Europe's Exit from the Greek Crisis (Part I)

The fiscal crisis has created the conditions in which Europe can assemble the political momentum to deal with the underlying cause of its present economic problems. That cause is a huge loss of competitiveness vis-à-vis Asia, which had been concealed from view by the artificial and temporary credit expansion of the past ten years.

That credit expansion was a sort of anesthetic that dulled the pain of an underlying loss of competitiveness. Now that the anesthetic has been abruptly withdrawn, there is real pain. But that pain is a spur-to-action to cure the problem — and without it, the problem would have been allowed to get even worse before anything would have been done.

European countries will have to restore competitiveness by shifting resources into education and infrastructure — and away from consumption of all kinds, including government consumption, and by cutting service and wage costs through greater competition and productivity.

The European Union will have to take on the powers necessary to prevent a recurrence of a Greek-style crisis — powers it should have been given when the currency union was formed.

For example, Greece — very much for its own sake, as it turns out now — should not have been allowed to join the euro until it had first undertaken structural reforms that would have put its public finances on a sound and transparent footing on a long-term basis.

Specifically, the EU should have insisted that Greece's pension and tax collection problems, problems that are now being tackled in the midst of the crisis, were dealt with before Greece was allowed to join the euro.

True, this would have required much greater EU interference in matters that Greeks might then have regarded as purely national questions.

But if, as now appears to be the case, states within the euro are not to be allowed to default — and are thus to benefit from low interest rates that stem from being in a currency union — then there is no choice but to have this sort of interference.

Otherwise, there would be a continuing risk of euro countries going off the rails repeatedly and having other countries repeatedly in a position of having to pledge their credit to get them back on track.

This same sort of EU involvement with domestic economic policymaking will continue to be necessary after a country has joined the euro. While the problems of Greece predated its entry to the euro, those of Spain and Ireland arose after they had joined and were able to enjoy interest rates that were lower than they would have had to pay if they still had their own currencies.

The EU needs to be able to supervise the volume and direction of credit expansion in member states of the euro to ensure that it does not lead to an unsustainable private-sector credit situation that eventually puts government credit at risk too.

The EU also needs to be able to supervise developments in the relative competitiveness of different countries within the eurozone. If a country is losing competitiveness because its costs are rising faster than those of its neighbors, it will lose business — and that will mean that its government revenues will fall.

That, in turn, could eventually lead to solvency questions for the government, as we have seen. If governments in the eurozone are not to be allowed to default on their debts — and if other EU states may have to ask their taxpayers to help out — that means that a loss in competitiveness of an individual eurozone country is a matter of legitimate concern for all eurozone countries.

Editor’s Note: Read Part II here.