Post Eurem: Maybe Tomorrow?

The death notices that will be written for the single currency will probably not dwell much on the difficulties faced in trying to knit together economies at very different states of economic advancement, for instance in terms of the stock of physical capital, i.e. roads, electricity grid, factories, equipment, etc., which a country's labour force has to work with. The lower this physical stock, the less productive its workers are and the smaller the cake or, in other words, the lower per capita GDP is. Moreover, the lower the level of capital/employee, the more their productivity increases, with the corollary that the return on the underlying financial capital and, usually, interest rates will be high. When the euro came into being in 1998, every future eurozone Member State had physical capital per employee of between 150,000 and 200,000 euro, all except three: Spain, Greece and Portugal. Ireland – somewhat counter-intuitively – and Italy sat comfortably in the middle of the pack.

The financial crisis then hit home, stifling property transactions, unleashing shock-waves through Spain, or pushing the banking sector to breaking point, sending Ireland reeling. Portugal, which does 35% of its trade with Spain and the UK, did not resist for long while the global recession soon caused Greek's public debt to sky-rocket. Budget deficits ballooned virtually across Europe, culminating in spring 2010 in a full-blown crisis of confidence which the EU has strived to respond to, unconvincingly, by pledging measures that are becoming increasingly awkward to implement. The pressures are that much greater because the less developed eurozone Member States have hardly made up any ground at all economically. By 2008, in spite of all the progress made since 1999, physical capital per employee was still pitched beneath rates in 'core' countries, some 30% below for Spain or Greece and as much as 60% for Portugal or the likes of Cyprus, Malta or Slovenia. Slovakia's shortfall is as great as 70% as is the case or even worse for other East European states in the EU. The incentives for investing in these economies will remain attractive for some to come, with all the inherent risks of waste that this implies.

In such circumstances, the EU should, above all, take action to prevent things from spiralling out of hand, especially any escalation of private-sector debt among those Member States lacking physical capital as this would be very damaging for its financial system. This would be no easy challenge though as it equates to squaring a circle because, at the same time, the EU has to endeavour to encourage productive investment in these economies. With no genuine federal government which alone would be capable of effectively closing the development gaps within Europe, some measures taking due account of national catch-up demands might help to space out or damp down the much heralded crises. At a public-sector level, the Stability & Growth Pact will need to be amended by stripping out public-sector investment in the lagging countries unless the external deficits on their current accounts overshoot, say, a rate of 8% or 10% of GDP. For its part, the ECB could exclude prices in the lagging countries from its inflation targeting. It goes without saying that this would not be a small step, but it would enable the ECB to avoid tightening monetary screws automatically when faced with rapid economic growth and fast-rising domestic pay/prices in countries that are lagging behind.

One more difference needs to be taken into consideration: the special case of countries on the euro-zone's periphery. These suffer worse than others from big swings in the euro's external value as they naturally undertake more trade with their neighbours outside the eurozone's borders. This is also true for countries that trade heavily with the UK or Sweden, both Member States whose currencies float free against the euro. It seems likely that, some day, perhaps when the next crisis flares up, London and, incidentally, Stockholm would be, not exactly forced, but vehemently urged to choose between joining the euro or leaving the EU. But we ought not to run ahead of ourselves...

The euro is looking rather brittle and is likely to remain so while the eurozone encompasses countries at varying stages of economic development. Blaming just the public sector and how it works for all the imbalances within Europe, as seems fashionable at present, is not sensible since, as is often the case, the scapegoat can mask the real causes of the malaise. As the axiom goes, “Those whom Jupiter wishes to destroy, he first sends mad”. Fortunately for us, Jupiter dwells in the rarefied atmosphere of Mount Olympus, not the City of Brussels... At least, let's hope he does...