Is Germany egoistic? No, we all are

By: Laurence Boone

The Greek finance crisis and its handling by the EU expose the structural weakness of the eurozone, namely the lack of economic policy coordination, a design error that the member states neglected to fix. It is impossible to accuse Germany to be uncooperative without looking at the bigger picture of European governance. From this perspective we find that all euro countries, in one form or another, have benefited from the common currency without considering what it takes to maintain the quality of this common good.

 

For EMU the only implemented European governance scheme is that of the Maastricht criteria: convergence of inflation, interest rates and public deficits/debts. These objectives have been more or less achieved with the introduction of the euro: the interest rates and inflation converged against those of Germany and France. With low interest rates and a favourable business cycle, public debt and deficits got in line with the Maastricht criteria. But then, rather quickly, the lack of a framework for economic policy coordination in the eurozone meant that each country was to exploit the benefits of the euro to its own advantage:  Low nominal interest rates benefited in particular member countries whose inflation rate was higher than the average of the eurozone and a fixed exchange rate facilitated trade exchange especially for the most competitive countries in the eurozone.

 

In the end the lack of coordination resulted in higher public or private debt in some eurozone countries and a rise in competitiveness for others. In some countries, like Spain and Ireland, with an inflation rate only slightly above the average of the unregulated credit market, the euro encouraged the built up of record levels of private sector debts. Rapid credit growth financed household consumption in a non-sustainable way, which means that it surpassed their capacity to reimburse.

 

In other countries like Greece, low interest rates encouraged the built-up of public debt and thus the financing of a generous social system at reduced costs.  Public deficits and debt rose as a result there.

 

Other countries benefited from the transparency offered by the euro to raise their competitiveness.  This is the case for the German wage moderation. Entered into EMU with an exchange rate, which was often considered to be undervalued, especially together with a tight control on wage growth, Germany was able to steadily improve its competitiveness against other member countries of the eurozone. The loss in competitiveness vis-à-vis Germany in terms of labour costs is of the order of 7% for Greece, 10% for Portugal, 12% for Spain and 20% for Ireland. With the single currency, the exchange rate could no longer correct for such differences.

 

Ireland compensated the relatively high wage costs with low tax rates on companies´ profits, which transformed Ireland into a hub for foreign investments. During the current adjustment period, Ireland pursued a strategy of low wage rises for the public sector, which helped to boost competitiveness without touching the low company tax rate. A winning strategy… at least for Ireland.

 

This all shows that there is a significant lack of coordination among countries which seek their own advantages out of the euro without any long term strategy. The question for the eurozone thus is how to reinforce economic governance? Two factors will be determinant. How to ensure that member states care about their common good, the euro? This leads us directly to the second question of how to force countries to direct their economic policies towards the common objectives. Do we need a common finance base (either in form of a bigger EU budget, a European Monetary Fund or emission of common Euro bonds) and, in this case, what sort of revenues to finance such a base, what tax system? It is the degree of integration of the eurozone countries that needs to be reconsidered.

 

Laurence Boone is Chief Economist for France at Barclays Capital.  The original article in French was published by Le Monde.

 

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