The eurozone can make a rules-based monetary system succeed
The eurozone is widely viewed as a failure, held together only for political reasons. This, it is said, has been proved by the financial crisis and the failure to manage the debt problems of governments in southern Europe. At least, that is the dominant view among the Anglo-Saxons; one searches far and wide for a favourable verdict.
Yet adjustment is taking place. Bit by bit, imbalances are being reduced. Some peripheral economies have moved into surplus – Spain, Portugal, even Greece are in balance. The net foreign asset position is gradually being stabilised.
Ah, comes the retort, this all comes from import suppression – a drop in demand for imports due to austerity. This is partly true but is not the whole truth; e.g. Spanish exports have been growing healthily for two years. It is not all due to a fall in imports.
Also, relative prices are adjusting. The squeeze on domestic demand is reducing unit labour costs in the periphery. What is disappointing is that lower labour costs have been slow to translate into lower export prices. Profit margins have been widening – possibly reflecting a lack of adequate competition in certain product markets. Debtor countries have done quite a lot on labour market reform but much less on liberalising product markets.
The media boil it down to a simple story about “austerity” and the “straitjacket” of the fixed exchange rate system of the eurozone. To be sure, the short and medium term effects of stabilization policies on employment have been negative but that is not the full story:
First, it is wrong to assert that government finances are not improving; they are. Governments must continue the consolidation and will gradually reap the benefits. It was essential to bring down public debt ratios to retain investor confidence and restore a sustainable position.
Second, while there is still a long way to go, the major part has already been done; for example, if you set as a target a 60% debt to GDP ratio, even Greece has made considerable progress towards it. The people of these countries have not suffered in vain. Indeed, most of the needed consolidation of public finances has been achieved. How often is this reported in the press?
Thirdly, the cost of borrowing for capital investment has come down considerably, in the peripheral countries, from crisis peaks. True, Greece faced very difficult conditions because its economy is not open (by contrast with that, say, of Ireland). Ireland has done well but it is not fair to take it as a model country as its starting point, pre-crisis, was much better than that of others. The causes of the shock were different – it was not initially a government debt crisis.
The peripheral countries of the eurozone have implemented structural reforms in products and services such as transport. They are much more competitive.
Moreover all these countries are moving into surplus despite the fact that Germany’s surplus has not declined, as its net exports to non-EU markets have soared.
Even the IMF projects growth rising from 1 percent in 2014 to 1.4 percent in 2015, though the pickup is expected to be more modest in economies under stress, despite some upward revisions including Spain. High debt, both public and private, and financial fragmentation will hold back domestic demand. However, exports should further contribute to growth.
It will be interesting to see whether, in the end, the countries of the much-maligned fixed rate system of the eurozone have achieved adjustment at greater, or at less, cost that the United Kingdom with its famous floating pound and its famous central bank and its wonderful set of superior commentators and central bankers giving thanks that “we” have escaped “their” fate. All one may note at present is that the UK’s productivity performance continues to be poor, the external deficit is widening, fiscal consolidation still has a long way to go, and the Bank of England may after all be the first to raise rates.
In The Money Trap, I argue for the adoption of a fixed rate system among leading currencies. I do not need to be told this is out of the question politically at present. But the economic arguments are not as clear cut as many assume. Economists who point to the experience of the eurozone as showing such a reform to be a nonsense may need to reconsider.
The eurozone’s experience with such a system, which after all has been the historical rule makes it an interesting laboratory with potentially wider application. The government of China will be among those watching the outcome with interest. For what the Chinese – and many other peoples – want above all is something the present monetary system does not, and cannot, supply: monetary stability.
I would not be surprised to see the eurozone come out of this in better shape than other developed economies, with the euro joining the RMB in challenging the international role of the dollar; though it may take 10 years.