GLOBAL FINANCIAL CRISIS: by Colin TeeseNews Weekly
European debt crisis reveals globalisation's shortcomings
, May 29, 2010
Sitting here on the other side of the world, one is tempted to imagine that what happens in Europe matters little to Australians. We tend to rate as more significant our relationships with the United States and, more recently, East Asia.
This is all the more so because we are fed a steady diet of negatives about Europe and the European Union from the proponents of orthodox economics. Whatever happens in the EU, they argue, is a result of following bad economic examples.
US commentator Robert J. Samuelson recently followed this line of reasoning when he said of the EU's current financial woes that "the central cause is not the euro.... Budget deficits and debt are the real problem"
(Robert J. Samuelson, "The welfare state's death spiral", Washington Post
, May 10, 2010). Well, being an American, he should know!
The same sort of message is being peddled, for self-serving reasons, by the rich member-states of the EU against their less fortunate fellows - and, significantly, also by the European Central Bank, where economic thinking is German-dominated.
These forces insist there is nothing wrong with the EU, or its monetary union; the trouble lies with a few irresponsible Mediterranean states which don't seem to be able to emulate the northern European way of doing things. (Curiously, Ireland is counted among the irresponsible "Mediterraneans").
Until recently, the world was preoccupied with the EU's attempts to find a way around the immediate problem of debt-laden Greece, always with a weather eye on the risk that, should the EU's policy fail, Greece's economic collapse would trigger a domino effect on other member-states.
At the beginning of the Greek crisis, the EU bureaucracy in Brussels, supported by the European Central Bank and Germany, tried bluster. The economically precarious PIIGS countries (Portugal, Italy, Ireland, Greece and Spain), they huffed, should be left to fix their self-generated problems arising from fiscal irresponsibly. There could not be, and would not be, any bail-out by other member-states of the EU, or, for that matter, from the EU itself.
On this latter point Brussels was emphatic. Constitutionally, the EU was not empowered to bail out any member-state in financial difficulties. And the rich member-states, including most emphatically Germany, made it clear that they neither could nor would fund any rescue packages.
So there! Greece, along with the other four PIIGS countries which might follow them into financial chaos - should go it alone.
No mention was made of Britain in this context, even though it too was in a financial mess. Why not? Because Britain retains its pound sterling and is not part of the EU's monetary union.
The respectable path generally recommended for countries with unrepayable debts is currency devaluation. However, this argument is based upon nothing more than the fond hope that, by such means, economies can increase their competitiveness by making their exports cheaper and their imports dearer and thus be able to trade their way out of trouble.
This argument, superficially attractive though it is, is full of gaping holes. Unless a country's foreign debt is denominated in its own currency (and very often it is not), an act of devaluation actually increases the size of the debt obligation. Moreover, supposing, as mostly happens, the indebted country is unable to increase exports by the amount needed to cover the debt principal and interest - what then? The devaluation option is available only to countries, such as Britain, which have retained their own national currencies.
However, Greece, like most other EU member-states, has long since adopted the euro as its currency. Thus, whatever may be the merits of devaluation, that option is not available to Greece.
The same is true of the other seriously indebted PIIGS economies. This fact presents the EU with a major problem that cannot be solved by bluster, or by moral blackmail with reference to these EU member-states' financial irresponsibility.
In the context of the global economy the EU is an important player. It is the world's second biggest market after the United States. What happens in Europe affects the rest of the world, whether we like it or not.
A major EU financial collapse would cause a deep downturn in EU output and jobs (not to mention demand for Australian exports). This is a reality which EU power-brokers have been trying to paper over as they have pressed the seriously indebted member-states to fix their own problems.
Greece was, of course, the headline risk economy. Its debt obligation was the greatest, amounting to some US$400 billion. Any sensible observer must have realised that Greece, on any realistic assumptions, could never repay that sum.
The other PIIGS economies are in slightly less serious circumstances, but, taken together, the group constitute a real threat to the stability of the EU and, by extension, to the entire world economy.
It is instructive to note that backing and filling went on within the EU, but did not result in any credible solution to the crisis. Shareholders around the world began to draw the obvious conclusions, and share prices everywhere tumbled.
