Eurozone's economic troubles are far from over

12/5/2014

By Barry Eichengreen

If we have learned one thing from the last four years, it is that the European Union lacks the capacity to act decisively, writes Barry Eichengreen

This month marks the fourth anniversary of the May 2010 financial rescue of Greece. Previously, the idea that a eurozone member would seek emergency assistance from the International Monetary Fund, along with the European Commission and the European Central Bank, was unthinkable. The rescue thus marked Europe's descent into full-blown crisis.

Four years later, European officials are assuring everyone that the crisis is over. The IMF has raised its forecast for eurozone growth this year to 1.2%. Even Greece is forecast to grow by a modest but not insignificant 0.6%.

Bond markets, too, are indicating that the crisis is over. Yields on Irish government bonds have fallen below 3%. Last month, Portugal was able to issue 10-year bonds at 3.57%. Even Greece has been able to sell five-year bonds at rates below 5%.

Clearly, the supposed experts who predicted the imminent disintegration of the eurozone have been proved wrong. But it is equally likely that those now declaring that the crisis is over will be proved wrong as well.

If we have learned one thing from the last four years, it is that the European Union lacks the capacity to act decisively. With 28 member countries, decision-making processes are tedious and time-consuming. Common interests are difficult to define, making burden-sharing agreements difficult to reach. Action is regarded as more urgent in some quarters than in others.

Moreover, the patient is far from cured. Ireland, Portugal, Spain, and Greece have made considerable progress in lowering their unit labour costs to 1999 levels relative to Germany. The problem is that 1999 levels are not enough, because producers now have China and other emerging markets with which to contend. Italy and France, meanwhile, have made considerably less progress on improving their international competitiveness.

Nor is it clear where the crisis countries will find the demand that they need. With domestic spending subdued, they have been relying on exports. But now that growth in emerging markets has slowed, their export markets are weakening. Spanish exports, on a positive trend until recently, have stopped rising. And Spain may be the proverbial canary in a coalmine.

The ECB, for its part, continues to do too little to support demand. It has been behind the curve since 2011. If it finally turns to quantitative easing in June, it will take only baby steps down this path, because ECB President Mario Draghi and his team remain reluctant to embrace the kind of radical measures that would shock their political masters.

On the budgetary front, the new French and Italian prime ministers, Manuel Valls and Matteo Renzi, respectively, have proposed cutting taxes for low-paid workers and their employers. This is a positive step toward addressing the plight of those who have suffered the most from the unemployment crisis. But Valls and Renzi also plan to cut spending to prevent their budget deficits from rising, which means that their initiatives will not boost demand.

Meanwhile, Europe's banking crisis is unresolved. Loans to finance fixed investment continue to fall. Remarkably, the European Banking Authority's latest stress test for the eurozone's banks does not contemplate the possibility of deflation in its adverse scenario. The implication is clear: the banks' capital shortfall will be understated, and the amount of new capital they will be required to raise will be inadequate. If the goal is to restore confidence and get the banking system firing on all cylinders, this is not how to go about it.

And everyone knows that Europe's much vaunted banking union is deeply flawed. It creates a single supervisor, but only for the largest banks. It harmonises deposit-insurance coverage but does not provide a common deposit-insurance fund. The resolution mechanism for bad banks is incomprehensible and unworkable. The associated resolution fund will possess only €55bn (£44bn) of its own capital, whereas European bank liabilities are of the order of €1tn.

Finally, there is that pesky matter of public debt, which is still 90% of eurozone GDP. European officials propose to work this down to their target of 60% over a couple of decades. You read that right. Check back to see how they've done in 2034.

All of this has the makings of a dismal prognosis. But it is how Europe progresses. Its banking union may be flawed, but at least it exists, and over time those flaws can be fixed. The stress tests may be flawed, but at least they are better than Europe's two previous attempts. ECB action this summer may underwhelm, but at least the eurozone's monetary-policy officials will do something.

The eurozone will not collapse this year, but its troubles are far from over. Europe will not draw a line under its crisis. Decisiveness is not the EU way.

• Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley.

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