The growth of private international financial institutions since the 1970s has seriously curtailed the ability of national governments to exercise democratic control over economic policy. This was vividly demonstrated early in the 1980s, when capital flight forced the French government of President Mitterand to abandon its programme of progressive economic reforms. Since then, private global finance has become much stronger, and the constraints are especially severe for smaller countries.
A strengthening of the European Union (EU) and a single monetary bloc comparable in size to the United States could be used to achieve a major shift in the balance of power between democratically elected political authorities and private financial institutions. By acting at a European level it would be possible to achieve greater democratic control over economic policy than is possible in individual European states.
Major corporations, which organise their activities on a global basis, can play countries off against each other, obtaining concessions by threatening to shift production and jobs to other locations. But because the European market as a whole – like that of the US or China – is too important to abandon, it would be possible to impose greater social regulation on corporations’ activities at a European level.
The EU has, of course, in practice taken a different path. Since the 1980s in particular, EU policy has been dominated – as in most member states – by a strongly neoliberal approach. Instead of trying to promote greater social control over private capital, it has explicitly allied itself with the interests of private business, leading to a rising social cleavage in much of Europe. The EU has also embraced a greater integration into world markets, promoting an aggressive, mercantilist trade policy – to the detriment of many developing countries.
The EU’s most ambitious project, the launch of the euro in 1999, has been based on major flaws. It involves a common monetary policy, but there is no common fiscal policy, let alone a common wage or industrial policy. The common monetary policy, furthermore, is based on highly restrictive principles inherited from the German Bundesbank. While this approach proved beneficial for German business so long as other European countries pursued high growth strategies that took higher inflation in their stride, it has proved fatal when imposed on the euro area as a whole, contributing to higher rates of unemployment even before the outbreak of the crisis in 2007.
The EuroMemo group (Economists for an Alternative Economic Policy in Europe) has since its founding in the mid-1990s consistently criticised the undemocratic structures of the EU and the neoliberal policies pursued by both the EU and its member states, and argued that progressive economic policies can be most effective if implemented at a European level. The most pressing issue addressed in this year’s EuroMemo Report is the need for an alternative to the EU’s response to the crisis of the euro area. This crisis is the result of two interlocking factors: the international financial crisis which began in the US, and major imbalances within the euro area itself.
The financial crisis broke in the US following years of over-lending in August 2007 and deepened dramatically in September 2008. Big European banks had expanded their business in the US since the 1990s in order to take advantage of the apparently higher returns there and, when the crisis broke, both US and European banks were hit with big losses. A major financial collapse in October 2008 was only prevented through large-scale government injections of capital into many of the biggest banks.
The financial crisis led to a major contraction of credit, and in the final quarter of 2008 and the first quarter of 2009 the US and Europe were faced with the most severe recession since the 1930s. EU output fell by almost 5%, and the impact would have been even more severe had governments not responded by introducing emergency programmes to boost their economies.
The rescue of the banks, the cost of the emergency fiscal programmes, and a sharp fall in tax revenues due to the recession led a large increase in government deficits. In the euro area the deficit jumped from 0.7% of GDP in 2007 to 6.4% in 2009.
When countries joined the euro area, their interest rates converged on the (lower) German level. The lower interest rates contributed to higher economic growth and rising wages in Southern Europe, although higher inflation than in Germany eroded the real value of the wage increases to some extent. Lower interest rates also fuelled a boom in house prices in Ireland and Spain.
In Germany, by contrast, policies introduced by the Social Democrat – Green government meant that wages did not rise at all in real terms between the introduction of the euro in 1999 and the outbreak of the crisis in 2007. With stagnant consumer spending, economic growth was dependent on rising exports. Thanks to the single currency, Germany was able to expand its exports to other euro area countries without the value of its currency rising (and making its exports more expensive) as would have occurred without the euro.
As a result of these contrary developments, between 2000 and 2007 the German trade surplus increased from 65 bn to 195 bn euro, and this was closely mirrored by the trade deficit of Greece, Portugal and Spain, which increased from 61 bn to 160 bn euro. The deficit of the Southern countries was largely financed by loans from banks in Germany and France.
The weakest link in the polarised relation between Southern and Northern Europe was Greece. In 2007, even before the crisis began to bite, the government deficit was equal to 5% of GDP, principally because of a failure to tax the well-off, and this rose to some 15% in 2009 (the exact figure is disputed in Greece). As financial investors began to smell blood, speculation against Greek government bonds intensified in early 2010. The failure of the EU to respond until the situation became critical in May led to a weakening of the euro and the onset of the euro area crisis.
Although it was the big banks which caused the crisis in 2007 and which – after being rescued by governments – led the speculation against euro area government bonds, the measures which the EU has adopted to reform the financial sector are even milder than those introduced in the US. Instead of fundamentally reforming the financial sector, the EU’s response to the crisis – led by Germany – has focussed on imposing fiscal discipline on deficit countries. But fiscal deficits are the result not the cause of the crisis. Apart from Greece, other peripheral euro area countries had small fiscal deficits before the crisis and Spain actually had a fiscal surplus. In most countries, it was the private sector that had run up debts.
