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Global macro & geopolitics from a small economy perspective

Lessons from the Eurozone

David Skilling
Singapore Straits Times, 7 July 2012

The rumours of the death of the Eurozone have been much exaggerated. Over the past couple of years, Eurozone crisis commentary has filled the pages of newspapers around the world and occupied television’s talking heads. The tone of much of this commentary – certainly in the Anglosphere – has been overwhelmingly negative, with consistent predictions of inevitable disintegration. And often accompanied by more than a little schaudenfreude. There have been too-many-to-count predictions of the imminent doom of the Euro project; the numerous apparently final deadlines for resolution of the crisis; and the constant refrain of the need for governments to get ahead of financial markets. The Germans have come in for particularly heavy criticism for not doing enough, and for ignoring economic realities.

Given this apparent consensus view, it is remarkable that in July 2012, over two years into the crisis, the Eurozone is still standing – with major challenges to be sure, but still alive. No disorderly Grexit, no major blow-ups, and a relatively stable value of the euro against the US dollar. There are many economic and fiscal challenges still ahead, as well as the increasingly obvious social and political strains associated with austerity and slow or non-existent growth in many countries. But getting to this stage is a real achievement, particularly given the enormously costly consequences of an implosion of the Eurozone.

I take three lessons from this experience. First, that the Eurozone issues – and indeed, many other international economic issues such as disputes around external imbalances or exchange rates – are primarily political in nature. It is political because it is fundamentally about the allocation of losses and risks across many countries in ways that are seen as approximately fair and sustainable. Given the scale of the political and economic challenges being faced, the performance of Eurozone leaders has been more than creditable. Although heavily criticised, they have done about as good a job as could reasonably be expected in the circumstances.

Arguments that the absence of a solution reflects a lack of political courage or intellect are simplistic – the Eurozone’s problems are fiendishly complex, with tough cross-border politics. A useful way of characterising the current approach of ‘kicking the can down the road’ is that Eurozone leaders have been buying time to identify solutions and achieve a political environment in which solutions are possible. And progress is being made. The current permission to act is much larger than six months ago; real discussions on issues like banking union were simply not possible until recently.

Second, that because this is fundamentally a political issue, the conventional wisdom – which seems to have been shaped largely by economic and market commentators – is not particularly helpful. Many of the most strident predictions of Eurozone doom have come from the economic analysts, financial markets, and with particular force from the US and the UK. Economists point to the failure of Eurozone leadership to adopt apparently obvious solutions; market commentators note the absence of ‘shock and awe’ measures to improve investor sentiment; and the Anglo media tend to convey the sentiment that ‘we told you this was a bad idea’. Aside from the continued existence of the Eurozone, one indicator of the lack of market insight is the consistent pattern over the past couple of years of a market surge after a Eurozone Summit followed by a sharp fall within a couple of days after a recognition that the problems have not been ‘fixed’.

In a world in which politics, and the actions of governments, are increasingly important, understanding these developments requires insight into political economy as well as economics and markets. Laws of economic gravity have not been suspended, and economic analysis is still of use, but in a world where political economy looms large thoughtful political commentators offer valuable insights. The conventional wisdom on international economic issues needs to be shaped by people who understand politics and history as well as economics and markets. In the Eurozone context, this would have highlighted the deep political commitment to the Eurozone and a willingness to stave off collapse.

The third lesson is that, to the extent possible, governments should operate on political time rather than market time (particularly on challenging issues such as the Eurozone). It is commonly believed that financial markets act as the ultimate check on government. James Carville, advisor to Bill Clinton, famously noted that if reincarnated, he would like to return as the bond market so that he could intimidate everyone. And government leaders across the Eurozone have been under sustained pressure to respond not only to economic fundamentals, but also to more volatile market sentiment. But the European experience has shown the wisdom of focusing on structural and institutional issues that are necessary to resolve the crisis rather than responding to the short-term pressures of markets. Perhaps ironically, this medium-term focus may be why the Eurozone is making more progress on fiscal consolidation and structural reform than the US, which is relying on market-friendly fiscal and monetary stimulus.

The Eurozone crisis remains deeply challenging, and it is not clear whether the Eurozone will remain permanently in its current form. But the political strategy of muddling through has worked tolerably well, and is increasing the likelihood of a lasting solution being achieved. Structural reforms and changes will be required, but these will be political choices – that reflect economic fundamentals – rather than decisions imposed by markets. This experience is a reminder that politics matters greatly in resolving international economic challenges, that governments have meaningful choices to make about how best to proceed, and that the conventional wisdom is not always right.