Thursday, June 17, 2010


Wolfgang Münchau

The European Union is a tyranny of small countries, and this has served it well. But the small-country syndrome is counterproductive when it comes to macroeconomics. I was struck last week by two remarks from Herman Van Rompuy, the president of the European Council. He defended the fast spreading austerity programmes on the grounds of the robust economic recovery. And on intra-eurozone imbalances, he said it was mostly a problem of countries with current account deficits.

Mr Van Rompuy, like the majority of EU leaders, hails from a small country - in his case, Belgium. When small-country politicians talk about economics, they naturally talk within the framework of a small open economy. One of the most important characteristics of a small open economy is that its own actions have little impact on the rest of the world. In a small open economy, success boils down to competitiveness, more or less. Running the Irish economy is like running a very large business, or a football club.

To paraphrase a hoary old saying, you can take the Portuguese or Belgian prime ministers out of their small open economies but it seems you can't take the small open economy mindset out of these men. Mr Van Rompuy does not give the impression that he is about to recommend a policy framework for the world's largest economy. He has briefly, and bravely, toyed with the idea of a common European bond, but immediately gave up on the idea when he ran into German opposition. There is no vision for the global economy and Europe's role in it.

We have returned to the habit of navel-gazing that has characterised the first 10 years of the euro. Governments now implement austerity packages without any consideration of the effect on other countries. Austerity started in Greece, spread to Portugal, Spain, Italy and Germany. The winner of last week's elections in the Netherlands, the liberal-conservative VVD, campaigned for an extreme version of austerity - and succeeded.

The Bank of Italy last week estimated that the effect of the austerity package would be to reduce the country's already anaemic economic growth by 0.5 percentage points. In other words, the package is very likely to throw Italy back into recession. The same is almost certainly going to happen in Greece and Spain. The Dutch plan will probably also be significant. Germany's austerity programme amounts to about half a percentage point of gross domestic product in 2011. The only good news is that France will not be joining in and will not do so until after the presidential elections in 2012.

From my own conversations with French politicians and economists, I have no doubt that the majority of them think the German obsession with austerity is crazy. France is probably the only country in the eurozone with a large-country mindset. It is France's tragedy - and possibly that of the eurozone - that France is not the largest country.

The rush to austerity creates a formidable dilemma for France. The strategic alternative is either to accept it or risk a break with Germany, thus reversing more than 25 years of Franco-German monetary and fiscal convergence. It is a deeply serious choice. Nicolas Sarkozy, the French president, last week criticised the European austerity policies as recessionary. He is right.

My guess is that he - or his successor - will end up accepting austerity, because of a lack of viable strategic alternatives. But I am not too sure of it. The situation is not the same as it was in the early 1980s, when former president François Mitterrand embarked on a policy of fiscal and monetary rigour. At that time, there was the supposed benefit of a joint economic and monetary future. Today, we know the reality. And if the next French leader were to conclude that a monetary union based on austerity without growth is unsustainable, he or she might decide not to follow suit.

Another aspect of the small- country syndrome is the way the European Union approaches the question of growth. While most people seem to agree that growth matters somewhat, the prevailing view in Brussels and Frankfurt is that the growth problem is 100 per cent structural. I do not deny the presence of structural obstacles to growth, but the EU's strategy is likely to fail for two reasons.

First, it is insufficiently focused. The European Commission's agenda is not primarily geared towards growth, but competitiveness. For an economy with a more or less balanced current account, this is an odd choice.

The second reason is lack of sufficient macroeconomic support. The exit strategies have come prematurely, and were unco-ordinated. There will be no co-ordination of wage-setting procedures, no common bond and no common or co-ordinated European approach to bank resolution. There may even be a case for another interest rate cut by the European Central Bank or an extension of the bond purchasing programme to a policy of quantitative easing, but this is not going to happen. The message the EU sends to the rest of the world is that it does not care about growth. But sustainable debt reduction is extremely difficult in the absence of growth.

It is the tragedy of the eurozone that it is run as a collective of small countries.

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