Writing in this column two months ago, I suggested that Treaty change would be needed to save the Euro. Where once such talk was taboo, it is now clear that we are faced with such constitutional change, irrespective of the UK position. A real fiscal union would involve transfers to those regions for whom a one-size-fits-all monetary policy is inappropriate. What is in prospect is not a fiscal union, however, but an austerity club.
European leaders have finally realized the need for bold reform, but they’ve completely missed the point. The Eurozone crisis is less about members’ debts, and more about their competitiveness.
If a country cannot remain competitive, it cannot generate the exports it needs to finance repayments to foreign creditors. As we are all now painfully aware, a country in monetary union cannot recover cost competitiveness by devaluing its currency, but only through ‘internal devaluation’.
An ‘internal devaluation’ occurs when labour costs fall relative to your competitors. This happens either because your wages fall or, far less painfully, if they rise slower than those of your competitors.
Unit labour costs in Ireland have declined significantly during the crisis. That’s what happens when one in ten of the workforce loses their job, or is ‘decimated’, to use the old Roman expression. The live register soared from 4.5% to 14.5% in four years.
For Ireland, just as for her citizens, debt repayment capacity falls with income. Ireland’s best case scenario is that debt-to-GDP peaks in two years at about the level faced by Italy today.
In early 2012, the Irish government will introduce a Fiscal Responsibility Bill. This will include a ‘Public Finances Correction Rule’ which will put a legally binding fiscal straightjacket on Finance Ministers for years to come.
Until our debt-to-GDP ratio is halved to the ‘Maastricht’ level of 60%, we will not only have to reduce our deficit further than the 3% target, but actually run a significant surplus until we hit the 60% target. The Government’s recent Medium Term Fiscal Statement sets out a baseline scenario where this level is achieved in 2039. Our age of austerity has only begun!
Can we service such debts, odious or not? With difficulty, maybe. But if the global economy undermines our exports-only recovery strategy, all bets are off.
So can the Euro hold together? With difficulty, maybe. But the prospects for Greece, to take the most extreme example, are not good. Even after its partial default, its debts will be 120% of GDP. Where Ireland has recovered competitiveness, and has a thriving export sector, Greece not only has further to travel, they have hardly begun the journey.
Georges Papandreou tried to call a referendum in Greece not to out-manoeuvre the opposition, but because he needed political cover for ushering in decades of austerity.
With crippling debts, a deflationary spiral and endless budget cuts on the horizon, it is hard to believe that the current path is socially or politically sustainable in Greece.
There is one medium-term development that could secure the long term sustainability of the Euro, but it is the one thing so anathema to Germany that they may well prefer a return of the Deutschemark: Inflation could be the Euro’s savior. German inflation at 4-6% per annum, combined with expansionary fiscal policy, would allow countries like Greece to adjust gradually over a number of years without experiencing deflation.
What was agreed at the EU summit of December 9th was another short-term fix: an intergovernmental treaty to lock debtor countries into austerity, but no mechanism to correct the very economic imbalances that doomed the Euro ‘mark I’ in the first place. ‘Ever closer union’ on those terms may be neither desirable nor sustainable.
Whether inside or outside the Lisbon Treaty framework, the introduction of mandatory financial sanctions on countries with excessive deficits involves a very real transfer of sovereignty and a change to our constitutional set-up. It would be a brave government that tried to bypass the will of the people on such a fundamental decision.