Now that the euro has bankrupted Greece and pushed Italy and other Mediterranean states to the brink, Angela Merkel proposes tough, EU-administered disciplines on national deficits. Those would thrust the Mediterranean states into decade-long recessions without fixing flaws in the Eurozone architecture that caused all the borrowing and crushing debt in the first place.
At the end of 1998, wages, prices and government bonds were converted from national currencies into euro according to prevailing exchange rates. To the extent those rates reflected market prices, the euro adequately priced labor, exports and public debt across borders.
Unfortunately, among the 17 members of the currency union, labor market policies, social programs, and industrial policies are separately established and financed, and vary much more than among the 50 states in the dollar zone. Specifically, union and worker protection rules are federally enforced in the United States, the 50 states don’t own big chunks of industrial enterprises, as do German Landers, to build exports and block outsourcing, and Social Security and Medicare/Medicaid are federally financed.
Owing to significant differences in labor-market and industrial policies, investment and productivity grew more rapidly in Germany and other strong northern economies, and labor and exports became overpriced in Italy and other now troubled southern economies.
Generally, the European Central Bank permitted the euro to float, and its value against the dollar yen tends to reflect wages, productivity and economic strength of the 17 Eurozone countries as a whole. Consequently, the euro is undervalued for the German and other northern economies, making them export juggernauts, and woefully overvalued for Italy and other Mediterranean states, imposing on them chronic trade deficits.
In the South, imports chronically exceeding exports created huge holes in demand for domestic goods and labor, and deprived national governments of tax revenues. Huge budget deficits became endemic to prop up employment and finance social programs.
The terrible debt now burdening the balance sheets of Mediterranean states is the direct result of flaws in the architecture of the Eurozone—the absence of unified labor market regulations, genuine limits on mercantilist industrial policies, and a fiscal regime to finance benefits for seniors, health care, unemployment insurance and the like. Chancellor Merkel’s disciplines on member country budgets won’t fix those imperfections.
Recently, I discussed these issues with Peter Altmaier, chief whip of the Christian Democratic Union. He advises that Italy and others adopt German reforms. That’s puzzling.
Germany’s economic strategy is substantially based on an undervalued currency, institutional constraints on outsourcing and amassing huge trade surpluses. As one country’s trade surplus must be another country’s trade deficit, not all European states can simultaneously accomplish Germany’s mercantilist alchemy and resulting growth.
Austerity and EU supervision of member country finances won’t make troubled states more competitive, but it will leave them woefully uncompetitive and unable to finance health care and pensions, even at levels below those acceptable to most Germans. And, those policies won’t enable troubled governments to pay their debts.
As things stand, labor and exports are overpriced across the Mediterranean states, and their economies must endure tortuous recessions, lasting a decade or more, to push down wages to competitive levels—but such deflation may not be enough.
Draconian austerity would leave those economies with insufficient public infrastructure and outdated private capital, and no matter how much wages fell, those handicaps would keep productivity too low for exports to be competitive.
To pay foreign debts, Mediterranean states must earn euro by exporting more than importing, and they must accomplish budget surpluses. However, such feats would require Germany and other northern countries to endure trade and budget deficits—Germany and others are not likely to come to recognize that requirement easily or happily.
What Merkel prescribeswould institutionalize German economic dominance—Germany and other northern states get the exports and Italy and other southern states get the imports, the former makes loans to the latter to paper over the imbalance, and in the end, Germany, as the principal creditor state, controls the EU Commission and debtor states, just as Berlin now calls the shots at the ECB.
To make the euro work, austerity and budget disciplines on southern countries must be complemented by EU-wide regulation of labor markets, genuine disciplines on beggar-thy-neighbor industrial policies and a substantial EU wide value-added tax—matched by comparable reductions in national levies—to finance a Eurozone-wide Social Security and health care systems.
That’s a tall order, but without those reforms, a single currency is more than Europeans can expect.
Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.