Introduction
At the end of 2010 I was expecting global economic recovery, albeit at a reduced rate, to take place during 2011. A year later, this has not occurred and the risk of a double dip to the Great Recession is depressingly real. During 2011, however, the global dimension of the crisis has become more discernible, as spillovers to the emerging market economies and developing countries have grown exponentially. During last year, even the spectacularly growing BRIC economies have stumbled, particularly Brazil and India. Meanwhile China is coming under pressure to cap its growth with calls for it to appreciate its currency (Yuan) and play a greater role in correcting global trade and financial imbalances.
Two areas are of pressing concern. Firstly, the fragility of both private and public expenditure in the advanced industrialized economies. And secondly, the emergence of the Eurozone as the new geographic epicentre of the global crisis, replacing the United States. The fragility of private spending in rich countries resides in their current higher levels of unemployment, when compared to pre-crisis levels. Alongside this, the growth in wages has been marginal, thereby compounding the negative effects on private consumption of rising unemployment. In turn the decline in consumption has indirectly reduced private demand for investment expenditure and worsened the investment outlook.
As regards public spending, two circumstances presently rule. One is that Keynesian type stimulus spending in the rich countries has become politically very unpopular, because of its alleged weak effects during 2008 and fears of future inflation. Ironically, recent spending on public infrastructural services (energy, transportation, and telecommunications), which stimulus spending favours accounts for about one quarter of global GDP (US$14 trillion). Secondly, global private financial markets have become extremely sceptical of government interventionist policies and increases in sovereign indebtedness. Governments are responding to these market concerns out of fear that adverse private speculation could severely damage their economies as well as their re-election prospects.
Systemic obstacles
As pointed out above, the Eurozone area (and the European Union (EU) more broadly) constitute the present epicentre of the global crisis. The Eurozone area uses the euro as its common currency and sole legal tender as part of its economic and monetary union. Formed in 1999 it comprises 17 countries of the EU with a population of about 332 million persons and a current GDP of about ten trillion euros. The area faces several systemic obstacles in the way of closer integration, most of which have important lessons for the future advance of integration in the Caricom region.
The first of these is that the area’s central bank (European Central Bank (ECB)), which issues the euro, is unlike other central banks in that it cannot operate as a lender of last resort in the area. This restriction is built in to its legal charter. To the best of my knowledge, this was pushed by Germany and was deliberately designed to avoid moral hazard among member states. Experience shows this occurs when governments know there is a back-stop to protect them from their own fiscal irresponsibility.
Second, the Eurozone area does not practise fiscal union. And, while economists find fiscal measures are too blunt for short-term macroeconomic regulation, in its absence (or other enforceable fiscal rules) the common currency (euro) would be put under immense market pressures if one or more members act fiscally irresponsibly to the detriment of all member states, as has in fact occurred.
Thirdly, the 17 member states have had very disparate economic and financial performance records since the inception of the area. This is particularly the case in regard to their real GDP growth, employment and wage levels, and the growth and distribution of personal incomes and wealth. Furthermore, the macroeconomic management of the member states has widely differed over this period.
Policy responses
There has been a mix of Eurozone policy responses to the situation but the jury is still out on their overall effectiveness. One of these measures provides long term capital and liquidity to shore up banks operating in the area to help them defend against possible ‘runs.‘ Similarly, they have provided resources to the IMF in order to improve its effectiveness as the global lender of last resort. Correspondingly, it has improved its own capacity to cope with financial contagion. This has been achieved by adding near term funding and bringing forward operational changes in its two most important firewalls, namely, the European Financial Stability Fund (EFSF) and the European Stability Mechanism (ESM). The latter is its permanent bailout fund.
The two crucial remaining policy challenges are 1) reform of the ECB and 2) establishment of a fiscal union. For both of these, the actions taken so far have been modest. The ECB is still not a lender of last resort. At present also, there is only a fiscal compact in process. This is built around yet to be agreed fiscal rules, which have no legal enforcement mechanism and depend entirely on political will to come into effect during 2012.
Some of the proposed fiscal rules include 1) limiting structural deficits (that is, deficits adjusted to the phase of the business cycle) to 0.5 per cent of GDP; 2) reducing government debt at an agreed annual rate; 3) having a balanced budget rule (that is, budgets balanced or in surplus in structural terms) written into all member states’ national constitutions.
Conclusion
Markets seem unconvinced that the Eurozone can ever overcome its crisis, without the ECB becoming a lender of last resort and/or a definite fiscal union being established. The belief is that Europe has found it quite difficult to fund the Greek crisis and does not have the resources to cope with a wider crisis involving several larger member states at the same time.
The conclusion readers should draw from all this is that the EU crisis exposes the long held economic myth that rich sovereign countries cannot default on their debt. This is similar to the layperson’s myth that housing prices do not fall precipitously. This was exposed three years ago when the epicentre of the global crisis was then firmly located in the United States.
