Whether ‘S’ Stands for System or for Spain will Decide Future of the Euro

by Ferdi De Ville

Since long, discerning observers have argued that Spain, not Greece (or Ireland or Portugal for that matter), would be the real test for the euro. Now, this moment has arrived. The question is whether decision makers will again argue that the troubles in Spain are a Spanish problem that it has to solve them in exchange for temporary support, or if eurozone leaders will finally recognise that the euro crisis is a collective responsibility that can only be solved through collective adjustments and action.
What is happening in Spain is the inevitable deleveraging-recession-deflationary spiral coming to a head. The origins of the Spanish problems are a massive real estate bubble that inflated during the 2000s and burst after the global financial crisis erupted in 2008. While Spain was a fiscal model before 2008, the implosion of the property market has throttled the state. Its fiscal position has been tackled from all sides. First, an important source of government income in the form of property taxes has diminished. Second, with the mind-blowing rise in unemployment (especially among the recently graduated and former construction workers), income from taxes on labour has dropped and expenses on unemployment benefits soared. Third, the government has to support banks that suffer from a high percentage of failing loans. Fourth, the (federal as well as regional) government is faced with prohibitively high interest yields to refinance outstanding debt and finance deficits.
Under pressure from the financial markets and from new eurozone agreements made in the past two years, the Spanish state has already taken significant austerity measures. However, as in other countries trying this recipe (and as always in history apart from some very specific exceptions), this only makes things worse. The economy sinks deeper because on top of private deleveraging also the government is tightening the belt, and unemployment increases further. This only exacerbates all the fiscal pressures. Unemployed people are unable to repay their loans, affecting the banks. They do not contribute to but have to live from the government budget. The financial markets rightly believe that this cannot endure and, consequently, retreat.
The only way out of this trap is to relax austerity, focus on growth and employment and bring down the financing costs. None of this Spain can do on its own. Its eurozone partners have to agree to give it at least five years time before focussing on fiscal balancing. Northern countries with fiscal space and a low unemployment rate should be prepared to undertake fiscal stimulus and accept temporary higher inflation to allow the periphery to grow their way out of this crisis. And they should at least accept the mutualisation of the part of the debt that is the legacy of the crisis (not necessarily future debt).
The reason why all of these measures that had been proposed since long by an increasing number of observers have not (yet) been taken, is that most of the politicians in the northern countries have not yet recognised that the crisis is a collective responsibility or at least do not dare to say so in public. There are several reasons for this lethal deception. First, there is the ‘Greece effect’. The eurozone crisis started in Greece, where in contrast with other countries that are now in trouble a large responsibility for the crisis is fiscal mismanagement by the government. Because this has –on top of sometimes outrageous overstatement and stereotyping in the case of Greece– wrongly been generalised to other peripheral countries, these have also been treated as if they had justly been punished for their own sins. Second is the opposite believe, especially in Germany, that the AAA countries deserve their rewards and should certainly not be asked to pay for the sinners’ Schulden. They have made painful sacrifices after the introduction of the euro for which they are now compensated and if the southern countries want to further enjoy the benefits of eurozone membership they should be prepared to make the same adjustments. Third is a cultural inclination in stability-oriented countries to refrain from helping troubled countries through fiscal and monetary stimulus because this would encourage moral hazard and lead to inflation and, thus, instability.
The creditor countries thereby fatally overlook their own responsibility for the current crisis. As the crisis has to a large extent been caused by a systemic design error, they are, as ‘fathers’ of this system, just as responsible for its crash as the debtor countries. Similarly, everybody recognises that the current problems are the consequence of reckless (private and public) borrowing. But for every euro of reckless borrowing some reckless lender has been the counterparty. Besides this collective responsibility for the (systemically induced) inappropriate capital flows, deflationary reforms made by Germany (through the Hartz Gesetze) and others are not guiltless either. In a monetary union, individually increasing competitiveness through wage and price restraint is just as collectively harmful as irresponsible fiscal policies.
Only if northern politicians quickly recognise their own countries’ co-responsibility for the crisis, explain it to their populations, and act accordingly, does the euro stand a chance of survival. If, conversely, the narrative will again be that the crisis is a Spanish problem –caused by (the close relationship between) corrupt bankers, politicians and property developers, by its structurally weak labour market and by megalomaniac and irresponsible regional governments– that has to be solved first and foremost by Spain itself, it will very soon be game over for the euro.

Dr. Ferdi De Ville is assistant professor at the Centre for EU Studies, Department of Political Science, Ghent University where he teaches and writes on economic and monetary union and the euro crisis.