How to Save Europe
Gordon Brown is the former prime minister of Great Britain.
London—It was said of one 19th century British politician that he never missed a chance to let slip an opportunity.
Will the Euro summit of 2011 be remembered as “the day European leaders faced the crisis down”—or will it be viewed, in retrospect, as the turning point at which history failed to turn?
Up against almost impossible constraints—the contradictory wishes of 16 Euro members, German public opinion and the European treaty itself—it is to German Chancellor Angela Merkel and French President Nicolas Sarkozy’s credit that they brokered a deal which kept Greece liquid and calmed European markets down.
But these constraints—which mean there can be no bailout, no default, no devaluation and no more money—exist and seem unchallengeable because Europe has not yet faced up to the scale of its crisis. All European leaders can agree on is that they face a fiscal crisis hitting their periphery. Yet the European crisis is not one-dimensional but three-dimensional: not just a fiscal crisis but a banking crisis—one of massive unfunded bank liabilities—and a crisis of low growth, itself the result of the Euro’s inbuilt impediments to recovery. Together and in lethal combination they threaten a tragic roll call year after year of millions of European citizens unnecessarily condemned to joblessness.
At moments of crisis, statesmen and stateswomen have to lead markets and display irresistible resolve. The best example is when, pushing uphill against the constraints of the day, Roosevelt’s New Deal of the 1930s turned orthodoxy on its head and pursued stimulus instead of austerity. In April 2009 at the London G-20 Summit, the world had to underpin its economy by the boldest and most dramatic of measures.
Europe needS to break from its past constraints and agree to historic changes—the costly restructuring of banks, the coordination of monetary and fiscal policies, and reforms to the Euro itself to remove structural barriers to growth. Specifically, the Brussels summit in July needed to accept the inevitability of fiscal transfers, prepare for a precautionary facility for Italy and Spain, and, at a minimum, expand the European stability fund, underpinning it with a backstop facility far bigger than its current size. Yet not one of these items even reached the agenda.
Action, however, that is deferred at one point of crisis will mean even more radical action is required at the next juncture. What might have satisfied markets last month—a Brady-style bailout for Greece—will next time not be sufficient to end Europe’s economic agony. And I fear that in a few months’ time we will need a far bigger backstop—perhaps up to 2 trillion euros to cover the future funding needs of Italy, Ireland, Greece, Portugal, Spain and Belgium. On top of this, bank restructuring may cost as much as 200 billion euros in new capital, perhaps even 300 billion euros, requiring an overall package—partly Euro-member-state-financed, partly IMF-financed—equivalent to a quarter of euro zone GDP. Then we will also have to create a European debt facility (perhaps for up to 60 percent of national GDPs) and, as a sequel to that, greater fiscal and monetary coordination—which will, in turn, mean fiscal transfers on the model of, if nothing yet akin to the scale of, the USA.
But, even if all these stabilization measures are agreed upon, Europe’s growth will remain anemic, and, far from falling according to plan, deficits and unemployment may remain too high. So there is a final inescapable dimension, what I call the “global Europe plan”—a determination that Europe stops looking inwards and looks outwards to export markets in the eight fastest-growing economies (India, China, Brazil, Russia, Indonesia, Turkey, South Korea and Mexico) that will generate most of the world’s new growth. Today only 7.5 percent of Europe’s exports go to these fast-rising economies that will create 70 percent of the world’s growth.
The key to achieving sustained growth is not only a repositioning of Europe from consumption-led growth to export-led growth, but radical capital product and labor market reforms to equip the Euro area for global competition — and a G-20 agreement with America and Asia to coordinate a higher path for global growth.
None of this was discussed in any detail in Brussels. Yet without that agenda for growth, even the most painful austerity is unlikely to prevent contagion to come.
European leaders, who assumed for 10 years that the stability pact was all they needed to cope with a crisis, will find they also have to face up to unprecedented constitutional change. One of the reasons I opposed Britain joining the Euro was that it had no crisis-prevention or crisis-resolution mechanism and no line of accountability when things went wrong. Today we find Europe’s political leaders blocked from expanding the already fragile European Financial Stability Facility because of a voting structure that requires unanimity; still unsure who is responsible in a crisis not least because of their ambiguous relationship with the independent European Central Bank; and even now unable to contemplate the constitutional issues raised by fiscal integration.
