The eurozone needs reform, but devaluation, lower output and rising debt across the continent are nothing but a toxic brew
The outcome of the Italian elections should send a clear message to Europe's leaders: the austerity policies that they have pursued are being rejected by voters.
The European project, as idealistic as it was, was always a top-down endeavour. But it is another matter altogether to encourage technocrats to run countries, seemingly circumventing democratic processes, and foist upon them policies that lead to widespread public misery.
While Europe's leaders shy away from the word, the reality is that much of the EU is in depression.
The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930s. The youth unemployment rate in Greece now exceeds 60%, and the figure for Spain is above 50%.
With the destruction of human capital, Europe's social fabric is tearing, and its future is being thrown into jeopardy.
The economy's doctors say that the patient must stay the course. Political leaders who suggest otherwise are labelled populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease.
It will take 10 years or more to recover the losses incurred in this austerity process.
It is neither populism nor shortsightedness that has led citizens to reject the policies imposed upon them. Rather, it is an understanding that these policies are deeply misguided.
Europe's talents and resources – its physical, human, and natural capital – are the same today as they were before the crisis began. The problem is that the prescriptions imposed are leading to massive under-utilisation of these resources. Whatever Europe's problem, a response that entails waste on this scale cannot be the solution.
The simplistic diagnosis of Europe's woes – that the crisis countries were living beyond their means – is, at least partly, wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.
An alternative set of well-discussed policies could work. Europe needs greater fiscal federalism, not just centralised oversight of national budgets.
Europe might not need the two-to-one ratio of federal to state spending found in the US; but it clearly needs far more European-level expenditure, unlike the miniscule 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.
European leaders recognise that, without growth, debt burdens will continue to grow, and that 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, being policies that address Europe's internal imbalances and Germany's huge external surplus, which now is on par with China's (and more than twice as high relative to GDP).
That means wage increases in Germany, and industrial policies that promote exports and productivity in Europe's peripheral economies.
What will not work, at least for most eurozone countries, is internal devaluation – that is, forcing down wages and prices – as this would increase the debt burden for households, firms, and governments (which overwhelmingly hold euro-denominated debts).
And, with adjustments in different sectors occurring at different speeds, deflation would fuel massive distortions in the economy.
If internal devaluation were the solution, the gold standard would not have been a problem in the Great Depression. Internal devaluation, combined with austerity and the single-market principle (which facilitates capital flight and the haemorrhaging of banking systems), is a toxic combination.
The European project was, and is, a great political idea. It has the potential to promote prosperity and peace. But, rather than enhancing solidarity within Europe, it is sowing seeds of discord within and between countries.
Europe's leaders repeatedly vow to do everything necessary to save the euro. The promise of Mario Draghi, president of the European Central Bank, to do "whatever it takes" has succeeded in creating temporary calm.
But Germany has consistently rejected every policy that would provide a long-term solution.
Of course, the Germans have reluctantly come to accept the necessity of a banking union that includes common deposit insurance. But the pace with which the country accedes to such reforms is out of kilter with the markets. Banking systems in several countries are already on life support. How many more will be in intensive care before a banking union becomes a reality?
Europe needs structural reform, as austerity advocates insist. But it is structural reform of the eurozone's institutional arrangements, not reforms within individual countries, that will have the greatest impact. Unless Europe is willing to make those reforms, it may have to let the euro die to save itself.
The EU's economic and monetary union was a means to an end, not an end in itself. The European electorate seems to have recognised that, under current arrangements, the euro is undermining the very purposes for which it was supposedly created. That is the simple truth that Europe's leaders have yet to grasp.
Copyright: Project Syndicate, 2013
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