WP 2012-03. Executive Summary
Update Jul’14: The paper has been published by Palgrave Macmillan and is available on Amazon.The European crisis is not behind us and easy solutions do not readily present themselves. Some of the causes of the crisis may be regarded as temporary while others are of a more structural nature. The housing bubble belongs to the former category; the failure of governments to implement common sense, growth-enhancing policies belongs to the latter. Of course, each country has its own characteristics and, therefore, its own account of the crisis. With this caveat, this paper represents a detailed analysis of three causal features common to the whole euro area. First, the monetary authorities of the Union insisted on an expansionary policy for at least a decade: as a consequence, banks were induced to lend freely even if it meant taking risks on high-risk loans, persons who were not credit-worthy were encouraged to borrow amounts which lay outside their capacity to repay, and governments found it easy to engage in profligate spending and finance it through debt. Second, the EU authorities did nothing to disabuse bond markets in their belief that national debt was being underwritten by the EU. Put differently, public opinion was persuaded that the governments and banks of the countries of the European Monetary Union could never fail. This feeling was strengthened by the mistaken belief that the technocratic regulation and monitoring of national economies would be sufficient to keep the EMU ship afloat. Regrettably, and this is the third common feature, those technocrats did a very poor job at analyzing risk and fulfilling their promises about supervision. The various chapters of this book illustrate the consequences of these failures. In some cases (e.g. Spain and Ireland), excessive borrowing ended up in a housing bubble. When the bubble exploded, the banks were badly hit by the rise of non-performing mortgages that eventually turned into losses. As we know, governments stepped in to bail them out at the cost of compromising their own financial situation. A public-debt crisis followed before long. In other cases, too much borrowing made governments’ financial credibility vulnerable to potential rises in interest rates. When this vulnerability was perceived, the risk premium increased: it nullified all efforts to keep interest rates low and put financial stability in jeopardy. Of course, the least painful way out of the crises would be resorting to fast growth: the richer the debtor, the higher the chances that he puts his house in order and pays back his dues. Yet, low growth has been the other common structural weakness of the euro area. The expansion of the spending and regulatory roles of government have failed to restrain privileges and have made it more and more difficult (or less attractive) for entrepreneurs to develop their ideas, for investors to see risk-taking remunerated, and for individuals to invest resources in their own human capital. If structural reforms do not come true, if the role of government is not significantly downsized, and if the issue of individual responsibility does not become the reference point of any policy-making proposal, this crisis will permanently scar the European economic landscape. Will our banks and governments rulers behave more responsibly in the future? We hope so, although the record is not exciting: one should not forget that during the past ten years governments were not able to stick to the budgetary rules that they had themselves created, that violations have hardly been punished and that imaginative budgetary interpretations (cheating) have not been infrequent. Certainly, the future role of the euro remains an open question. The immediate viability of the euro is directly proportional to the amount of sovereignty national governments are prepared to surrender. Today, centralized policy-making is a popular option, which might come true if, by giving away their sovereignty, the weak countries succeed in persuading the strong partners to guarantee the debts of the whole Union. But of course, even if the troubled countries are de facto bailed out, fiscal-policy centralization will do little to solve the Union’s structural problems and might actually contribute to their aggravation: central bureaucracies like regulation more than de-regulation. In the longer run, the danger is that debtors will tire of austerity; creditors will weary of bail outs; and any of the Member States may find the gradual erosion of sovereignty sufficiently offensive to want to leave. In the end, the only sure conclusion is that so far the “common currency” has failed. The European idea, by removing artificial barriers between countries, has conferred many real and lasting benefits on the citizens of its member countries. But the single currency was a step too far. Unfortunately, this misadventure places all the gains of a single European market in jeopardy. Europe was not and is not an optimal currency area. Furthermore, and in contrast with the politicians’ promises, it has not helped Europe to become a political union. On the contrary, and irrespective of the economic justification for the austerity programmes imposed upon many “weak” countries, it is clear that in these months those residents hardly look at Brussels and Frankfurt as a blessing. Sadly, the very project that was designed to bring Europe together has been the handmaiden of increasing economic imbalances and, by opening old wounds and reinforcing national stereotypes, of simmering political tensions.