It was then that there came pressure on the EU, from the most influential quarters, to fix the problem.
Why the urgency? Well, a setback in share prices, if it persists, eventually undermines the health of the real economy (that is, output and employment levels). All the more was this so in the case of the PIIGS's overall debt, because much of it was held by banks outside Europe.
But, beyond that, the worry was that a large-scale default affecting major European banks, which hold most of the debt, could trigger a chain reaction involving the world banking system, much of which was still on life-support following the global financial crisis.
A way therefore had to be found to generate some kind of rescue package. With the help of the International Monetary Fund, a US$1 trillion emergency package has been cobbled together. Slightly more than half came from the International Monetary Fund, and the rest from EU sources - and yes, you guessed it - including from those very same wealthy EU member-states that earlier had emphatically declared that they would not and could not contribute.
Will the package do the job? This is unlikely. It is no less flawed than the package that the IMF tried to force on the Asian countries during the 1997-98 Asian financial crisis. The IMF proposed the following remedies: cut domestic spending, cut costs and wages, increase exports and thereby repay debts.
It didn't work with Asia, and it won't work now. And, of course, it is the exact opposite of what the major Western economies did in reaction to the downturn caused by the recent global financial crisis. Spending, not saving, was their prescription for recovery.
Why would the opposite work for the PIIGS? For a start, is there really much scope for any of these countries to increase exports? Probably not. And, second, if spending is reduced and taxes increased, won't this mean less demand, reduced growth, more unemployment and fewer imports?
Imagine the economic impact of all this on the EU and its richest member-states. German banks are the biggest lenders to the indebted countries. The monies lent have enabled the PIIGS to import the output of German industry. Paying back their loans would mean they would buy less - not merely from the Germans but from the rest of the world. And keep in mind that the EU is the world's second largest trading bloc.
Then there is the political impact on the PIIGS. How likely is it that any emergency austerity package can be enforced without provoking a huge public outcry and social disturbance, as we have witnessed in Greece?
Ultimately, the outcome of all this could be a large contraction of world trade.
Dani Rodrik, a professor of political economy at Harvard University, has warned recently, in a timely article on the political problems associated with globalisation, of what he calls "the political trilemma of the world economy", and explains why this is behind the problems facing the EU.
He writes: "Economic globalisation, political democracy, and the nation-state are mutually irreconcilable. We can have at most two
at one time. Democracy is compatible with national sovereignty only if we restrict globalisation. If we push for globalisation while retaining the nation-state, we must jettison democracy. And if we want democracy along with globalisation, we must shove the nation-state aside and strive for greater international governance." (Dani Rodrik, "Greek lessons for the world economy", Project Syndicate
, May 11, 2010).
The first attempt at globalisation before 1914, Rodrik reminds us, was undermined by the emergence of democracy. The domestic political demands of newly enfranchised voters and unionised workers began to impose constraints on unfettered markets and free capital mobility.
Right now, Rodrik's concept of "the political trilemma" vividly illustrates the current plight of the EU. It is almost certain that the pursuit of increased globalisation through a single European currency, the euro, can only work if member-states surrender even more of their sovereignty. That is, the choice for an EU member-state is either to succumb to the political prerequisites of globalisation, or else to retain greater national sovereignty, including democratic self-government.
How clearly the EU's apparatchiks understand this dilemma is not clear. However, Realpolitik
, along with economic common sense, tells us that the rescue package won't - indeed can't - succeed in bailing out the indebted EU member-states.
If all this is clear to this writer, then it should be assumed that the authors of the emergency rescue package also know it.
That being so, the package may have been devised, not with the belief that it will necessarily work or that the debts will repaid, but rather to placate jittery markets and to cover up a reality that would be uncomfortably embarrassing to disclose at this time.
In effect, doing something - which appears to punish the irresponsible but without actually doing so - might be as far as EU authorities can go for now, without risking the break-up of the EU.
This all sounds very Machiavellian, but stranger things have happened.Colin Teese is a former deputy secretary of the Department of Trade.
Robert J. Samuelson, "The welfare state's death spiral", Washington Post
, May 10, 2010.
Dani Rodrik, "Greek lessons for the world economy", Project Syndicate
(Prague), May 11, 2010.