Austerity Fail—Europe Requires Fiscal Federalism & Banking Union For Growth & Recovery.

Italy’s recent election outcome—reigning government out and divided government of anti-austerity parties installed with no one strong enough to be Prime Minister—should send a clear message to Europe’s leaders: the austerity policies pursued are being rejected by voters. American Republicans should take heed as they irresponsibly advocate similar U.S. austerity.

The European project of forming a Union was always a top-down endeavor by elites who knew Europe could not prosper in the globalized economy as small independent nation-entities. It is, however, another matter entirely to impose technocrats to run countries, circumventing democratic processes and foisting upon citizens policies that lead to widespread public misery.

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While Europe’s leaders evade the word, the reality is that much of the European Union is in Depression. With this destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy…with willful negligence.

francois_hollande_angela_merkelThe German-imposed diktat is that sick patients must stay the course of blood-letting. Political leaders who suggest otherwise are labeled as irresponsible populists. The reality, though, is that the cure is not working (never did and never will), and there is no hope that it will—that is, without the “cure” (torture) being worse than the disease. Indeed, it will likely take a decade or more to recover the losses incurred in this absurd austerity process.

The simplistic diagnosis of Europe’s woes—that the crisis countries were living beyond their means—is notably at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. Greece was the only real problem, and Europe could have handled it easily.

An alternative set of policies are more likely to work.

  • Europe needs greater fiscal federalism, not just centralized oversight of national budgets. To be sure, it clearly needs far more European-level expenditure, unlike the current minuscule EU budget (whittled down further by austerity advocates).
  • A banking union, too, is needed. But it needs to be a real union, with common deposit insurance and common resolution procedures, as well as common supervision.
  • There will also have to be Eurobonds, or an equivalent instrument.

Without growth, debt burdens will continue to grow. Austerity by itself is an anti-growth strategy. Yet years have gone by, and no growth strategy is on the table, though its components are well known:

  • Policies that address Europe’s internal imbalances and Germany’s huge external surplus, now is on par with China’s.
  • For Germany, this means wage increases and,
  • For Europe’s peripheral economies, industrial policies that promote exports and productivity are required.

What will not work, the prescription imposed by Germany, is internal devaluation—forcing down wages and prices—as this increases the debt burden of households, firms, and governments. Moreover, deflation would fuel even more massive and disruptive distortions in the economy than have been experienced.

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Draghi & Merkel

Europe’s leaders repeatedly vow to do everything necessary to save the euro—witness European Central Bank President Mario Draghi’s promise to do “whatever it takes.”

Yet, the German Diktat prevails as Germany has consistently rejected every policy that would provide a long-term solution. Germans are doing for Europe everything except what is needed.

Finally, after much pleading and begging, the Germans reluctantly accepted the necessity of a banking union that includes common deposit insurance, even while they have deliberately stymied the pace of transition well behind what markets require. How many more european national banking systems will be on Central Bank life-support before a real and proper banking union is established?

Indeed, Europe needs structural reforms—as austerity advocates, Germany’s acolytes, insist. However, it is the structure of the eurozone’s institutional arrangements that need restructuring…now. Failing further to make these necessary reforms, Europe will have to save itself by letting the Euro die…or killing it.

photo-1The EU’s Economic and Monetary Union was a means to a better end, not a bitter end in itself. European electorates appear to be recognizing the truth that, under current arrangements, the euro is undermining the very purposes of prosperity in a globalized economy for which it was created. Europe’s leaders have yet to grasp this ultimate truth.

European citizens may soon give Europe’s leaders a lesson they will not soon forget.

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