The actual situation is largely a consequence of imbalances in wages, productivity and trade between northern and southern eurozone countries. The present "prussian approach" by Germany (and others) is unsustainable: it assumes that it is the "others" (periphery) full fault and incompetence that created the present situation.
But reality is more complex: solution for the euro conundrum will require concerted actions both from northern as southern countries, and both sides are liable to responsible action, and they may be not very palatable for each of them.
Kermal Dervis, from Brookings Institution and from a non EU country (Turkey), posted a good analysis (Rebalancing the eurozone) in Project Syndicate, calling for action by northern countries as well as southern ones:
The hard austerity policy by periphery may well disintegrate EU: Portugal may be too small to be important, but nobody can argue the same for Italy and Spain. Sooner or later the social tensions within these countries will create a divisive and dangerous clivage in EU. If Greece exits the eurozone, it is Greece fault - but it is also a dramatic political fiasco from inappropriate collective action by the european partners, that failed a balanced policy within reasonable social, human and political costs for greek people. The recessive effects of "austerity only" were easily predictable:
- excessive austerity and deflation could defeat its own purpose and make the “reforms” to improve the southern European countries’ competitiveness impossible to implement. The right approach must combine reasonable wage restraint and low (but not negative) inflation with microeconomic policy measures aimed at encouraging productivity increases.
- In short, internal adjustment in the eurozone is achievable without serious deflation in the south, provided that productivity growth there accelerates, and that the north does its part by encouraging modestly faster wage gains. The smaller current-account surplus in northern Europe that might result from this should itself be welcome. If the north insists on maintaining the low wage growth of the 2000-2010 period, internal adjustment would require significant unemployment and deflation in the south, making it more difficult and perhaps politically impossible to achieve.
Kermal calls for more inflation, growth of wages and consumption in northern countries, together with restraint from southern (periphery):
- Reversing the large differential in unit labor costs that has emerged in the euro’s first decade thus requires not only wage restraint and productivity-enhancing reforms in the south, but also higher wage gains in the north. A simulation shows that if German wages grew at 4% annually instead of the 1.5% of the last decade, and if annual productivity growth in Spain accelerated to 2% (it was close to 0.7% in both countries), Spain could reverse the unit-labor-cost differential that emerged with Germany since 2000 in five years, with Spanish wages growing at about 1.7% per annum.
- This should not be an impossible scenario. It would require restraint in Spain, where wages grew at an average annual rate of 3.4% in 2000-2010, as well as a serious effort to accelerate productivity growth. But it would not require falling wages or significant price deflation: annual wage growth of 1.7% and productivity growth of 2% would be compatible with inflation close to zero. Productivity growth at the historical rate of 0.7% in Germany, with wage growth of 4%, would be compatible with an inflation rate a little above 3%.
- Indeed, excessive wage deflation is likely to have negative effects on productivity. Skilled labor is likely to emigrate faster, and extreme austerity, falling prices, and high unemployment – and the resulting likelihood of social tension – are not exactly conducive to investment, innovation, or labor mobility.
- economic policy should not break a society’s confidence in itself; what economists call “animal spirits” must be able to reflect hope for the future.
Meanwhile, Charles Wyplosz, in a post entitled "The impossible hope of an end to austerity" (voxeu.org) concludes that
- The madness of holding governments to infeasible debt reductions within a couple of years or so must be replaced by the realisation that this objective will take decades, not years, to be reached.
- Some countries will have to default, partly at least, entirely for Greece. Inevitably, the costs will be borne by everyone – bondholders, banks and their governments, and the Eurosystem.
- EIB and Commission money will help a little if they are promptly disbursed. Germany must also conclude that playing the locomotive is in its deep interest and that a little bit of inflation is much more preferable than letting the euro disappear. After all, average German inflation over the roughly 50 years before the euro (1950-98) was 2.7%.
- Sticking to austerity is bound to lead to more Greek-style elections. This is after all the lesson from German history – voters who suffered and despaired and felt mistreated by foreign powers ended up voting for Hitler.
(Update, 16 may: "Only the IMF can break euro logjam", by Charles Goodhart (from LBE) in FT:
- The current asymmetric and incomplete adjustment plan for the eurozone, which focuses solely on the peripheral economies, is self-destructive.
- The IMF must also overcome French and German resistance to a deepening of the single market in services. Last but not least, the IMF should demand a clear and credible road map for reforming the functioning of the eurozone.)
(Update, 17 May: Krugman post about the euro crisis:
- We need a conversion experience here, not in Athens, but in Berlin and Frankfurt. Otherwise, the game is almost over.)
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