As another EU summit approaches May 23rd, “economic growth” is on the agenda, a reflection of shifting political will. Investors wonder if new European Union policy will emerge and save the euro zone while the crisis intensifies and conditions in Spain deteriorate.
Will shifting political will create new EU policy?
The European Union has been an expression of political will since its inception to unify the EU economically and maintain peaceful prosperity between diverse member states.
Recent election results and social chaos across the EU reflect deep frustration and anger with EU leaders’ inability to solve the on-going euro debt problems. To many, accelerated austerity measures appear to be a greater cause of economic dis-integration than a cure for it. Euro-pessimism has the grips on investor confidence and capital flows are exiting peripheral countries making European integration impossible for EU leaders to manage. With Greece on the cusp of a euro exit and Spain emerging as a still bigger risk, the “growth summit” is a critical time for new EU policy to emerge and a new cycle of EU governance to begin. If now is the time for a new political cycle of EU governance, the question remains as to whether or not it will emerge.
With the French-German relationship at the core of the EU’s political foundation, there is reason for optimism. In spite of differences in culture, politics, constituencies, and beliefs, both Chancellor Merkel and President Hollande have expressed a willingness to work together; certainly both are pro-euro zone and both are pragmatists. The argument of “austerity” vs. “austerity and growth,” however, should be only part of the discussion as part of the larger shift in policy that is needed to save the euro zone now, and to lay the foundation for a more stable euro zone in the future.
What shift in EU policy is needed?
One of the lessons of EU policy is that the recent Fiscal Compact is proving unmanageable by the weaker countries implementing it at an accelerated pace. While no one doubts the importance of fiscal unity and the importance of spending cuts, it is a long and arduous process. EU policy needs to recognize a slower pace will be required for the weaker countries to be able to manage the process and maintain investor confidence. Otherwise, countries weak on growth can become “trapped” by unrealistic EU debt and deficit targets.
In the example of Spain, the country is now in an “austerity trap,” as no Spanish spending policy seems to be a viable way to meet the EU debt and deficit targets and instill investor confidence. If the government cuts too much spending, investors don’t believe the debt load will be sustainable in the absence of economic growth. Alternatively, if the government isn’t able to make enough spending cuts, investors believe the government lacks the credibility and isn’t capable of reaching EU targets.
Instilling investor confidence will require more lenient timelines, giving investors reason to believe that the government can attain the spending cuts and deficit goals while allowing time to make needed structural reforms.
Can the EU create policy to improve regional imbalances in productivity and competitiveness?
If weaker European countries were more competitive they would export more to northern Europe and the world, generate growth in employment and wealth, which would contribute to reducing the imbalances of the European “core” and “periphery,” improving European economic integration.
One potential policy measure is that the European Investment Bank could be given more common EU resources to finance investment in infrastructure projects. These policies fall short of establishing a transfer state of wealth from richer to poorer countries, which would never be acceptable to Northern European countries. Instead, it should be seen as a long term investment to improve the competitive position of weaker countries in addressing regional disparities. It may also be a policy which preceeds the bigger question of issuing Eurobonds, bonds issued that are backed by common EU resources, an intensely debated topic within EU leadership currently. Some type of euro bond is likely to be agreed upon eventually as the EU political will shifts, in spite of German opposition now, as an emergency measure to lower debt issuance costs for weaker countries while spreading risk over strong and weak countries.
The Spanish government could foster private investment in strategic sectors to increase competitiveness. Spain could be a greater exporter of technology to Latin America. Currently, the opposite is true, Spain is losing competitive advantage in many manufacturing sectors and cutting research and development in science.
Can EU policy consider other measures of economic integration?
Countries qualified for euro membership by meeting “Maastricht Convergence Criteria” in 1998, 5 economic goals to make countries similar enough be unified by the common currency and one central bank policy. Given the on-going diversity in euro country economies, measuring economic integration with Maastricht “convergence criteria” isn’t enough to define economic integration. EU policy makers could also use underlying economic trends to measure measure integration. In the example of Spain, underlying trends would include a youth unemployment rate of over 50% and growing, and unemployment rate nearing 25%. Looking more closely at the potential changes the labor market is also disturbing as there is emigration of both skilled and less skilled workers. Though underlying trends may be more difficult to “factor in” to uniform EU policy, the underlying trends do have policy implications on present and future productivity and competiveness, both of which are at the root of regional economic imbalances.
Can a new political will result in EU policy that will save the euro zone?
After over two years of ineffective EU policy to contain the debt crisis, the upcoming “growth summit” is likely to reflect the shifting political will that supports the need for new EU policy and governance and mark the beginning of new EU policy cycle meant to save the euro zone. Though it may be too late to save Greece, Spain has the industrial base to recover and both the manufacturing and the service sectors can become more competitive.
At a minimum, EU policy needs to recognize the need to temper the pace of austerity with the reality that the EU has diverse member states with slower growth and less productive economies. At best, EU policy should make the policy shift to improve the underlying competitiveness of weaker countries and broaden the measures of economic integration, in what is already a two-tier euro economy by many measures.
A credible EU policy would inspire investor confidence, euro-optimism, and capital flows into weaker countries, resulting in falling bond yields and lower government financing costs. Alternatively, without a fundamental shift in the governance of the EU, euro-pessimism is certain to keep the grips on the euro zone, exacerbating the existing trends towards economic dis-integration as investors seek safety of “core” countries, while weaker countries will continue to diverge economically and politically. The time has come to move from containing the crisis to resolving it.