A balanced EU is just as vital as a balanced budget
Published 25/10/2011 | 08:00
Let's assume - and I know it is a dangerous assumption - that they eventually manage to do a credible deal that carries the three elements needed to stitch together the eurozone for a while yet.
These are: a default for Greece, support for European banks, and expansion of the European Financial Stability Facility. Where do we go from there?
Well, a huge amount will depend on the detail. But let's assume that this will be a good enough patch to carry confidence through the winter and thereby buy the eurozone authorities some time. If that is right then the focus will switch from bailout to adjustment: from financial consequences of past errors to the need to correct present ones.
There are several elements to this. One is the need to have a budgetary position that is sustainable (ie, that can be financed from the markets without recourse to any external guarantee). In other words it may be acceptable for the time being for Germany to guarantee some element of Spanish or Italian borrowings but that cannot be a long-term sustainable situation.
Getting budgets back to balance or surplus is just the start. There is another, and in some ways more difficult adjustment, which is to reduce the trade and payments imbalances both within Europe and in the rest of the world. As far as Europe is concerned one of the huge problems is that the common currency has led to economic divergence rather than convergence. Costs have shot up in the weaker countries and been held down in the strongest one, Germany. So Germany, which arguably joined the eurozone at too high a rate, has become super-competitive, while much of southern Europe has become progressively less so.
There is a response. Countries can do what in effect Germany did, which is to crunch down costs, boost productivity, improve quality so that goods can be sold at a premium and get out of lower-value-added lines. But, among the fringe European countries, only Ireland is so far succeeding in making this transition, with sharp cuts to wage rates as well as other austerity measures.
It is the practical difficulties of making such huge adjustments to pay and benefits that have usually led to countries devaluing their currencies. That is by no means a painless way of cutting costs and it does have the effect of reducing living standards through higher inflation, but in practice it is easier, partly because it shifts some of the burden to savers.
Another way of looking at the need for adjustment is to look at countries' external asset position: the value of a country's overseas assets minus the value of assets within the country owned by foreigners. Countries that run large current account surpluses eventually pile up external assets, either in the form of foreign securities (eg, China buying US treasury bonds) or other assets abroad (eg, Germany owning US car plants). Similarly, countries that run current account deficits will eventually build up external liabilities.
In the case of the US and UK, our persistent current account deficits have led to both countries moving to a net deficit on the stock of external assets. However, the deficits in both cases are not huge relative to GDP.
Within the eurozone, however, the position is less stable. Taken as a whole the eurozone remains in modest deficit but within the eurozone there has been a sharp divergence between Germany and Spain.
Does this matter? Well it may come to matter a great deal. You have to ask: to what extent is it tolerable for one country to 'own' another? What do the owners want in exchange? So there is a reverse Robin Hood effect. Those poorer countries have to pay money, either in interest, rent or dividends, to the richest one.
This is bound to cause tension and is certainly not what the eurozone was supposed to do.
But the alternative, not paying the money, is in effect to declare a default and not just for Greece.