There are many aspects to the euro-zone crisis but, the message from the EU’s policymakers remains the same – the turmoil was precipitated by fiscal profligacy on the part of peripheral nations including Greece, Ireland, Portugal and Spain. This diagnosis means that the solution advocated by countries belonging to the single currency’s core is centred upon fiscal austerity and structural reforms. But, is the standard European narrative supported by the facts?
The Germanic view, which has become the conventional line at European policy level, is not corroborated by the evidence however, and is an inaccurate representation of the facts at best, since the data suggests that unsustainable fiscal positions among the periphery were largely a result of the crisis and not its primary cause. Indeed, following the adoption of the single currency and up until the crisis struck, the average fiscal deficit registered in the peripheral countries was below the Maastricht criteria of three per cent of GDP and not materially higher than the core countries’ average fiscal deficit until 2008.
Upon closer examination, the historical record reveals that only Greece can be truly accused of fiscal profligacy over the period in question with the country’s fiscal deficit exceeding the Maastricht criteria each year between 2001 and 2007, and averaging more than five-and-a-half per cent of GDP over that period. The average deficit for the remaining peripheral countries however, was below two per cent each year until 2008, and lower than the German deficit between 2001 and 2006.
The evidence demonstrates that deficit spending was not prevalent among the periphery pre-crisis. Indeed, Ireland managed to register a surplus through most of the period, and Spain recorded a surplus between 2005 and 2007. Further, the facts also dispel the notion that Germany was a ‘paragon of virtue’ in the years leading up to the crisis, as the record shows the Germans posted a fiscal deficit in excess of the Maastricht criteria between 2002 and 2005. This served to undermine the Stability and Growth Pact (SGP), and delivered a slap in the face to countries such as Austria and the Netherlands, who had taken difficult decisions to comply with its terms.
Gross government debt ratios before the onset of the crisis tell a similar story. Greece proves to be an outlier once again, as it sported a public debt-to-GDP ratio of more than 100 per cent pre-crisis – well in excess of the Maastricht criteria of 60 per cent. Meanwhile, the figures for Ireland and Spain looked remarkably healthy at 36 and 24 per cent respectively while, the figure for Portugal was 68 per cent, about the same as France and Germany at 64 and 65 per cent respectively. Importantly, the periphery’s average public debt ratio was not significantly higher than either France or Germany at 68 per cent, though five of the seven countries including Germany, were not complying with the SGP.
It is quite clear that apart from Greece, the euro crisis cannot be attributed to reckless fiscal policy in the peripheral countries. The truth of the matter is that the crisis has less to do with fiscal profligacy and more to do with the large and persistent intra-euro zone imbalances built up during the upswing. The average current account deficit among the periphery increased from just four per cent of GDP in 2003 to almost eleven per cent by the time the crisis struck, which caused net foreign liabilities to rise to more than seventy per cent of GDP in Greece, Portugal and Spain.
External debt indicators all vastly exceeded levels that had previously triggered crises in developing countries, but the warning signs were ignored because the euro-zone itself was largely in balance with the rest of the world. Further, the periphery’s deficits were financed through the flow of capital downhill from the high-income surplus countries, which caused some to argue that the imbalances were a normal part of the convergence process.
However, the current account deficits were not a function of higher investment rates that promised to deliver higher future income growth, but lower savings rates and excessive consumption driven by negative real interest rates alongside sharply rising asset prices in the case of Ireland and Spain. The continued rise in net foreign liabilities was simply not sustainable, and the inevitable cessation of external lending precipitated both a government funding and banking crisis.
The surge in public debt-to-GDP ratios alongside the large jump in the yields on government debt prompted Europe’s policymakers to see unsound government finances as the problem and thus, the focus on fiscal austerity. However, the primary cause of the crisis was unsustainable intra-regional imbalances, which ultimately gave way to a balance of payments crisis, as the cessation of private sector lending to the periphery alongside capital flight led to a deficit position on both the current and capital accounts, which has since been funded by official sources.
The bottom line is that fiscal adjustment in the troubled peripheral nations is not sufficient to end the crisis on its own, as a sharp turnaround in the current account is required to stabilise the level of net foreign liabilities. However, without stimulus in the core countries such as Germany that prompts a narrowing of their surplus position, a reversal will only be achieved through a collapse in imports, which implies a contracting economy. In this scenario, public and private sector debts will continue to rise.
Needless to say, the euro crisis is far from over.
Previously posted on www.charliefell.com
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