A Second Chance for European Reform

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The European Central Bank has managed to calm the marketswith its promise of unlimited purchases of eurozone government bonds, becauseit effectively assured bondholders that the taxpayers and pensioners of theeurozone’s still-sound economies would, if necessary, shoulder the repaymentburden. Although the ECB left open how this would be carried out, itscommitment whetted investors’ appetite, reduced interest-rate spreads in theeurozone, and made it possible to reduce the funding of crisis-strickeneconomies through the printing press (Target credit).
This respite offers an idealopportunity to push forward with reforms. Greek Prime Minister Antonis Samarasmust convince his countrymen that he is serious about implementing them.Spanish Prime Minister Mariano Rajoy and Portuguese Finance Minister VitorGaspar deserve more support for their plans. And one can only hope that Italy’scaretaker prime minister, Mario Monti, contests the next general election. All of theseleaders understand what must be done.
France, by contrast, does not appear to have noticed thewriting on the wall. President François Hollande wants to solve his country’sproblems with growth programs. But when politicians say “growth,” they mean“borrowing.” That is the last thing that France needs.
France’s debt/GDP ratio is already around 90%; even if its 2013budget deficit does not exceed 3.5% of GDP, its debt/GDP ratio will haveclimbed to 93% by the end of the year. The government’s GDP share, at 56%, isthe highest in the eurozone and second highest among all developed countries.
It is not only film actors like Gérard Depardieu who areleaving the country to escape its high taxes; industry is fleeing as well.France’s once-proud carmakers are fighting forsurvival.
Indeed, France’s manufacturing industry has shrunk tobarely 9% of GDP, less than Britain’s manufacturing share (10%) and less thanhalf of Germany’s (20%). Its current account is sliding into an ever-deeperdeficit hole. Unemployment is rising to record levels.
France’s basic problem, like that of the countries mostaffected by the crisis, is that the wave of cheap credit that the euro’sintroduction made possible fueled an inflationary bubble that robbed it of itscompetitiveness. Goldman Sachs has calculated that France must become 20%cheaper to service its debt on a sustainablebasis.
The same is true of Spain, while Italy would have to become10-15% cheaper and Greece and Portugal would need domestic prices to fall 30%and 35%, respectively. The OECD purchasing-power statistics paint a similarpicture, with Greece needing to depreciate by 39% and Portugal by 32% just toreach the price level prevailing in Turkey. But, so far, virtually nothing hasbeen done in this respect. Worse, some of the troubled countries’ inflationrates are still running higher than those of their trading partners.
Eurozone politicians tend to believe that it is possible toregain competitiveness by carrying out reforms, undertaking infrastructureprojects, and improving productivity, but without reducing domestic prices.That is a fallacy, because such steps improvecompetitiveness only in the same measure as they reduce domestic pricesvis-à-vis eurozone competitors. There is no way around a reduction in relativedomestic prices as long as these countries remain in the currency union: eitherthey deflate, or their trading partners inflate faster.
There is no easy or socially comfortable way to accomplishthis. In some cases, such a course can be so perilousthat it should not be wished upon any society. The gap is simply too largebetween what is needed to restore competitiveness and what citizens can stomach if they remain part of the monetary union.
In order to become cheaper, a country’s inflation rate muststay below that of its competitors, but that can be accomplished only throughan economic slump. The more trade unions defend existing wage structures, andthe lower productivity growth is, the longer the slump will be. Spain andFrance would need a ten-year slump, with annual inflation 2% lower than that oftheir competitors, to regain their competitiveness. For Italy, the path towardcompetitiveness is shorter, but for Portugal and Greece it is substantiallylonger – perhaps too long.
Italy, France, and Spain should be able to regaincompetitiveness in the eurozone within a foreseeable period of time. After all,Germany cut its prices relative to its eurozone trading partners by 22% from1995, when the euro was definitively announced, to 2008, when the globalfinancial crisis erupted.
Ten years ago, Germany was like France is today – the sickman of Europe. It suffered from increasing unemployment and a lack ofinvestment. Most of its savings were being invested abroad, and its domesticnet investment share was among the lowest of all OECD countries. Under growingpressure to act, Gerhard Schröder’s Social Democratic government decided in2003 to deprive millions of Germans of their second-tier unemploymentinsurance, thus paving the way for the creation of a low-wage sector, in turnreducing the rate of inflation.
Unfortunately, thus far, there is no sign that the crisiscountries, above all France, are ready to bite the bullet.The longer they cling to a belief in magic formulas, the longer the euro crisiswill be with us.

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关键词：European Chance Europe Reform Second government necessary possible carried

The European Central Bank has managed to calm the marketswith its promise of unlimited purchases of eurozone government bonds, becauseit effectively assured bondholders that the taxpayers and pensioners of theeurozone’s still-sound economies would, if necessary, shoulder the repaymentburden. Although the ECB left open how this would be carried out, itscommitment whetted investors’ appetite, reduced interest-rate spreads in theeurozone, and made it possible to reduce the funding of crisis-strickeneconomies through the printing press (Target credit).
Thisrespite offers an ideal opportunity to pushforward with reforms. Eurozone politicians tend to believe that it is possible toregain competitiveness by carrying out reforms, undertaking infrastructureprojects, and improving productivity, but without reducing domestic prices.That is a fallacy, because such steps improvecompetitiveness only in the same measure as they reduce domestic pricesvis-à-vis eurozone competitors. There is no way around a reduction in relativedomestic prices as long as these countries remain in the currency union: eitherthey deflate, or their trading partners inflate faster.

In order to become cheaper, a country’s inflation ratemust stay below that of its competitors, but that can be accomplished onlythrough an economic slump.

Ten years ago, Germany was like France is today – thesick man of Europe. It suffered from increasing unemployment and a lack ofinvestment. Most of its savings were being invested abroad, and its domesticnet investment share was among the lowest of all OECD countries. Under growingpressure to act, Gerhard Schröder’s Social Democratic government decided in2003 to deprive millions of Germans of their second-tier unemploymentinsurance, thus paving the way for the creation of a low-wage sector, in turnreducing the rate of inflation.