Is There Growth or Is it Just Plain Wishful Thinking?

Elena Panaritis – Christopher Pissarides

High-profile European officials are playing up the fact that Europe is expected to see positive growth in 2014. But what they don’t like to talk about is the fact that it will be miniscule compared to the United States and much of the rest of the world. They also rarely talk about how deeper the recession in Europe has got since the global financial crisis erupted in 2008. It is so deep that Europe still needs a lot more time to get back to where it was in 2007, when advanced countries reached their pre-recession peak.

– Today, domestic output in the Eurozone as a whole is still very low (3% below what it was in 2007), a gap that is not expected to close in 2014.

– The rate of unemployment in the Eurozone is 12%, compared with 7.5% in 2007.

In the United States, output is almost 7% higher than its level in 2007, even though the rate of unemployment remains somewhat higher, climbing to 6.7% this month from a five-year low of 6.6%.

For us southern Europeans, the facts are rather depressing. When discussing the situation today our European leaders fail to mention that there is an unequal distribution of the rewards from growth. It is not without irony that the relatively rich north is getting richer and the relatively poor south is getting poorer.

Germany’s domestic production, for instance, is currently running at about 3% higher than in 2007. In Greece, it has fallen by more than 27%. As for the rate of unemployment in Germany, it is just 5.2% – this is 3.5 percentage points lower than when the crisis started. In Greece, the rate of unemployment has soared to a high of 28% – this is 20 percentage points higher.

If one probes deeper into these unemployment figures, they will be confronted with yet another horror story: youth unemployment. In Germany, the rate of unemployment for men and women aged between 15 and 24 has actually dropped from 12% to 7.8%. Not so in Greece, where youth unemployment has risen from 22% in 2007 to a staggering 58% in 2013. Meanwhile, in the Eurozone as a whole (where EU heavyweight Germany is the biggest member), the rate of youth unemployment increased from 15% in 2008 to 23.7%, according to the latest available figures.

In addition, the serious mishandling of the Eurozone crisis has highlighted a dangerous lack of leadership that would inspire European citizens, which in turn has created a growing and very angry outburst of populism.

This is in stark contrast to how previous world crises were handled and is causing further erosion of confidence in the EU and in the proposed solution packages. A pertinent example of a previous economic crisis is Germany’s need for reconstruction after World War Two. The United States provided generous assistance through the Marshall Plan without any recourse to US taxpayers for their views. The leaders at the time had a forward-looking vision, realising that a prosperous Germany was better for the West than a bankrupt one. In the first economic crisis of the 21st century, however, we have a popularized leadership that sometimes makes financial decisions not on the basis of sound economic argument but on the basis of whether or not voters want to pay higher taxes now (ignoring future benefits that might accrue).

Positive growth in Europe does not mean that the Eurozone crisis is over, or that the Euro will survive.

The austerity policies that the EU adopted in 2010 and continues to implement are unsustainable and quite frankly harmful. One of the most difficult lessons learned as far back as the Great Depression of the 1930s is that austerity cannot reverse recession. The situation in Greece and Spain is not all that different from the one that the United States and other advanced countries had to deal with in the 1930s, but the lesson does not seem to have been learnt. Another example of the damage that austerity can do is from the austerity that the Allies imposed on the Weimar Republic after the First World War. It merely served to fuel political extremism. This is something that we are starting to see in Greece.

The root of all the problems of the Eurozone is structural and manifested in overly complicated and burdensome rules and regulations that are unfriendly to entrepreneurship, new ideas and innovation. This has ultimately resulted in large debts and an over-expanded inefficient banking system. These problems have to be fixed first before austerity can be effective.

What is needed is some serious productivity improvement that is supported by innovation and entrepreneurial activity and that will open up new sectors of economic activity and will lead to much-needed job creation. Europe desperately needs more investment – not more austerity which in the end serves to stifle demand and create more problems than intended to solve.

It is futile to expect a population to go through the pains of structural reform without the promise of immediate rewards.

There are no immediate rewards under austerity because the implementation of such reforms is put at risk and even if successful, there is no demand for the products of new enterprises and there can be no growth.

The usual response to a plea like ours is to ask “What about the debt?” and “Won’t an abandonment of austerity lead to more and even less sustainable burdens of debt?”

Indeed, this is the case in countries like Greece that have a very large debt to GDP ratio. But low debt is neither necessary nor sufficient as a safety valve against default. Even if debt is low, default can still occur.

This is what we experienced in the 1990s when many Latin American countries defaulted with a much lower debt to GDP ratio than the eurozone periphery has today. For example, Argentina defaulted with a debt of about 60% of its GDP, much less than the eurozone average (96%). The countries of Latin America that defaulted managed to exit their crisis thanks to serious structural reforms coupled with macro adjustment. Some Asian countries underwent a similar solvency crisis and adjustment period. What all this means is that austerity-induced debt reduction in Greece is no guarantee against default.

But there is no doubt that structural adjustment is easier to achieve when the debt burden does not weigh heavily on people’s shoulders. In this respect, Europe can learn from the experiences of Latin American and Asia. In these crises, as well as in Eastern Europe after in the 1990s, debt forgiveness played a key role in recovery. For this reason we suggest that in order to give structural reform a chance to succeed, debt forgiveness must first be seriously considered in the case of Greece and be given priority over other assistance initiatives.

The Eurozone partners need to take stock of how far the union has come and what kind of union do they really want for the future.

The high debt levels can at least partly be blamed on badly-designed Eurozone institutions. Some reforms have been implemented, but we are still a long way from the necessary banking union – not to mention a fiscal union of some kind. Instead of a Latin American-style default, we believe there should be a mutualization of European debt in order to facilitate structural reform and recovery which will transform the Eurozone (almost overnight) into a true union of equal partners. Mutualization can easily be achieved in a number of ways. The most obvious is the issuing of freely traded Eurobonds by the European Central Bank, which can be used to service sovereign debts. This seems to us to be preferable to defaults, or even to a break-up of the union, which will merely disrupt the European economy even more. Europe needs to take more firm action and it needs to do this fast in order to get out of the vicious cycle of austerity-recession-austerity-recession. This is the only way to rescue an entire generation from sinking deeper into an abyss of oblivion.