Europe’s Poisoned Chalice of Growth
CAMBRIDGE – After a double-dip recession and an extended period of stagnation, the eurozone is finally seeing green shoots of recovery. Consumer confidence is rising. Retail sales and new car registrations are up. The European Commission foresees 1.3% growth this year, which is not bad by European standards. But it could be very bad for European reform.
It is not hard to see why growth has picked up. Most obviously, the European Central Bank announced an ambitious program of asset purchases – quantitative easing – in late January. That prospect rapidly drove down the euro’s exchange rate, enhancing the international competitiveness of European goods.
But the euro’s depreciation is too recent to have made much difference yet. Historical evidence, not to mention Japan’s experience with a falling yen, suggests that it takes several quarters, or even years, before the positive impact of currency depreciation on net exports is felt.
So other factors must be at work. One is that spending and growth are now under less pressure from fiscal consolidation. The structural primary budget balance, the International Monetary Fund’s preferred measure of “fiscal thrust,” tightened by an additional 1-1.5% of GDP each year from 2010 to 2012, after which it remained broadly stable. The subsequent two years of neutral fiscal policy has made a positive difference for economic performance.And, however regrettable the uneven application of the EU’s fiscal rules, the European Commission’s recent decision to give France more time to reduce its budget deficit to 3% of GDP is welcome, coming as it did against the backdrop of a weak economy.
Another factor behind the upturn is the meaningful progress that a number of European countries, such as Spain, have made on structural reform. Labor-market regulation has been loosened, and unit labor costs have come down. This, too, is showing up as further improvement in Europe’s competitiveness.
A third driver of recovery is the fact that banks and financial markets are now better insulated from the turmoil in Greece. French and German banks have been able to sell their holdings of Greek government bonds, largely to the ECB, which has acted as bond purchaser of last resort. The ECB has also promised to support other countries’ bond markets in the event of a Greek accident. Hence Europe’s recovery is less at risk of being derailed by instability in Athens.
Fourth and finally, even dead cats bounce.
Economic growth heals many wounds. It strengthens banks’ balance sheets by reducing the volume of non-performing loans. It narrows government budget deficits by increasing tax revenues and limiting welfare spending. By raising the denominator of the debt/GDP ratio, it enhances confidence in debt sustainability. And it produces these benefits automatically, without officials having to do anything more.
Unfortunately for Europe, growth also reduces the perceived urgency of action where action is urgently needed – for example, Greece. With the rest of Europe growing, other governments, believing themselves to be in a stronger economic position, are less inclined to compromise with Greece. Everyone understands that compromise is preferable to the collapse of negotiations, disorderly default, and Greece’s forced exit from the eurozone. But the more confident the rest of Europe becomes of the sustainability of its recovery, the more it adopts a hard line – and the more likely a disorderly denouement becomes.
Similarly, the more that recovery and sustained growth strengthen banks’ balance sheets, the less urgency policymakers feel to address structural shortcomings, such as the implicit guarantees enjoyed by state banks and municipal savings banks in Germany, and the problems of family-controlled banks like Banco Espirito Santo in Portugal.
And even 2% growth will not render Europe’s triple-digit debt/GDP ratios sustainable. Europe still needs debt restructuring, though the continent’s leaders refuse to acknowledge this. Economic recovery merely enables them to delay the inevitable day of reckoning.
Finally, there are the more ambitious reforms – fiscal union and political union – that must complement monetary union if Europe is to avoid a similar crisis in the future. If there is one lesson to be learned from Europe’s recent travails, it is that monetary union without fiscal and political union will not work. Yet, given intense opposition to further fiscal and political integration, progress, if it is to occur, will entail difficult and divisive negotiations. So any European growth that occurs without these measures will create an incentive to put them off.
The problem, quite simply, is that many of the underlying conditions that produced the eurozone crisis remain unaddressed. If Europe now grows without making the hard decisions needed to address them, those decisions become correspondingly less likely to be made.
In developing countries, it is said that good times are bad times for economic reform. Welcome to developing Europe.
Copyright: Project Syndicate, 2015.
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