What can we expect to be the outcome of the EU summits leading up to the November 3rd Cannes G-20? It is difficult to interpret the signals and one feels like one has to give the day and time when such an article is written since things seem to be constantly moving and changing. But let’s assume for a moment that the EU will get its act together and one of the presidents, prime ministers, or chancellors will get up and lead his or her colleagues to act decisively and to implement a shock and awe strategy for the capital markets in the coming weeks.
Greece gets a 50 percent haircut and with just one more austerity program is able to have a balanced primary budget. The European Financial Stability Facility (EFSF) will be leveraged enough to convince markets that further attacks that undermine Portugal’s or other Club Med countries’ ability to finance their budget deficits are doomed to fail. Can we then turn to other pressing problems—like how to support the Arab Spring—and consider the euro crisis solved?
At the moment the whole discussion focuses on the fiscal and monetary aspects of the crisis. The underlying economic reasons for the crisis within the currency union of the seventeen very different states are rarely discussed. The huge internal macroeconomic imbalances are caused by a shift of competitiveness within the union. But was that shift unforeseeable and sudden, or is it a rather continuous trend where some regions within the currency union benefit from on average higher productivity growth than others? If the latter is true, and I think it is, there are exactly four ways how the weaker-growth regions can adapt:
They can depreciate their currency relative to the growth gap. That, of course, is no longer possible within a currency union.
They can keep wage increases relatively lower compared to the economically stronger regions.
Their workforces can migrate to the stronger regions as they get laid off at home due to shrinking competitiveness.
The faster growing regions can transfer money to the slower regions to support those who no longer can be competitive enough to earn a living or to support a state that cannot generate enough income for redistribution when the economy is shrinking.
If none of the four adjustment mechanisms—or any combination of those—works, either the faster or the slower growing region will leave the currency union voluntarily or after a revolutionary process.
Just look at Germany as an example. Germany’s southwestern region benefits from higher productivity and economic growth than the north and the east. Since all of Germany uses the same currency, we see a combination of mechanisms 2 to 4 mentioned above. Wages in the private industry increase a bit more in the southwest, East Germans migrated in large numbers to the West and with the Länderfinanzausgleich (the financial equalization scheme) the states of Hesse, Baden-Wuertemberg, and Bavaria transfer billions every year to the north and east. That is why Germany and its sixteen diverse Länder could stay together as a currency union. Somewhat the same is true for the United States. Can we imagine the euro zone developing in that same direction?
Since the beginning of the euro the countries with lower productivity growth have not stayed behind the region with faster growing productivity when it comes to wage development. Until today we have not seen a significant migration of workforce from the periphery to the core of the euro zone. And how can you expect the northern Europeans to show lasting solidarity with, for example, southern Italy if not even the northern Italians are willing to pay for their poorer countrymen?
Whatever the outcome of the next two weeks will be, it will at best calm markets and buy more time to deal with the fundamentals of a currency union that consists of economically very diverse regions.
Dr. Tim Stuchtey is the managing director of the Brandenburgisches Institut für Gesellschaft und Sicherheit (BIGS), a homeland security think-tank based in Potsdam, Germany. He is also a Senior Fellow and Director of the Business & Economics Program at AICGS.
This essay appeared in the October 21, 2011 AICGS Advisor.