Costs and Benefits of the Euro

By Rainer Emschermann

Germany does it again: After two world wars, it is again trying to dominate Europe, this time by forcing the eurozone under its economic tutelage. While it was ok for eurozone countries to buy German products and boost German growth during the last decade, Germany is now refusing solidarity with its customers who are struggling to pay the bill. The austerity imposed on southern Europe will starve off southern European industry and perpetuate German economic and political dominance over the continent. Is the Euro’s hidden agenda finally coming to light?

Hang on a minute! What may be accepted facts in the European debate may not quite live up to closer scrutiny. To begin with, opinions differ about the reasons behind the introduction of the euro. Most Germans were perfectly happy with the Deutschmark, which had provided a stable currency and consequently low borrowing costs for the industry, which was envied by those not in the DM-Zone. While it would go too far to say that the euro was the price Germany had to pay for re-unification, the simultaneousness of the decision for monetary union (EMU) is also more than a coincidence. For the German elites, the deeply unpopular new currency was a way to more firmly anchor the bigger Germany in the EU.

Now let’s take a look at the distribution of costs and benefits since the introduction of the Euro. Once the EMU was decided, financial markets anticipated the event and interest rates for Italian, Portuguese, Greek and Spanish bonds dramatically converged towards the German Bund. Public budgets experienced huge windfall gains through lower borrowing costs.

Lower interest rates in Southern Europe fuelled an economic boom: Between January 2001 and December 2009 Ireland grew by 30%, Greece by 29%, Spain by 21%, while Portugal (+5.5%) and Italy (+1.5%) could not transpose these gains into growth. On the other hand, also Germany (+5.4%) stagnated during this period, as much capital left for southern Europe. And the euro appreciated considerably since its introduction; still today it is more than 30% above its initial value against the dollar. However, Germany’s red-green government introduced reforms that led to strengthening its competitiveness. It is fair to say that while Germany adapted gradually to globalisation, necessary reforms were delayed in Southern Europe due to the windfall benefits from EMU.

The result was massive current account imbalances of southern European countries, joined by France. This means that the current discourse describing the crisis as ‘cyclical’ is dangerously euphemistic, as it ignores the structural problems of the region. The countries in question simply need to import less and export more. Fiscal stimuli by the EU would counter-act the necessary burst of the bubble. Youth unemployment in Spain for example has always been high, even during boom years. Its causes lie in the unfair distribution of opportunities between (older) employees and the (mostly young) unemployed. Such issues are to be addressed by Ordnungspolitik, not by throwing money at the problem. Or take the fact that Greece’s public sector has still not been reformed, the real economy not sufficiently opened to allow for a new entrepreneurship. Additional public investments can help soften the landing, but not address the root causes of the crisis. Eurobonds would provide more of the artificially cheap money which has delayed the real adaptation of the economies in the first place. Their joint liabilities clause would leave the health of more solid countries´ public finances entirely to the hands of the reform mood of the laggards.

So has Germany been the main beneficiary of the internal market and the euro? The simple economic fact is that the smaller an economy the bigger its benefit of joining the internal market. To take an extreme example: Luxemburg and Germany forming an economic union opens the huge German market to Luxemburg, while it doesn’t really change much for Germany. Moreover, since the year 2000, the share of the eurozone in total German exports has diminished from 48% to 41%. This is not to say that Germany does not benefit from the EU and the Euro. But it is wrong that, economically, it benefits more than others. Today it is easy to imagine that Germany, maybe together with some of its neighbours, would remain a global player even without the EU. But where would Spain be, where Portugal?

At the same time, the rules of the EMU do not reflect economic strength at all. Only a single one of the 6 members of the ECB´s Executive Board comes from an AAA rated country, Germany. The others are from Italy, Portugal, Spain, France and Belgium. Countries in distress can thus impose their monetary policy interests on the whole Eurozone. The massive purchase of sovereign debt on secondary markets and the more recent liquidity glut for banks – though both justifiable if limited emergency measures – are a case in point.

