The fate of Europe. Collapse or federation.
In his new book, Michel Aglietta explains how Europe reached a critical point and suggests solutions to the challenges met by the eurozone.By Michel Aglietta
Audio, January 18, 2012
A short non-technical and pedagogical book backed by heavy technical work (a two-year research project I have led to make a report for a big financial institution: “Caisse des Dépots et Consignations”).
The euro area suffers from long-standing institutional flaws encapsulated in its founding treaty. As a counterpart for tying up unified Germany to Europe, her partners have nominally accepted German ordo-liberalism. It has been anchored in an impossible triple no: no default, no bail-out and no transfer union. In the corset of those rules, the euro has been an incomplete currency for the monetary union and an external currency for all members.
The weakness of the European Commission and the lack of cooperation in the intergovernmental dialogue have let structural deficiencies grow into acute economic divergences. As was expected in an integrating region without countervailing industrial policy, polarization has arisen between an industrial German-led core and deindustrialized periphery, including France and Italy. The pattern of capital flows has exacerbated the real economic trends in fostering cumulative balance of payment imbalances. With the exception of Greece, the building up of financial fragility had nothing to do with public finance before the global financial crisis, but much to do with private indebtedness.
When private debt profligacy turned into debt deflation in the wake of the financial crisis, public finances were called to save the financial system and to stem the deflationary spiral like anywhere else in the developed world. However, the burden of surging public debt intermeshed with the structural impediments in the euro area to exacerbate the polarization. The discovery of Greece’s cheating on her public deficit was just the catalyst that inflamed anxious financial markets, undermined by the shock of the structured credit crisis and left astray by continuous political uncertainty. The spiral of escalating sovereign bond rates, spurred by the rating agencies, has only been interrupted by short-lived respites, induced by a reluctant ECB.
The book analyses the intertwining between the structural economic weaknesses, the destabilizing financial dynamics overwhelmed by liquidity scares and by the inadequate political governance. German authorities have been unable to exert proper leadership, because they are prisoner of their ideological biases: homeopathic step-by-step approach while radical overhaul is called for, obsession of fiscal austerity imposed to every country and above all no inflexion in their export-led economic model that fosters cost-deflation bias everywhere and deepens the balance of payment crisis in deficit countries. This policy pursued in times of private sector deleveraging undermines the very existence of the euro zone.
The day of reckoning is coming in 2012 with heavy refinancing requirements and with critical political events, while the whole of Southern Europe is slipping into recession. After 15% decline in GDP and the very destruction of the middle class Greece and presumably Portugal are on the verge of collapse. Whether disorderly Greece’s exit arises, contagion will become overriding. The euro zone crisis will reverberate all over the world.
The book takes systemic risk seriously and provides a comprehensive framework to solve the crisis in stressing the need to reassess the objective of the six-decade European construction, in pointing out the interactions between improved cooperative European governance and economic rebalancing and in focusing to the time sequence of reforms. Nothing less than drastic overhaul of basic political tenets will work: unbiased fiscal union, ECB’s responsibility enlarged to overall financial stability, Eurobond issues, centralization of financial regulation and above all European industrial policy aiming at inverting the continuous potential growth decline of Europe and reindustrializing deserted regions.
The latter is all-important. Public debt consolidation is a long-run process, essentially conditioned by long-term growth, which is the main factor in determining the range of sustainable debt paths. The growth process should be driven by policies that stimulate innovations rooted in the territories by their very nature to regenerate countries that have been impoverished by liberal policies. It should also involve deep fiscal reforms to stem the socially destructive impact of widening inequalities. The successful consolidation process in Scandinavia after the financial crisis in early 1990’s is a useful model that gives insights for the consistency of policy changes in different economic sectors.
The following sequence is relevant: bank restructuring and tougher regulation to strengthen their balance sheets and make them more responsible to the financing of the domestic economy, aggressive exchange rate policy to sustain demand while fiscal consolidation is underway and industrial policy aiming at elevating the productive system to the technological frontier in boosting the generic innovation of the time in IT. Fiscal restructuring was guided by the industrial goal and legitimacy was fulfilled by a large consensus in parliament.
In the book it is argued that the innovation of our time, worth pursuing to rejuvenate entrepreneurial spirit, is environmental. This type of innovation is validated by the urgency of climate change mitigation and adaptation. It has the advantage of triggering industrial projects that are territorialized by their very nature. It can be driven by price policy that can change the structure of returns and risks to attract investors in creating a new asset class: carbon assets. They would be created by the institution of a social value of carbon via a European carbon tax levied at the EU level, which will have the advantage of broadening the EU budget. The book shows how a financial intermediation can be built upon the proceed of the tax, used to provide guarantee to bond issue by a public financial intermediary I call the Green European Fund. This new institution will issue bonds to attract institutional investors on its liability side and finance a large array of diversified projects on the asset side.
The book shows how Europe can be a new brand of federation structured by fiscal cooperation and by common industrial policy at the edge of the new wave of industrial revolution. The last chapter argues that the euro can become a full international currency in the aftermath of this comprehensive reform and that it can play its part in the transition to multipolar world.
Zone Euro : éclatement ou fédération, Paris : Michalon Editions, 2012.