Europe bailout will be ineffective

The European economic crisis not only persists but continues to get deeper despite the efforts of International Monetary Fund, European Central Bank and other multilateral agencies. Reason is a wrong diagnosis of the disease. It is believed that the main problem of Europe is the disconnect between monetary and fiscal policies. Monetary policies such as interest rates and liquidity in the money market of all members of the Eurozone are determined by the European Central Bank (ECB). However, every member country is free to determine its own fiscal policies such as tax rates and unemployment compensation. Problem is that the two policies are often working in opposite directions. For example, the ECB has followed a tight monetary policy in order to control inflation. However, countries like Greece have adopted an easy fiscal policy. They have increased expenditures on salaries of government employees and welfare programs such as unemployment compensation and health benefits. The loose fiscal policy requires the government to borrow large amounts from the markets. This is not possible in a tight monetary policy framework. The Greek Government has had to consequently borrow at high rates of interest. The interest burden has mounted and the Greek government has become insolvent. It is unable to repay its debts leading to an imminent default. Greece could have simply printed its currency and financed these expenditures had it been a master of its own monetary policy. Indeed, that would have led to devaluation of its currency but that would not lead to a crisis. The lenders would have lost value of their loans quietly and borne the same without demur. Greece has lost the option of devaluation and that can be held to be responsible for the present crisis. In other words, the crisis can be attributed to the disjoint between fiscal and monetary policies.

Consensus has been reached among G-20 that the basic problem of Europe is this disconnect between a unified monetary policy and fragmented fiscal policy. European countries have committed to work towards a fiscal union. G-20 have decided to provide bailout though the International Monetary Fund with this understanding.

I do not think attaining a fiscal union will be easy. It is like ceding sovereignty to a European Parliament. The National Governments will lose control over policies like tax rates, welfare programs and defense expenditures. Political difficulties aside, the question is whether even such a fiscal union will pull Europe out of the economic mess.

Indeed the specific problem of weak countries such as Greece will be somewhat managed. The Greek Government will not be able to spend as much money as it wants on salaries of government employees and welfare programs. Consequently it will not have to borrow huge amounts to finance these expenditures. But that will not solve the basic problem of competitiveness.

The problem of all high-wage developed countries including those of Europe, United States and Japan is lack of competitiveness with emerging low-wage economies like those of India and China. The American crisis of 2008 had its roots in the pressure on jobs of American workers exerted by low-priced goods made in China and low-priced services provided from India. Till the nineties only low-priced goods were being imported from China. But the internet revolution changed the game. It has become possible to outsource services such as call centers, translation and legal research to service providers in India. Consequently American workers started losing their jobs in this hitherto protected sector. The workers were not able to repay their housing loans. Banks had to foreclose their properties and sell them at a huge loss. Losses were incurred by the banks and they pulled the entire economy down along with them.

Europe is not able to compete with China and India any more than the United States. The wages in Europe are more or less equal to those prevailing in the United States. Welfare benefits are more sumptuous. This puts an additional burden on the government budgets. This loss of competitiveness is leading to lesser tax revenues forcing the governments to borrow more to meet their welfare obligations which, in turn, is manifesting in the form of debt crisis. The interest burden is mounting and governments are unable to raise loans leading to a possible default.

The question before us is this: Will a fiscal union make Europe more competitive and pull it out of the crisis? Say a patient is suffering from chronic malnutrition and is admitted to the hospital. The physician and radiologist put him on separate regimens leading to some troubles. Coordination between the two doctors will certainly make the treatment more effective. But the basic problem of chronic malnutrition will not be solved because the hospital has no arrangement to provide wholesome food for long periods of time. Similarly coordination between monetary and fiscal policies will help Europe manage its immediate problems but not solve the problem of loss of competitiveness which is rooted in high wages. It is in this perspective that we must read American Congressman Tom Coburn’s statement: “We’re throwing good money after bad down a hole that I think is not a solvable problem… Europe is going to default eventually, so why would you socialize their profligate spending.” Coburn is planning to bring a legislation directing the U.S. government to veto an expanded role for the IMF in Europe.

The problem of Europe and America is loss of competiveness thanks, partly, at least, to globalization. Low wages combined with frontline technologies brought by FDI has made it difficult for businesses to survive in the developed countries. The present global crisis started in 2008 in America. Europe was going strong at that time.

Global capital had existed the United States Dollar and was moving into the Euro. The European crisis became sever in 2011. The United States, in the meanwhile, has stabilized somewhat at a lower level of wages and standards of living. Now global capital is moving from Europe to America. The dollar is rising and Euro is under pressure. A see-saw is in operation between the two major groups. One goes up while the other goes down. Together they are sinking slowly.
This problem will not be solved by strengthening the capital base of European or other banks. Ultimately, the banks have to earn income from the monies lent by them. The borrowers have to earn profits from the monies borrowed. Increasing the capital base of banks will not help the companies earn profits. It will only enable the banks to bear through losses for a longer time. This will not help. Therefore, both Europe and America should focus on improving the competitiveness of their economies instead of propping up their loss-making companies for a longer time.