Overall, however, this amplifies the erosion of trust in the EU that can be observed in Germany, Holland, Finland and Estonia. This erosion of trust started when the explicit no-bail out clause of the EU treaty was broken in May 2010 after threats by President Sarkozy that otherwise France and some southern European countries would leave the eurozone. German governments were of course not at all innocent in the demise of the stability pact. But no matter if forced about by circumstance or political will – the violation of the Treaty’s no-bail-out rule means that for the first time in EU history a constitutional deal between the peoples of Europe has been broken. This is like abandoning the EU´s agricultural policy over a weekend – only that agriculture amounts to less than 2% of France’s GDP while by now each of the Eurozone countries has agreed to guarantees amounting to a quarter of their GDP, and rising. For ordinary Germans, the gains and benefits of the euro – and that is easily translated into ‘Europe’ – look disastrous: after ten economically difficult years, part of the rescue packages may have to be written off, price stability is in jeopardy and monetary policy is controlled by countries with different agendas. And, adding insult to injury, Germany has become Europe’s bogeyman.

Meanwhile Germany’s centre-left opposition is demanding further and more permanent contributions from its citizens, thus heavily borrowing against the EU´s fast diminishing political credibility. Still haunted by the ghosts of Germany’s past and badly wanting to represent the ‘good Germany’, it over-stretches the EU´s political credit and risks provoking a backlash against its institutions, Europe’s biggest post-war achievement. That is not what a sustainable European policy looks like. Ultimately, it is not laws, institutions or eurobonds that make EU integration last, but public support.

But what, then, is the way out of the crisis? Well, Greece is all but formally defaulted; much of its debt will have to be written off. Member States – in the ECB´s stead – should contribute to the debt reduction.

There should be no more fudging with fake “loans” which turn sour and decrease the public’s trust in politicians all over Europe. A “firewall” needed which will protect Spain and Italy against contagion from Greece and, possibly, Portugal. But this firewall is not identical with the money put up by governments, but it has to be convincing for the markets, otherwise it fails. And financial markets are markets of expectations: the same signals can be achieved by credible reforms today can lead to immediate discounts on interest rates – as the example of Italian reforms has shown. Still, the public debate’s obsession with rescue packages instead of reforms doesn’t bode well for the future of the Euro.

The crisis is as much a political crisis as an economic one. This is also illustrated by the fact that Spanish and Italian bond spreads over the Bund are today quite similar they were before the introduction of the Euro; it is just the adaptation to that status quo ante that – very understandably – hurts by squeezing public budgets. The current discussions are thus really about throwing around a hot potato between Europe’s politicians – the potato of who is to convey the bad news about the bubble that has burst and the harsh reforms that are necessary.

This is why the idea of putting the Greek budget under EU supervision was so ridiculous. It was not because the democratic core principle of “no taxation without representation” is no longer valid. But the argument is not about legitimacy; Europe is not a normal democracy but has different political realities and demoi which demand respect. Greece cannot be forced to do what is necessary. This is also why the crisis must not be seen as the founding moment for a fuller European fiscal federalism. And finally, this is why the Fiscal Compact is so counter-productive as it attributes the role of valuating a country’s public finances to politicians (who, including of course the German government, may ultimately collude for their own short-term benefits) rather than leaving it with – admittedly, equally imperfect – financial markets or with new, more independent rating agencies.

Germany’s current strength does not come for its own merits but by the default of a 2-year-long reluctance of Southern European countries to balance their current accounts in earnest. This has pushed Germany into an unwanted – because expensive – leadership role, which it has always been and will always be too weak to fill out alone – and even less to dominate the continent. Its elites are mostly lawyers and business folk; its government is sorely lacking macro-economic guts and nerve to lead Europe out of the crisis. For all these reasons, and being German myself, I hope that the Spanish and Italian governments will get their houses in order so as to take back their place as equal partners. As the example of recent reforms in Italy shows, this lies first and foremost in their own hands.

Rainer Emschermann is an economist and lives in Brussels.