As Europe?s debt crisis drags on, it is clear that underlying the economic and financial mess is a deeper political problem. The financial problem is clear: private and public sectors in various parts of Europe borrowed more than was sustainable. In this sense, the problem was similar to that of the US; indeed, it was partly created by what was going on in the US. But Europe?s economic problems are compounded by its politics, in ways beyond what a single country would face, even one like the US, with its current dysfunctional polarisation.
The mainstream view of what needs to be done to contain Europe?s financial mess is epitomised in a recent leader in The Economist magazine. The four-pronged recommendation there is, first, to separate insolvent from illiquid governments, restructuring the former?s debt but making sure the latter do not get sucked into insolvency. Second, recapitalise Europe?s banks. Third, shift the macroeconomic stance from fiscal austerity to growth promotion. Fourth, design a new system to prevent a repeat of the current scenario. Underlying these recommendations is a calculation that a disorderly default, contagion and a breakup of the euro will cost much more than any bailout.
The political problem at the heart of the slow-burning fuse on the European crisis has been the German reluctance to pay for the fecklessness of another country?s government (and its people). The Germans have been prudent, after all. Why should they bear the burden of paying for Greece, Portugal or Spain?s profligacy? This is, of course, an argument about fairness and about redistribution?these are inherently political issues. Single countries, like the US or India, also have to deal with such issues with respect to subnational governments, and have responded differently at different times.
An important additional argument comes from Hans-Werner Sinn, a prominent and influential German economist. His concern is that the bailouts do not just reward past bad behaviour, but they are also encouraging a continuation of that behaviour. Countries like Greece, Portugal and Spain borrowed heavily from abroad, running large current account deficits and not using the capital inflows productively. Instead, their price levels rose faster than their eurozone partners, leading to real appreciation even though the common currency fixes the nominal ?exchange rate?. Sinn argues that the bailouts are postponing the necessary domestic adjustments.
While Sinn agrees with The Economist on bank recapitalisation and the need for new institutions for the future, he differs starkly on the role of the European Central Bank (ECB) and the European Financial Stability Facility (EFSF). The Economist would have these institutions act as lenders of last resort, backstopping countries in temporary trouble (but not trying to avoid a Greek default). This is what the US Federal Reserve has done for its own economy (and many other countries at the height of the 2008 crisis). Sinn would instead prohibit future government bond purchases by the ECB or EFSF. He believes that ongoing bailouts will only expand and sink the ?good? euro countries with the ?bad?.
Looking a bit deeper, however, it seems that Sinn accepts the need for ?temporary? help on the liquidity front for solvent crisis countries. He wants a time-bound formula for separating out liquidity problems from those of solvency. In a sense, he is arguing that solving the current crisis can only be done by drawing up an exit plan and making future institutions clear?this will lead to better decisions now. Current actions will be within a specified framework, rather than ?political ad hoc actions?, which is how he views what is now happening.
But this skirts the core issue. The crisis and responses are inherently political. It is easy and right to blame profligate and inept governments in the ?periphery?, as Sinn calls it, for starting the problems. But German responses have also been inept, driven by short-run domestic concerns rather than a vision for a European future that led first to the Union and then the common currency. Less German austerity and more robust demand from Germans might have helped Greece more efficiently than the bailouts now required. German tourists with more money could have vacationed in Greece, Portugal and Spain, rather than having their tax dollars go to bailouts.
Ultimately, the politics of Europe is illustrated by Sinn?s framing of his arguments. Ireland, in his periphery, comes in for scrutiny, even though it is small and has borne its full share of economic pain to adjust after the crisis. On the other hand, Italy barely gets a mention, probably because it is one of the original six European Common Market members, and so part of the ?centre?. It is close to France and Germany in size. Its economy and its politics are fragile and messy. The question is where Europe will draw the line. Certainly to protect Italy. But then why not Spain? And Portugal? The idea of Europe is ultimately a political one, and the markets need reassurance right away on Germany?s commitment to that idea.
The author is professor of economics, University of California, Santa Cruz