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Bailouts and Austerity Measures Aren’t Working: Is This the Euro’s Last Stand?
Monday 28 November 2011
By Michael Schuman
Who has time for pleasantries when the fate of Europe and the global economy is at stake? After Mario Monti, an economist with little experience in the rough world of Italian politics, was sworn in as the country’s new Prime Minister on Nov. 16, German Chancellor Angela Merkel sent him a congratulatory letter that minced no words. With Italy, the euro zone’s third largest economy, gripped in a debt crisis, Europe was counting on him to repair his country and save the euro from disaster. "There are many hopes and expectations set on you," she wrote. "It would behoove you and your government to decide upon and implement decisive and significant reforms."
Monti is committed to doing his best. On Nov. 17, he told Italy’s Senate he’d slice the national budget and introduce progrowth reforms. "We can’t be considered the weak link of Europe," Monti warned. But even if Monti lives up to his nickname — Super Mario — the crisis roiling the euro zone has become far too big for Monti, or even Italy, to solve on their own. What Monti needs most of all wasn’t mentioned in Merkel’s letter — much greater cooperation among the members of the monetary union and significant changes to the euro zone. The only way to save the euro is to forge a renewed monetary union based on much deeper integration. "There is no way around it, if we want to avoid the euro breaking apart," says Sigmar Gabriel, the chairman of Germany’s Social Democratic Party. (See more on Monti.)
Virtually everyone in Europe, if not the world, agrees. At their many conferences and summits throughout the two-year debt crisis, Europe’s leaders have routinely insisted that further coordination is the best solution. "We are indeed now facing a truly systemic crisis that requires an even stronger commitment from all," José Manuel Barroso, president of the European Commission, said on Nov. 16. Merkel expresses similar sentiments. As Italy tumbled into crisis, she called for "more Europe, not less Europe" to protect the euro.
But "more Europe" has come slowly and grudgingly, and crucially, there is no consensus among the zone’s varied members on what, exactly, "more Europe" means or how to bring that goal to fruition. Many insist that euro-zone countries must inevitably give up more autonomy over national policies and take greater responsibility for the problems of their fellow members. But others, particularly in Germany and other more stable countries, don’t necessarily see things that way, and have been reluctant to take drastic steps. As a result, a continent-wide wrestling match has broken out over who should bear the burden of rescuing the euro and what that critical balance between state and union should be. How much money and sovereignty should nations sacrifice for the greater good? The survival of the euro, and the dream of a peaceful, united Europe it symbolizes, may depend on that question. (See pictures of the protests in Greece.)
Separated at Birth
What’s paralyzing Europe is a flaw buried deep within the monetary union’s structure — the unresolved conflict between the needs of the euro and the independence of its members. When the euro launched in 1999, critics pointed out that the monetary union was, in fact, only half a union, and thus susceptible to failure. The 11 original members surrendered their national currencies and control over monetary policy to the European Central Bank (ECB) but retained their power to tax, spend and borrow. With no overarching political authority, the individual states of the zone could easily march off in vastly different economic directions, tearing the monetary union apart. To prevent that from happening, all members were supposed to adhere to rules to keep their financial positions roughly the same. Budget deficits weren’t to exceed 3% of GDP, and government debt 60%. That didn’t work. Few members followed the rules strictly. (Even austere Germany violated deficit limits.)
As more countries joined the union — there are now 17 — the inequalities between their economies grew. Some, such as Greece and Portugal, used the luster of euro-zone membership to borrow at lower interest rates than they could have received otherwise, building up ever higher mountains of debt. Meanwhile, a core of more disciplined countries, led by Germany, controlled spending, reformed their economies and became more competitive in global markets. This schism went unchecked. Twelve years after its founding, there were in fact two euro zones — one of relatively healthy, competitive economies, mainly in the north, and another of slow-growth, indebted, uncompetitive countries, primarily in the south. Instead of fostering a greater convergence of Europe’s economies, the euro had brought about dangerous divergence.
