The changing narrative of the euro crisis

Diego Zuluaga // 05.10.2016

When the eurozone debt crisis broke out in late 2009, there was considerable agreement among policymakers that budgetary prudence and structural reform must be at the heart of the crisis response. All of the countries which ended up seeking external assistance – Greece, Ireland, Portugal, Spain and Cyprus – had been overwhelmed by mounting public deficits, sometimes the product of government largesse in the boom years – as in Greece – other times the consequence of bank bailouts. With annual shortfalls often well in excess of 10 per cent of GDP, these countries found themselves unable to borrow at competitive rates on international markets.

That was the genesis of austerity, the combination of fiscal consolidation and market reforms which became the standard recipe of the EU institutions for struggling Member States. It is questionable whether spending reductions were in fact as deep as the conventional account suggests. Greece, which both in the nature and extent of its slump is an outlier, has seen acute real-terms cuts as the size of its economy contracted by a quarter between 2008 and the present time.


But, as OECD data illustrate, the general trend of government spending as a share of GDP in the crisis countries was upwards between 2003 and 2014, and the figures have barely budged – and sometimes increased – since 2009. One may argue that these relative increases are the natural consequence of recession, during which the private side of the economy contracts, whilst the public and transfer side remains stable and may even increase as the ranks of the unemployed grow. Yet, if we define austerity as relative spending reductions, then most of the worst-hit member states never experienced it. There was hardship, to be sure, as people lost their jobs, wages fell, and taxes rose – but real-terms expenditure cuts were scarce.

It is safe to say that any political consensus there was around the need for fiscal consolidation and reform has evaporated with the onset of recovery, however modest. Spain and Portugal were recently granted additional fiscal leeway by the European Commission, even though their accumulated debt and budget shortfalls remain far above the rules of the Stability and Growth Pact. The SGP itself has been watered down, and its rationale questioned, by EU officials.

Whatever budget-balancing zeal there was has by now been replaced by a Keynesian propensity for stimulus spending, particularly in the form of infrastructure projects. There is an irony in this, since Keynesians are fond of quipping that the time for fiscal consolidation is when growth is healthy and unemployment low. Even conceding that this might be the optimal policy within the model, reality gets in the way: few elected governments – the German one possibly a rare exemplar – will lower expenditure in the boom times.

For a taste of the kind of narrative that is emerging around the causes and remedies for the eurozone crisis, you need go no further than Joseph Stiglitz’s most recent book, The euro: how a common currency threatens the future of Europe.

Stiglitz, a professor at Columbia University and 2001 Nobel laureate in economics, is a sceptic of markets and proponent of an activist government: he was awarded the most prestigious prize in the discipline for his theory of imperfect information, which posits numerous so-called market failures that governments are presumably well-placed to address. To neoclassical economists’ assumption of perfect information among all market participants, Stiglitz responded with a perfect government: benevolent, efficient and omniscient. Hardly a reflection of your average European administration!

Stiglitz has some inside knowledge of the euro crisis, having advised the ill-fated administrations of Andreas Papandreou in Greece and José Luis Rodríguez Zapatero in Spain in the early years of the downturn. He is also close friends with former Greek Finance Minister Yanis Varoufakis, whom he mistakenly describes as “the only economist” in the Eurogroup (his Spanish counterpart Luis de Guindos is also an economist, and there may be others).

The book is more partisan tract than cold analysis of the euro crisis. Stiglitz proclaims that support for budget cuts and market reforms is just an ideology, unbacked by economic evidence. In his view, the consensus among economists – whilst unacknowledged by “neoliberal” politicians – is that adjustment made problems in the crisis countries worse, and that, without deeper risk-sharing among Member States, they are bound to become ever worse, with the euro’s failure as the probable end-product. Indeed, Stiglitz favours the effective dissolution of the single currency – which would be replaced by a system of more or less national monies and widespread exchange controls – if Germany and others refuse to acquiesce.

It would be inaccurate to describe Stiglitz’ views as fringe: some economists have previously called for more centralisation, including a common treasury, common taxes and possibly joint debt issues. Some of these proposals formed part of the notorious Five Presidents’ Report on the future of the euro. Yet, to refuse to acknowledge structural reforms and balanced budgets as legitimate economic arguments involves a level of dogmatism that is quite exceptional among professional economists.

Not only is there firm academic grounding for public spending restraint, starting with the work of Alberto Alesina at Harvard, and evidence from around the world that market reforms improve employment and productivity outcomes. But, in the circumstances of 2009-2012, it would have been unthinkable for Greece, Ireland and the rest to refuse any adjustments. Like Argentina and Venezuela, they would swiftly have found themselves shut out of bond markets – which some did – and their banks rendered insolvent in the absence of emergency liquidity from the ECB. Stiglitz mocks TINA – “There Is No Alternative” – a dictum that became famous in Thatcherite Britain and was later adopted by proponents of austerity. He may be right that there was an alternative – but if there was, it wasn’t pretty.

Similar arguments to those put forward by Stiglitz have captured the imagination of citizens and politicians across Europe. There is crisis exhaustion and people are looking for alternative policies to the ones that have tended to dominate (even if implementation left much to be desired). But, whilst the idea that all we need are more administrative structures and greater burden-sharing among countries is tempting, it is unlikely to restore the euro area to growth.

For one, the main problem afflicting euro countries is not a cumulative lack of aggregate demand. If that were the case, one would expect macroeconomic performance to exhibit similar trends across Member States. Yet, Ireland is growing at average annual rates of 7 to 9 per cent, whilst Spain’s growth is a healthy 3 per cent. This compares to near-zero figures in Italy and France. Consumer confidence, even alongside joint post-Brexit fluctuations, varies widely across countries, as do wage and productivity growth.

The key distinguishing feature of these two groups of countries is the extent, and the degree of implementation, of liberalising reforms. For instance, one can draw a neat relationship between the passage of labour market reform in Spain in 2012, and the trend reversal in unemployment from early 2013. Notably, the current job recovery is speedier than that experienced – from similar levels of joblessness – following the late 1970s and mid-1990s recessions.


Market-friendly policies can achieve the twin objectives of preserving the euro and providing for a stronger recovery than that witnessed in the past three years. But these goals are not always aligned: a Stiglitzian agenda of centralisation, without profound liberalisation in the Member States, might give the euro a longer lease of life. But it would come at the cost of long-term performance, as harmful behaviours would be encouraged on the part of national governments, whilst productive activity was made harder by tax and regulation.

As policymakers work to improve the governance of the eurozone, they should keep in mind that the single currency was intended as a means to widespread prosperity, not an end in itself.

Diego Zuluaga is Head of Research at EPICENTER.

EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).


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