The Ancient Roots of EU Problems
Il Sole 24 Ore just published an editorial I wrote with Jean-Luc Gaffard, on the structural problems facing the EU. Here is an English (slightly longer and different) version of the piece:
It is hard not to rejoice at the ECB announcement that it would buy, if necessary, an unlimited amount of government bonds. The Outright Monetary Transactions (OMT) program is meant to protect from speculation countries that would otherwise have no choice but to abandon the euro zone, causing the implosion of the single currency. As had to be expected, the mere announcement that the ECB was willing to act (at least partially) as a lender of last resort calmed speculation and spreads came down to more reasonable levels.
The decision is not uncontroversial. Mario Draghi has certainly stretched the interpretation of the mandate for price stability, arguing that excessive spreads and the risk of contagion hamper the transmission mechanism of monetary policy, thus threatening its capacity to protect the stability of the eurozone. And it is legitimate to ask whether it should be a prerogative of a technocratic institution rather than of a political instance, to “do whatever it takes” (in Mario Draghi’s words) to save the euro and especially its most vulnerable members. These criticisms, however, once put in context, appear unjustified. The ECB was forced to intervene by three years of inaction from European governments, only capable to deliver an endless sequence of decisive summits, whose effects faded in a matter of weeks (when not in days). The ECB had no choice but to fill a political void, to prevent speculation from occupying it with catastrophic economic and social consequences.
What is really worrisome, on the other hand, is the conditionality attached to the ECB program. Countries demanding for support should show commitment to structural reforms and enhanced austerity, submitting their policies to close scrutiny by the Troika. In some sense the ECB would substitute markets as well, taking up their role of watchdog and imposing supposedly good behaviour to undisciplined countries.
It would be reassuring to read Draghi’s insistence on conditionality as a tactic move aimed at obtaining the consensus of core eurozone countries. In reality, the ECB’s Italian President does not deviate from his predecessors’ views. These views are inspired by the orthodoxy that emerged in the 1980s in response to the Keynesian crisis, which inspired the policies adopted or invoked by the European Union since the 1980s.
Let’s go back in time. In 1986, the Single European Act, which organizes and regulates the European single market, was approved without any discussion on fiscal or social convergence. This created from the outset the conditions for a race to the bottom, in which growth had to be sought at the expenses of partner countries; an economic war that was fought with alternate fortunes by European countries.
The next episode is the Maastricht Treaty, which responds among other things to the political need to anchor the newly reunified Germany into a more integrated Europe. The price paid for this is known. The new European central bank is modeled after the Bundesbank: a mandate limited to price stability and the prohibition to finance countries potentially tempted to free ride. Together with the constraints imposed on deficit and public debt, and with the emphasis on structural reforms, this was supposed to ensure convergence, and allow the flexibility to cope with asymmetric shocks without any discretionary government intervention.
The crisis brought to the surface the structural flaws of the single currency, together with the shortcomings of the doctrines that had influenced its development. What could be expected by a single currency lacking a federal fiscal (if not political) structure? How could the emphasis on laissez faire have led to anything else than divergence between large and small countries, with the latter less dependent on domestic demand, and hence more capable to use fiscal and social competition to boost growth? And was it not obvious that large countries would sooner or later have to follow the same path, as Germany did, thus being forced to rely on export-led growth?
The inability to use the exchange rate and the absence of a proper federal structure deprived the eurozone countries of any macroeconomic convergence mechanism. It should have been obvious from the beginning that the simple convergence of fiscal policies could not compensate for differences in institutions, industrial structure, and social organization that were (and are) the source of real divergence. The crisis that began in 2007 simply exacerbated an economic war that was fought since the 1980s.
Mario Draghi’s announcement is part of this story, old of more than a quarter of a century. There is no doubt that the ECB had to end an anomaly, and fully assume its role of lender of last resort. But as necessary as this may be, it does not address the problem of real divergence among European economies. Worse still, the conditions imposed on beneficiaries will increase the differences in performance for a short run that could become dangerously long, and impact growth of the area as a whole. The conditions required from peripheral countries in trouble strikingly resemble to the structural adjustment programs imposed by the IMF in the 1990s, today rightly discredited. What to make of the fideistic insistence in the virtues of austerity, when even the institutions that impose it pile up evidence on the disastrous effects of restrictive policies? And how not to notice the difference with the new round of quantitative easing in the US, that the Fed would never even dream to condition on fiscal policy behaviour?
Once again, Europe seems incapable of learning from experience. The ECB has probably saved the euro from implosion. But having avoided the worst does not allow any optimism for a continent that remains prey of economic orthodoxy and condemns itself to many more years of economic stagnation.