The Eurozone Dystopia

The economic deterioration in Europe has accelerated substantially since the process of fiscal consolidation started in 2010. The Bundesbank, the most influential member of the ECB system, has enforced an agenda of austerity and strict price control that is at clashes with what peripheral countries need. 

This sequester orchestrated by the creditor nations runs contrary to the lessons learnt during prior crises and to the consensus of the international community –as even the IMF scaled back from expansionary fiscal consolidation theories and supports some of the most progressive views among the FED’s . The situation is such, that not even the most optimists among economists believe that structural reforms and Ricardian equivalences will re-ignite the peripheral economies. The periphery has suffered deflation since starting the crisis, yet, none of these countries have made any meaningful effort to achieve a more balanced position with their creditor counterparts, such as a dual mandate for the ECB (incorporating employment / GDP) or some form of solidarity-compensation stemming from Germany’s ever growing trade surpluses. 

These Governments (Ireland, Italy, Greece, Portugal and Spain) face stratified societies: senior citizens have all their assets denominated in Euro and don’t want to suffer the devaluation associated with leaving the common currency. Younger citizens, whether employed or not, would probably be better-off with the flexibility that a 'devaluable' (able to being devalued) currency would offer, but only the radical political parties echo such views, while the most highly-educated and entrepreneurial of them emigrate to northern latitudes. 

This framework has worked beautifully for the German exporters: not only they benefit from the undervalued domestic currency, they also extract rents from the subsidised labour and the strict anti-inflation mandates embedded in European institutions. 

The problem is to imagine how/when/where this race to the bottom converges with the views of a prosperous Europe that policy-makers had in mind when they designed the grandiose experiment. Sooner or later, the automation of the manufacturing sector will put German’s economic model in jeopardy (Productivity in the manufacturing space will keep raising higher than demand ever does). Equally, South-Europe cannot and should not survive by exporting tourism and olive oil. (There is a better way, even

Now, as the Euro approaches the average life expectancy of monetary unions (not followed by Political and Fiscal unions), the literature to help our ailed Euro-area policy-makers has expanded. Several books point out to the dangers of austerity, advocate for economic stimuli until economic health is restored, and for a new (social) contract between creditor and debtor nations. But perhaps more suggestive for those more strained at home is to dream about Mariana Mazzucato’s “Entrepreneurial State”. She advances that the fiscal multiplier, or the elasticity from the Governments spending in the economy, is greater when the investments are made in value-added sectors, such as research in life sciences, technology, clean-tech energies, etc. With a lion in the cover of her book, she ironizes that it has been Government funding schemes that have paved the way for the private sector to reap the benefits when these technologies have matured. For example: had it not been for the entrepreneurial, dynamic and creative role of the US Government through the DARPA and NIH programs, it would be difficult to imagine such thriving technology and biotech sectors as we know them today in the US. 

In summary, European policy-makers risk falling victims of complacency as sovereign risk premia decrease, but European institutions and R&D intensive SMEs are lagging the progress of international counterparts –sadly, cannot expect that to be reversed through a combination of price controls 

--written in Feb 2014 - Peter Martin fellowship at the FT