In the short term, the indebted countries cannot borrow more money in any case – it is simply impossible unless the European Central Bank buys the bonds and gets involved in the monetary financing of deficits. However, southern Europe is not failing because governments are spending and borrowing too little. Greece has outstanding debt of 140 per cent of national income and Italy’s debt is 120 per cent of national income. Spain has a more modest debt but is backing huge losses in private banks with government support.
It is possible for countries to ‘grow out’ of these levels of indebtedness but not through borrowing more. Increased borrowing would lead only to a very temporary boost to growth – if that – while leading to higher interest payments in the future, and a necessary reversal of policy which would mean that we simply had a more serious problem a few years down the road. Keynesians and supporters of fiscal prudence might be able to agree on one thing – that there should be some kind of recognition of bad debts. There is no point in governments that have reached the limit of indebtedness bailing out the banks.
Indebted governments are lending to bust banks which have lent to the same indebted governments; governments are bailing out each other; the various EU mechanisms – financed by the same governments – are bailing out the indebted governments; and the ECB – also financed by the governments – is bailing out everybody. Parties have lent money to other parties, who will not repay, and the sooner this is recognised the better. This will mean the orderly failure of some banks and losses being taken by investors. If governments default, then there should be a programme of privatisation – some indebted countries have huge state assets – to pay back creditors.
But the indebted countries are not going to grow out of their debt problem and reduce unemployment unless serious long-term structural problems are addressed that are nothing to do with the crisis, but everything to do with bloated government. On average, 70 per cent of 60-64 year olds in the European Union do not work. This figure is 80 per cent for many of the most indebted countries. Perhaps even more shockingly, the average inactivity rate between 55 and 64 is around 55 per cent – again even higher for the most indebted countries.
Typically, the southern EU countries have shadow economies between 20 per cent and 25 per cent of national income. These are long-standing structural problems and their causes can be traced back to dysfunctional labour markets and social insurance systems, regulation and high taxation as well as, in some cases, endemic corruption. Reforms are necessary for long-term growth, but the reforms must take place now.
Meanwhile, it is impossible to envisage the economies of the southern European countries recovering while they are members of the eurozone. Economic shocks require price adjustments. Before the single currency, this would happen through exchange rate changes. Post the single currency, price adjustments can only be brought about by changes in nominal wages, prices and social security benefits – probably of the order of 20-25 per cent. The dysfunctional micro-economic situation throughout most of the EU prevents such changes.
An orderly departure from the euro is necessary unless reforms are so rapid and so radical that the indebted countries can adjust to the economic situation that is facing them. The three point plan for the indebted eurozone countries now in recession is simple – though not easy: recognise bad debt for what it is; orderly exits from the single currency; radical economic reforms. One part of this programme cannot wait for another. All must happen now.
This article originally appeared in Public Service Europe.