(See "Europe’s Debt Crisis Agreement: The Good, the Bad, the Ugly.") All those years of avoiding these problems exploded in late 2009, when Greece first toppled into a debt crisis. The euro zone tried to stanch the problem with a $150 billion bailout for the country in May 2010, but with investors aware that Greece was just the first of several countries with potentially unsustainable debts coming due, that did nothing to squelch the contagion. By this summer, Ireland and Portugal had collapsed into bailouts as well, while Italy and Spain, both core members of the union, were at risk of default. The leaders of the euro zone have pressured these countries into gut-wrenching austerity and reform programs to stabilize debt levels and cut deficits, hoping such reforms could fix their finances, rebuild investor confidence and save the euro.
That strategy has failed. Investors aren’t convinced Europe’s politicians have the will, ability or political clout to push through such excruciating fiscal adjustments, at least not in any reasonable period of time. Research firm Capital Economics figures that even with reform, Italy will still need two decades to get its government debt level down to a more sustainable 100% of GDP from 120% today. The severe budget cuts Greece, Spain and Portugal have enacted have dampened growth, making the process of raising revenue and closing deficits even more difficult, all while generating widespread public resentment.
Meanwhile, assistance from the rest of the zone has been offered reluctantly. The euro zone formed a $1 trillion rescue fund called the European Financial Stability Facility (EFSF), backed in part by guarantees from its members, to provide emergency bailouts while troubled economies mend their ways. But as the crisis has spread to giants like Italy, the EFSF has become too small to be a credible euro defender. Euro-zone leaders, fearful of exposing their taxpayers to further potential losses, have resisted enlarging it. Instead, they’ve gone begging to China and other emerging economies, hoping to woo them into donating cash. (See why there is no joy in Greece over the E.U. deal.)
Other euro-zone agreements have also drifted. A second bailout of Greece, approved in July, has been held up by political bickering, while a plan to boost the firepower of the EFSF has faltered. Frustration with this lack of action is building. "Where is the implementation of these long-standing decisions?" asked ECB President Mario Draghi in a Nov. 18 speech.
Much More Europe, Please
Marshaling the might of the entire euro zone — a $13 trillion economy — could provide an extinguisher powerful enough to put out the debt fire. That’s why Italy and other weak economies need not platitudes about "more Europe" but measures more sweeping than anything seriously being negotiated within the euro zone right now.
One such measure could be the introduction of a eurobond — a bond jointly backed by all euro-zone governments. Under such a scheme, euro-zone countries could issue eurobonds in place of regular national bonds, with certain limitations. Since they’d have the entire financial heft of the zone behind them, Italy, Spain and other weakened countries would be able to borrow at lower interest rates, alleviating the crisis.
Many economists also believe that the euro zone should move closer to a fiscal union, with more centralized control and coordination over the power to tax and spend. The zone has stabbed in that direction. A new process began this year in which national governments must submit their budgets in advance for review at the European level. But that’s just a baby step. Former ECB president Jean-Claude Trichet envisioned the creation of a euro-zone Ministry of Finance, with the authority to oversee national budgets and other economic policies. "A tighter fiscal union would help to calm market concerns," says John Chambers, chairman of the sovereign-ratings committee of Standard & Poor’s. "If that doesn’t happen, what’s next? You could have a long slog."
Better central control would only solve part of the euro zone’s problems, however. The root of the crisis is built into the nature of the union itself. Though they all use the same currency, the varied members of the euro zone have very different labor costs, levels of productivity, financial systems and other factors. Some countries are internationally competitive and, like Germany, amass big external surpluses; others, like Spain, are not and run record deficits. If Europe’s debt-heavy economies are to escape the crisis, these gaps need to be minimized. That will require reform not only in deficit nations — deregulation that will make labor markets more flexible and spur competition — but also in surplus countries. Germany, for example, could reform its less efficient, domestically oriented service sectors to create better-paying jobs, boost consumption and buy more from its struggling neighbors. (See pictures of the global financial crisis.)