When Greece, and subsequently Ireland and Portugal, were obliged to turn to the EU for financial support, this was made dependent on implementing austerity programmes involving severe cuts in wages, pensions and other public spending. This has driven countries into deep recessions and, in addition to the deeply regressive social impact, tax revenues have declined making it even more difficult for governments to service their debts. As the recession deepened in Greece in 2011, it was forced to return to the EU for yet further support. At the same time, Italy and Spain have been pressured to cut public spending as a condition of European Central Bank (ECB) support in the government bond market. The result is that the euro area, including Germany which depends on exports to other euro area countries, is expected at best to stagnate in 2012.
The EU summit in March 2011 agreed on a series of measures for dealing with imbalances in the euro area. However, these put the weight of adjustment on countries facing deficits. Countries with a trade surplus, such as Germany, are not required to expand. Countries where wages rise more than productivity, as in Southern Europe, are required to adjust, but not countries, again such as Germany, where wages rise less than productivity.
Since the onset of the euro area crisis, the EU’s response has been too little, too late. Its policies have either failed to deal with the cause of the crisis or actually made it worse. The insistence by Germany and others on making private investors take losses on their bond holdings led to panic selling which seriously exacerbated the crisis. The ECB’s 3-year loans to banks of a massive 489 bn euro at 1% interest in December involves a huge subsidy for the banks, with no guarantee that they will use the funds to buy government bonds. Due to private sell-offs, the interest rate which Italy and other countries will have to pay to refinance government debt in 2012 remains prohibitively expensive and there is a serious danger of further panic selling.
As an immediate measure the ECB should announce that it will spend whatever is necessary to stabilise government bond prices so as to end panic selling. The EU should then introduce measures to achieve a radical downsizing of the financial sector. In place of the current complex of giant profit-driven institutions and the opaque mountain of complex securities, cooperative and public-sector commercial banks should be promoted to provide financing for socially and environmentally desirable investment projects.
Unsustainable public debt, as in Greece, should be subject to a Debt Audit (as pioneered in Ecuador) to determine which debts are legitimate and which should be written off. Debt reduction should also be achieved through a wealth tax on the very rich. They own much of the 40 trillion euro financial wealth held in the euro area in 2011 and have benefited inordinately from neoliberal policies in recent decades. To prevent future speculation against weaker states, euro area governments should swap remaining government bonds for jointly issued euro bonds.
The common monetary policy should be complemented by a coordinated euro-area fiscal policy. In place of the current one-sided emphasis on fiscal discipline, this should aim to stabilise the economy and promote full employment with what the International Labour Organisation calls ‘decent work’. The EU budget, currently equal to a meagre 1% of EU GDP should be increased to at least 5% in order to have a macroeconomic impact and to provide greater support for weaker regions. To this end, the long-term decline in the taxation of higher incomes should be reversed, with incomes of over 250,000 euro a year taxed at around 75%. In addition, countries with a trade surplus, like Germany, should introduce expansionary policies so as to strengthen euro area demand and relieve the pressure on deficit countries.
A strong programme of public investment is necessary, especially in peripheral countries, in order to establish productive capacity based on modern technology and skilled jobs rather than on low wages. Financing for this should draw on the European Investment Bank, which is already empowered to issue bonds.
A coordinated euro area wage policy should ensure that the widespread decline in the share of wages in national income is reversed, and that wages in states with lower incomes begin to converge on those with higher incomes. Normal working hours should be reduced to 30 hours a week both to combat unemployment and as a contribution to building a society in which life is not dominated by waged work.
A progressive response to the crisis in the euro area also confronts a major challenge: while the debt crisis faced by peripheral euro area countries calls for economic growth, environmental sustainability requires a massive reduction in the consumption of non-renewable resources and the emission of green-house gasses.
The EU response to the crisis has been highly authoritarian. Fiscal discipline is to be imposed on euro area states by the European Commission and measures will be automatic unless meetings of EU finance ministers vote with a super-majority to suspend them. In countries such as Greece and Portugal democratic control over economic policy has been suspended for the foreseeable future.
The current situation in the euro area is unsustainable. Greece and other peripheral countries are confronted with the prospect of prolonged austerity and mass unemployment. But for a small country like Greece to leave the euro area would expose it to massive economic disruption and lead to a further large fall in living standards.
The EuroMemo argues for a coordinated European response to the crisis. In place of the current German-dominated axis with France, there should be a strengthened European economic government that is subject to effective democratic control. This will require a significant strengthening of the role of the European Parliament. But it will also be important to develop support for progressive European policies among the citizens of the EU.
The EuroMemo’s proposals have received support and been drawn on to a varying extent in different member states by unions, social movements including Attac, Left parties including the German ‘Linke’ and the Greek ‘Synaspismos’, and the left wing of some Social Democratic and Green parties. The proposals should now be developed through a deepened interchange between progressive economists and movement activists and used to help build European-wide support for a fundamental change in the direction of EU policy.
This article has previously been published in January 2012 by Red Pepper