But every time the big questions are avoided, and every time the outcome is a patchwork compromise, the next crisis gets ever closer and threatens to be more dangerous. That approach can no longer suffice. From now onwards, no one can assume that Europe’s past strength as a continent is enough to prevent the most difficult of future outcomes.
THE ROLE OF GERMANY | I can well understand the defiant mood in Germany today as it grapples with the crisis engulfing the euro zone. German anger is obvious and well founded.
Over the last 10 years, while Spain, Ireland, Portugal and others partied on low interest rates, the German people cut their wages, endured punishing structural reforms and accepted the pain of 5 million unemployed in a drive to modernize their own industries. Their sacrifices have brought them a large trade surplus and an 80 percent rise in German exports to China.
No other country could have simultaneously borne the costs of bringing 16 million people from Eastern Europe into a unified state, or joined the euro at such an uncompetitive rate and yet still rebuilt their country’s exporting strength.
Germany now has Europe’s strongest economy, and Angela Merkel and the German people deserve praise for the German export achievement. But if that were the only story to tell, then the cure for the current crisis would be simple: follow the German example: austerity, and, if that fails, even more austerity.
Three years ago, when the financial crisis first hit, the German government, like the rest of Europe, quickly defined the problem as an Anglo-Saxon one, and blamed America and Britain. A year later, as the financial crisis widened into a general economic crisis, the Germans retreated into even safer, more familiar territory, redefining the world crisis not as financial but as fiscal—one of deficits and debt.
As a result, Germany has denied any culpability for what has gone wrong. Indeed as long as it can argue that it is not a source of the problem, it can justify resisting costly measures to resolve it.
Yet according to the Bank for International Settlements, Germany lent almost $1.5 trillion to Greece, Spain, Portugal, Ireland and Italy. At the start of the crisis German banks had 30 percent of all loans made to these countries’ private and public sectors. Even today this one category of loans is equivalent to 15 percent of the size of the German economy.
Add to that heavy German involvement in the credit binge in American real estate (half America’s subprime assets were sold on to Europe), and in property speculation across Europe, and it is clear that wherever parties were taking place, German banks were supplying the drinks. The only party the German banks missed out on, one commentator has joked, was Bernie Madoff’s Ponzi scheme.
As a result, Germany’s banks are today the most highly leveraged of any of the major advanced economies, a massive two and a half times more leveraged than their US banking peers, according to the IMF.
Indeed, worried about the impact of stress tests on their credibility, German bank regulators have been hostile to the same disclosure and capital accounting requirements agreed on by every other euro zone country, and one Landesbank—the state-owned regional banks in Germany—went so far as to pull out of the tests the day before the results were released.
But why should this concern Germany, which is competitive, fiscally sound and economically robust? Because all across Europe the poor condition of the banking sector is becoming a risk to recovery and stability. German banks like other European banks rely on raising short term funds, and in the next three years these already weakly capitalized and poorly profitable banks have to raise 400 billion euros from the markets, an amount that is nearly one-third of the entire euro zone’s €1.4 trillion in wholesale debt.
More recently it was the turn of France—like Germany rated AAA by credit rating agencies—to face market pressure because of its high levels of exposure to the euro periphery. Each country’s problems are unique, but, as the epicenter of the crisis moves closer to Europe’s core, Germany too may find its once unchallengeable image as a financial bastion called into question.
In the short term, Germany would be right to push for Europe-wide bank recapitalization, from which it would itself benefit. But it is also time for Germany to acknowledge that it must be integral to solving the problem because it is has been integral to the problem itself.
Of course, no one should expect Germany to transfer a large percentage of its wealth to the EU’s poorer countries on the same scale as other federal states—the US, Australia and others—but it must be persuaded that the crisis cannot be solved without a common Euro-bond facility, legislation for greater fiscal and monetary coordination, and a role for the European Central Bank that takes it one step beyond being the guardian of low inflation by adding a second role as lender of last resort.
In the end, Germany will have to agree to a common mechanism for Europe to pay its way out of crises. Germany’s recent failure to act from a position of strength endangers not only the country itself, but the entire euro project that Germany has spent decades developing.