoots in the eurozone crisis, Europe’s statistics authority Eurostat had a pleasant surprise this week. For 2012, the government deficit for the combined eurozone fell to 3.7 per cent of GDP from 4.2 per cent the previous year.

So clearly, austerity policies are working and it must surely only be a matter of time until the European Union gets its house in order again to leave the nasty eurozone crisis behind, right?

Well, not quite. By digging a little deeper into the Eurostat figures it becomes clear that even the modest overall improvement in European public finances points towards a deepening of the crisis. But how can that be?

The answer is simple. If you hold one hand in icy water and the other in a boiling pot, then on average you might feel just fine. Unfortunately, you will also be both burnt and frozen. It is quite similar with the eurozone’s public finances.

What looks like a eurozone step in the right direction turns out to be a widening split of eurozone member states. Some countries are seeing marked improvements in their budgets while for others fiscal problems are spiralling out of control. As we know, it is precisely such imbalances that are the root cause of the euro crisis.

There are two further reasons to worry about the latest fiscal data, and these are the unimaginable absolute figures of Europe’s march into debt. In total, euro member states needed to raise €375 billion to plug the gaps in their budgets. And the eurozone’s total debt to GDP level increased to 90.6 per cent of GDP – or roughly €8.6 trillion. Staggering figures indeed.

Just as an aside, the latest data also confirm that hardly anyone in Europe is still playing by the rules once agreed to in the European Union’s Stability and Growth Pact. Remember, that was the treaty allowing government deficits of up to 3 per cent of GDP and a total debt burden of 60 per cent of GDP.

Well, as it turns out, there are only three out of 17 eurozone member states fulfilling both criteria: Estonia, Luxemburg and Finland. With all due respect, these three countries are not the giants of the eurozone. Meanwhile, 11 out 17 are in breach of the deficit rule; 12 out of 17 are violating the debt rule. And nine out of 17 members are simultaneously breaking both rules.

What is both dangerous and unsustainable, for the eurozone is the schism that has emerged between the healthier core and the crisis plagued periphery. Germany was the only country with a (very modest) budget surplus of 0.2 per cent of GDP. Estonia, Luxemburg, Austria and Finland recorded deficits below the 3 per cent mark.

At the same time, Belgium (3.9 per cent), France (4.8 per cent), Cyprus (6.3 per cent), Portugal (6.4 per cent), Ireland (7.6 per cent), Greece (10.0 per cent) and Spain (10.6 per cent) had budget deficits at levels that can only be called problematic.

The deficit countries are also the ones in which debt levels have reached dramatic levels: For Cyprus it stood at 85 per cent; France 90 per cent; Belgium 100 per cent; Ireland 118 per cent, Portugal 124 percent, Italy 127 per cent (though Italy was still only running a moderate 3 per cent deficit), and, of course, Greece at 157 per cent.

The picture that emerges is not one of a eurozone consolidating or strengthening, but to a monetary union that is falling apart. In a functioning common currency area you would expect economic discrepancies to get weaker over time. In the eurozone they become stronger as the crisis progresses.

It is quite obvious that the countries with the strongest austerity programmes were also the ones failing to consolidate their public finances. Perhaps this explains why EU Commission President José Manuel Barroso just questioned the EU’s hitherto pursued austerity policies. In a speech, he said that such policies had reached their limits, not least because the European public no longer supported them.

However, even if Barroso was right in his assessment, it is not clear what this would mean and what should follow. For countries like Spain, Ireland or Greece giving up on budget consolidation would be grossly irresponsible given their already high public debt levels. On the other hand, Barroso is certainly right that austerity, to be successful, needs to have a minimum level of public backing. With economic growth a distant dream and unemployment levels rising, it is equally obvious that the periphery’s appetite for budget tightening is dwindling.

Apart from these economic problems, there is a political complication. Barroso’s remarks triggered a strong response from the German government. In a most undiplomatic way, foreign secretary Guido Westerwelle publically rebuked Barroso for questioning the wisdom of austerity.

Little wonder: German voters do not want to pay any more for bailouts and rescue packages – and Germany is going to the polls later this year. This is why the German government does not have the least interest in even talking about alternatives to the EU’s current policies – never mind their success so far has been disappointing.

For the eurozone, there is no way out of these dilemmas. The euro binds countries together that do not have much in common. As Eurostat’s figures show, the differences between eurozone members are persistent and austerity policies are unlikely to change this picture.

Even eternal eurozone optimists should sooner or later come to the conclusion that with its current membership, the eurozone will always remain too diverse to work.

It is not enough for the eurozone to be working in aggregate only; it needs to work for each individual member state as well.

At the moment, the only countries able to function with the euro are those of the healthier euro core. They should allow the other eurozone members to depart from monetary union. Otherwise we will never be able to see some actual green shoots in Europe.

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