A crisis wasted

By: Wolfgang Münchau

Back in the late 1990, when the euro was introduced, I used to wonder what would happen in a really big crisis? “We will think of something,” is what a senior European official told me at the time. He actually meant it. When something happened, they would change the rules. This is how it always worked in the past. The idea that the euro area was not complete in terms of its economic policy apparatus did not bother this official. It would happen eventually. The priority at that point was to get the project going, and worry about the rest later

And then the crisis came, and not much happened. The European Union failed to produce a joint stimulus, not even a co-ordinated stimulus. The bank rescue programmes were also predominantly national. The only potentially far-reaching anti-crisis response was the De Larosiere’s committee, named after a former French central banker. It proposed greater co-ordination of bank supervisors, as well as the introduction of new macro prudential supervisory system. But the June EU summit effectively buried the most important element of the proposal: No decision should ever be taken to force a government to spend money against its will. This means that all effective power will remain with the member states. Of course, some committees will get upgraded, regulators promise to exchange information, the central banks are trying to fine-tune their crisis-detection alarm systems. But there will be nothing that is not there today – except some new committees.

Europe did something that it has never done before. It wasted a crisis. After the crisis, the euro area will be the same fair-weather construction as before.

The situation has several important implications. I am daring to make a few predictions.

The first is that global financial instability will continue. As the late American economist Hyman Minsky famously noted, financial instability is inherent in the global economy. A lethal cocktail of large financial sectors, globalisation, excessive investment spending produce periods of financial instability. We may be repairing some of the worst excesses of the past system, but we are not repairing the system as such. Regulatory reform in both the US and Europe is somewhere between weak and non-existent. Minsky would not have been surprised by this crisis, and he would probably expect today that this crisis would be followed by another crisis. It will be a different crisis, but the phenomenon of financial instability will persist. But this also means that the weather will continue to be stormy while the euro area remains the same old fair-weather construction that it was before.

My second prediction is that the stability and growth pact, the only effective tool of policy co-ordination at present – will lose its purpose, and will be increasingly superseded by national policies. Germany has already amended its constitution unilaterally to rule out budget deficits higher than 0.35% of GDP by 2016. This effectively means that Germany has introduced a national law to supersede a (much weaker) European law. France and several other European countries will not follow Germany in this direction, as a result of which we should expect to see political tensions among the member states.

My third prediction is that, the Lisbon Agenda notwithstanding, Europe will not return to the rates of economic growth that prevailed before the crisis. Most member states of the euro area still struggle to confront the post-industrial age. Countries like Germany and Italy still cling on to outmoded export-based industrial models. Spain has still not yet found a viable alternative to a model in which economic growth became a by-product of huge real estate price increases. My own guess is that the euro area’s future potential growth may not be much higher than 1 to 1.5%, which compares with estimates of 2-2.5% previously.

My fourth and final prediction is that in such an environment, the future of the euro area will remain in doubt. I am not saying that the euro area will collapse. It would probably not be in any member state’s interest to quit the euro area and adopt a national currency. But the big risk is not so much break-up, but mayhem. The euro area may enter into a permanent semi-depression, not quite bad enough to force countries out, but sufficient bad to lead to very negative economic consequences that remain unsolved.

So when we fail to co-ordinate policy, or accept the principle of a genuine European regulation and supervison for the banking sector, and continue to make a living by exporting more than importing, we will get deeper and deeper into trouble.

During the first ten years of the euro, we lived in the hope that the next crisis would sort everything out. It did not. Perhaps the next crisis will bring the much needed changes. I doubt it. Something will have to give in the long run. We will either have to sacrifice the supremacy of national policy, economic growth and prosperity, or the euro itself. Ten years ago, I would have been certain that we would have sacrificed national supremacy. Today, I am certain that it will be one of the other two.

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