Europe’s imposition of common, restrictive economic rules is draining the strength that arose from its structural diversity, argues Alan Shipman.
Carlsberg recently found a new tactic for preventing a strike at its Lithuanian brewery. It persuaded a court that beer supply is an essential public service. Employees would therefore be breaking the law if they disrupted the flow of lager-fuelled lifeblood. A British union leader, recalling the Danish brand’s iconic advertising slogan, called the court’s ruling “probably the most ridiculous decision in the world".
Though a blow for labour rights, this elastic legality might be good news for the wider cause of European survival. It would show that national diversity is alive and well within the troubled economic union.
The dangers of monoculture – whole crops wiped out by the same disease, species extinguished by change in an environment to which they’re too-well adapted – have been known to biologists for years.
But when economists tried to build on the success of Europe’s single market, they overlooked its lesson in the limits of uniformity. Although we need to standardise definitions for lager, jam and other products, progress then depends on generating variety and competition within the categories. The EU’s strength is based on its assemblage of nations that differ in what they’re best at producing, and what they most like to consume.
So when it comes to the single currency, efforts at ‘convergence’ have been a disaster. The formation of the Eurozone was predicated on the idea that its members would grow ever more structurally similar, so that their comparative production costs would move together (making exchange-rate adjustment unnecessary), and they would all experience and react to economic ‘shocks’ (like an oil-price rise or a banking collapse) in the same way.
This convergence was meant to ensure that the single market could be turned into a single currency area, without the inter-state labour mobility, large central budget and unified bond market enjoyed by the USA, the only other comparably large currency union.
'The dangers of monoculture have been known to biologists for years'
Defenders of Eurozone experiment still claim that problems arose because member states did not converge far or fast enough. They argue that if only Greece, Ireland, Portugal, Spain and Italy had behaved more like Germany – linking pay growth to productivity and making their labour markets more flexible, keeping budget deficits down, not borrowing too much – they would have been able to co-exist alongside Germany, without running up widening trade deficits against it and worsening debts to its banks.
But the Euro is actually suffering from an excess of convergence. The downward movement of new members’ interest rates towards Germany’s, underpriced their risk; while the upward movement of their wages towards the German level overpriced their labour. Investors’ scope to spread their risks was severely reduced because the more integrated stock and bond markets started to rise and fall together; correlation of asset values wrong-footed even the normally resilient hedge funds in the financial turmoil of 2011.
Pulling the wrong levers
The convergence of policy responses is proving even more damaging. By shackling every member to the same restrictive fiscal policy, the Eurozone is standing economic logic on its head.
Countries that have already overborrowed are being ordered to make budget-balancing efforts that are bound to fail, as stalled growth results in ongoing deficits that drive them to default. Larger countries that could afford to borrow more are deliberately not doing so: in particular, Germany restricted its fiscal deficit to 1% of its GDP last year. The reward for this Pyrrhic prudence is that its growth rate will drop to less than 1% this year (even on optimistic official forecasts), and it could end up having to support domestic banks that lent too much to its recession-hit trade partners, including Italy and Spain.
Recession-induced panic over ‘peripheral’ Eurozone sovereign debt has painfully prolonged the credit crunch that began with mortgage debt defaults in 2007-8. A drop in banks’ asset values has forced them to reduce the flow of new lending, which reduces investment demand and causes asset values to fall further.
Instead of arresting this ‘de-leveraging’, European governments have promoted it. They are raising capital and liquidity requirements so that banks must put a lot more in reserve before they lend again, and insurance companies restrict their investment in private-sector equity or debt. They are acting to stifle deficits that are actually the inevitable counterpart of big companies’ large surpluses (which reflect their lack of investment opportunity in a stagnant single market), and of households’ tightening of belts to pay-down debt
The European Central Bank has done its best to prevent another downturn, with massive purchases of public and private debt. But this will just leave it with a bundle of bad assets that ties its hands in future, unless its still-solvent member governments follow-up with some investments of their own. The Eurozone will meanwhile try to export its way back to health, in a world economy that cannot absorb more exports (especially if it is China’s turn for an asset-price drop).
Europe is unnecessarily following the example of Japan, which allowed a gradual collapse in banks’ leverage after its property bubble burst in 1990, resulting in two decades of painfully slow growth. But Japan had systems of redistribution – between regions and households – that appropriately spread the pain, and a willingness to prevent outright deflation by running large central government deficits.
Despite creating the opportunity to establish the euro as a global currency, Europe is deliberately avoiding the example of the US, which arrested the collapse in leverage with a federal stimulus programme comparable in scale to the New Deal public-works initiatives that halted the 1930s depression.
Significantly, the Americans took that action after realizing that they, too, had seen an excess of convergence. Their real-estate market had lost its regional diversity, so that property prices staged an economy-wide fall for the first time in 2007-8. But they were able to respond appropriately because of the large federal budget, which could move into deficit to complement the central bank’s asset-price stabilization efforts.
The Eurozone lacks the power to take such action centrally, and Germany has shown that it does not possess the political will to do so on behalf of the other 16 members.
If France’s new president can persuade Berlin to change course, there is hope of breaking the currency-union’s fall. If not, it will take more than the free flow of Lithuanian lager to drown the continent’s sorrows.
Alan Shipman 1 May 2012
Alan Shipman is a lecturer in Economics at the Open University. He is responsible for the modules You and your money:personal finance in context and Personal Investment in an uncertain world, part of the foundation degree in Financial Services.
The views expressed in this post, as in all posts on Society Matters, are the views of the author, not The Open University.
Cartoon by Catherine Pain
