Europe’s Poisoned Chalice of Growth
APR 14, 2015
CAMBRIDGE – After a
double-dip recession and an extended period of stagnation, the eurozone
is finally seeing green shoots of recovery. Consumer confidence is
rising. Retail sales and new car registrations are up. The European
Commission foresees 1.3% growth this year, which is not bad by European standards. But it could be very bad for European reform.
It is not hard to see why growth has picked up. Most obviously, the European Central Bank announced an ambitious program of asset purchases
– quantitative easing (QE)– in late January. That prospect rapidly drove
down the euro’s exchange rate, enhancing the international
competitiveness of European goods.
But the euro’s
depreciation is too recent to have made much difference yet. Historical
evidence, not to mention Japan’s experience with a falling yen, suggests
that it takes several quarters, or even years, before the positive
impact of currency depreciation on net exports is felt.
So other factors must be at work. One is that spending and growth are now under less pressure from fiscal consolidation. The structural primary budget balance,
the International Monetary Fund’s preferred measure of “fiscal thrust,”
tightened by an additional 1-1.5% of GDP each year from 2010 to 2012,
after which it remained broadly stable. The subsequent two years of
neutral fiscal policy has made a positive difference for economic
performance.
And, however
regrettable the uneven application of the EU’s fiscal rules, the
European Commission’s recent decision to give France more time to reduce
its budget deficit to 3% of GDP is welcome, coming as it did against
the backdrop of a weak economy.
Another
factor behind the upturn is the meaningful progress that a number of
European countries, such as Spain, have made on structural reform.
Labor-market regulation has been loosened, and unit labor costs have
come down. This, too, is showing up as further improvement in Europe’s
competitiveness.
A third driver of
recovery is the fact that banks and financial markets are now better
insulated from the turmoil in Greece. French and German banks have been
able to sell their holdings of Greek government bonds, largely to the
ECB, which has acted as bond purchaser of last resort. The ECB has also
promised to support other countries’ bond markets in the event of a
Greek accident. Hence Europe’s recovery is less at risk of being
derailed by instability in Athens.
Fourth and finally, even dead cats bounce.
Economic growth heals
many wounds. It strengthens banks’ balance sheets by reducing the
volume of non-performing loans. It narrows government budget deficits by
increasing tax revenues and limiting welfare spending. By raising the
denominator of the debt/GDP ratio, it enhances confidence in debt
sustainability. And it produces these benefits automatically, without
officials having to do anything more.
Unfortunately for
Europe, growth also reduces the perceived urgency of action where action
is urgently needed – for example, Greece. With the rest of Europe
growing, other governments, believing themselves to be in a stronger
economic position, are less inclined to compromise with Greece. Everyone
understands that compromise is preferable to the collapse of
negotiations, disorderly default, and Greece’s forced exit from the
eurozone. But the more confident the rest of Europe becomes of the
sustainability of its recovery, the more it adopts a hard line – and the
more likely a disorderly denouement becomes.
Similarly, the more
that recovery and sustained growth strengthen banks’ balance sheets, the
less urgency policymakers feel to address structural shortcomings, such
as the implicit guarantees enjoyed by state banks and municipal savings
banks in Germany, and the problems of family-controlled banks like
Banco Espirito Santo in Portugal.
And even 2% growth
will not render Europe’s triple-digit debt/GDP ratios sustainable.
Europe still needs debt restructuring, though the continent’s leaders
refuse to acknowledge this. Economic recovery merely enables them to
delay the inevitable day of reckoning.
Finally, there are
the more ambitious reforms – fiscal union and political union – that
must complement monetary union if Europe is to avoid a similar crisis in
the future. If there is one lesson to be learned from Europe’s recent
travails, it is that monetary union without fiscal and political union
will not work. Yet, given intense opposition to further fiscal and
political integration, progress, if it is to occur, will entail
difficult and divisive negotiations. So any European growth that occurs
without these measures will create an incentive to put them off.
The problem, quite
simply, is that many of the underlying conditions that produced the
eurozone crisis remain unaddressed. If Europe now grows without making
the hard decisions needed to address them, those decisions become
correspondingly less likely to be made.
In developing countries, it is said that good times are bad times for economic reform. Welcome to developing Europe.
Barry Eichengreen is Professor of Economics at the University of California, Berkeley
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