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Chancellor Merkel, a woman among NATO leaders, in Chicago, May 20, 2012.
Dr Peter Morici:
The European summit this week will feature a standoff between Chancellor Angela
Merkel advocating austerity and President François Hollande promoting stimulus
to boost growth.
Neither position is without merit, but neither by itself will solve what ails
Greece and other failing Club Med states. Sadly, none of the leaders involved,
including the insurgent left most likely to win the next Greek elections, appear
willing to accept that a successful strategy to put Europe back on track will
require abandoning the euro and returning to national currencies.
After the single currency was introduced in 1999, productivity growth was slower
and prices rose faster in southern Europe than in Germany and other northern
states owing to both cultural and immutable geographic conditions. Consequently,
the north enjoyed growing trade surpluses at the expense of deficits in the
Trade deficits can instigate high unemployment and curb tax revenues, and to
support employment and social programs on a par with their northern neighbors,
the Greek, Italian and Portuguese governments borrowed too much.
In Spain, northern Europeans purchasing second homes and vacationing in its
sunny climate instigated a rush of foreign funds into its banks to build
dwellings and hotels. Spain actually had budget surpluses prior to the 2008
global financial crisis, and its trade deficits were financed by bank borrowing
from foreign sources and questionable loans to homeowners—the American model of
Trade deficits permitted all the Club Med states to consume more than their
uncompetitive economies produced by borrowing, in one form or another, but none
used the opportunity to boost productivity and regain competitiveness.
When the US banking crisis thrust the global economy into the Great Recession,
investors became increasingly aware that Portugal, Italy, Greece and Spain were
pursuing flawed economic models and would never be able to pay what they owe.
Borrowing rates skyrocketed pushing governments in all four countries and
Spanish banks to the brink of collapse.
To get these economies growing again, all must, as Chancellor Merkel prescribes,
spend less on social programs. Europeans like Americans are living longer and
must work beyond current retirement ages or national finances simply can’t work,
and they must rid themselves of the notion their government owes them a living.
These economies must become more competitive too—exporting more, importing less,
running trade surpluses to earn euro to service debt. This requires lower wages
and prices for what they make, as valued in euro.
Lacking national currencies, austerity through high unemployment must force down
wages. For southern Europe that would require at least five, perhaps ten, years
of unemployment of at least 25%—that is simply not politically feasible.
Iceland had a banking crisis similar to Spain in 2008, but has it own currency.
It let the krona decline against the euro fall by more than 50%, dramatically
slashing wages as compared to the rest of Europe. Its government gave continuing
support to the unemployed and assisted troubled homeowners more aggressively
than the US and other European governments.
The combination made Iceland a competitive and attractive location for
investment, and supported the domestic economy as the private sector
Without the most substantial elements of the fiscal reforms prescribed by
Chancellor Merkel, southern Europe cannot become solvent and eventually
independent of German aid, but neither can it be without abandoning the euro and
some reasonable continuing assistance for the unemployed, homeowners and other
Germany, Finland and others need to support this course for their own good—their
private sectors are quite dependent on southern Europe for customers
Without abandoning the euro, southern Europe will collapse, and it will take
Germany and the other northern economies down with them.
Professor, Robert H. Smith School of Business, University of Maryland,