The Wrong Fix

Yesterday, both Bob Kuttner, here in the Prospect, and I ,in my Washington Post column, noted that the deal that German Chancellor Angela Merkel and French President Nicolas Sarkozy struck to save the Eurozone will inflict years of austerity on European nations that are already mired in depression. Spain, for instance, has an unemployment rate of about 20 percent and a youth unemployment rate that is approaching a mind-boggling 50 percent. It needs a massive Keynesian jolt to its economy, not budgetary constraints that will condemn it to a decade or quarter-century of penury.

Both Bob and I also noted that the Merkel-Sarokzy solution was based on a misdiagnosis of Europe’s woes. Some of Europe’s current basket cases were actually running budget surpluses in the years before the Lehman meltdown. Ireland and Spain weren’t overspending at all—but the banks and investors speculating on their housing markets most certainly were. When their banks went under, their economies collapsed, driving their unemployment rates, and their budget deficits, sky-high. If Ireland and Spain could do it over again, they’d have adopted far tighter bank regulations—something that the Merkel-Sarkozy deal doesn’t call for. As for adhering to fiscal restraints—well, they already did that, and look at them now.

A third column yesterday, from the great Martin Wolf, the Financial Times’ chief economics columnist, makes this point definitively. Wolf charts the fiscal balances and national debts of the eurozone nations between 1999 and 2007 and finds that every one of Europe’s currently beleaguered nations, with the single exception of Greece, actually complied with the Sarkozy-Merkel demand that they keep their budget deficits lower than 3 percent of their gross domestic product.

In other words, budget deficits weren’t the problem. So what was? The one factor that did foretell the performance of national economies after the bubble burst, Wolf demonstrates, was a nation’s current account balance—that is, a nation’s international balance of payments, which is composed chiefly of a nation’s trade balance. Charting the balance of payments of Eurozone nations from 1999 to 2007, Wolf shows that those Eurozone nations with a favorable balance—the value of whose exports exceeded the value of their imports – are the nations that have weathered the storm: Finland, the Netherlands, Belgium, Germany, Austria and France. Those nations with negative balances—Italy, Ireland, Spain, Greece and Portugal—are now the sick men of Europe. As Wolf writes: “This, then, is a balance of payments crisis. In 2008, private financing of external imbalances suffered “sudden stops”: private credit was cut off.”

The solution, Wolf writes, isn’t fiscal austerity but “external adjustments”—by which he means Germans have to stop selling so much of their goods to their European neighbors and step up their own consumption of same, while Spaniards and Italians need to start making more of what the world wants and sell it to the Germans. Otherwise, the Germans will continue to pile up surpluses of cash and the Spaniards and Italians will be forced to continue borrowing. Otherwise, the north-south divide in Europe will continue to be one of sellers and buyers, lenders and borrowers.

Wolf’s dispelling of the fiscal-profligacy-as-culprit myth also clarifies one of the conundrums that has arisen in trying to understand Europe’s dilemmas: The nations of Northern Europe have far more extensive social-welfare systems than those of their Southern neighbors. They also have much more efficient and productive economies. Shredding a nation’s safety net, then, doesn’t look like a very good way to bolster its economy. Northern Europe has found a way to have its welfare state bolster, not diminish, its productivity—a synthesis that has eluded the South.

At all events, what Merkel and Sarkozy have come up with is a fix for what doesn’t ail Europe—and a fix that may well injure it even more.