Austerity measures, improving competitiveness and creating a more unified euro zone all take hard work, tough decisions and painful sacrifices. It is an easy and popular media jab to assail Europe’s leaders for not showing leadership at crucial moments, but they have already taken steps toward greater integration that were unthinkable before the debt crisis began — like the whole notion of bailing out euro-zone members. And there are structural reasons sweeping reforms can be so halting: all members have to approve any changes in euro-zone policy, meaning any one country, no matter how small, can upend any change at any time. Europe’s national leaders, furthermore, derive no power or legitimacy from the European Union. They are beholden only to their voters back home, and sacrificing money and power to the zone aren’t necessarily vote getters. That’s because, to a great degree, Europeans — whether from the 17 countries of the euro zone or the 27 within the broader E.U. — don’t seem convinced that the grand experiments they have embarked upon are worth it.
Governments in Greece and Italy have already fallen attempting to implement unpopular austerity budgets, and Spain’s ruling party just got voted out of office in part because of the tough reforms it inflicted on the sagging economy.
While the euro enjoys widespread support, spending more money to save it doesn’t. Residents of rich countries like Germany resent seeing their hard-earned cash diverted to rescue Greeks, perceived as irresponsible, and Merkel and other politicians can ignore such sentiment only at their own peril. Recent polls show that more than half of Germans reject eurobonds, while 59% oppose further bailouts of euro-zone countries. (Is it a coincidence, then, that Merkel has steadfastly rejected the idea of eurobonds, labeling them "absolutely wrong"?) The French are only slightly more generous, with just under half against bailouts.
Euroskeptic political movements are capitalizing on ire over the debt crisis to gain more influence. In the Netherlands, the anti-euro Party for Freedom is gaining popularity; its chief, Geert Wilders, who has called the euro a "failed project," recently launched an investigation into the possibility of exiting the union. These movements are already influencing euro-zone policy. The success of the True Finns in national elections earlier this year turned tiny Finland into a big problem for the euro zone. The party’s antibailout stance led the country to demand collateral as part of the second Greek rescue, which undercut the entire plan. Even more mainstream parties are growing weary of euro-zone commitments. Merkel had to overcome a revolt from within her own coalition against expanding the power of the EFSF in September.
Such political resistance has left Europe’s leaders with few options. Some European politicians see the ECB as the only remaining institution with the financial muscle and credibility to save the euro. They’re advocating that the ECB become the lender of last resort by purchasing Italian, Spanish and other beleaguered bonds on a massive scale to bring down borrowing costs and buy time for these countries to reform themselves. "In the absence of ECB intervention," HSBC chief economist Stephen King recently commented, "the euro simply will not be able to survive." Yet this idea too has met fierce opposition. No less a figure than Draghi has strongly resisted the idea. Though the ECB has intervened to buy bonds on a small scale, Draghi believes a massive bond-buying program would undermine the bank’s credibility and violate its mandate. (See the Top 10 Things You Didn’t Know About Money.)
In the end, the only way to save the euro is for a new euro zone to emerge, one in which its politicians and citizens are more willing to sacrifice their own interests for the greater community — to make the dream of a united Europe more than a dream. Sadly, as the debt crisis widens differences within Europe and exacerbates social and political tensions, that dream seems further away than ever. At some point, though, Europeans will have to make the fateful choice between national sovereignty and the euro’s well-being. "It is time for a breakthrough to a new Europe," Merkel told her party’s annual conference in November. "The task of our generation is to complete economic union and to build political union in Europe step by step." Now is the time for the next step, or all of Europe may fall over.
— with reporting by Henning Hoff / Berlin, Leo Cendrowicz / Brussels and Bruce Crumley / Paris This article originally appeared in the Dec. 5, 2011 issue of TIME Europe. Is it time to admit the euro has failed? See 25 people to blame for the financial crisis.