Europe may have taken an historic step in its meeting on Thursday – it seems, for once, to have done more than “just kick the can down the road”. First, its leaders recognised that it is not just Greece that faces a problem; it is a European problem, which requires a European solution. The euro was, at birth, an unfinished project; it took away two key instruments of adjustment – interest and exchange rates – and put nothing in their place. As President Nicolas Sarkozy has emphasised, this is a major step in correcting this deficiency, creating a European monetary fund.
Second, the leaders recognised that Greece’s problems require a focus on debt sustainability – lowering the debt burden and increasing gross domestic product, and Europe is doing something about both. Not only are maturities being extended, but interest rates are being lowered; but even more important is the commitment to investments that will stimulate the economy, create jobs and increase tax revenues. Growth cannot be restored unless lending, especially for small and medium-sized enterprises, increases. The increased flexibility given to the European financial stability facility may help, but I suspect more needs to be done, for instance through creating a small business revolving fund.
The communiqué from the leaders recognised too the enormous strides that Greece has made and renews the commitment to technical assistance to help Athens implement the reforms that it has undertaken.
There were other important policy reforms – or at least moves in the right direction. The clear statement that public authorities should place less reliance on private rating agencies – the European Central Bank should not delegate responsibility to judging what is and is not acceptable as collateral – was long overdue, especially given the rating agencies’ terrible record in making judgments and the continued flaws in governance (often being paid by those that they are asked to rate). If the ECB is concerned that a credit event will lead to turmoil in financial markets, it should take a more active stance to address the underlying problems: eliminating the non-transparent over-the-counter derivatives, ensuring that banks are adequately capitalised and preventing banks from being excessively interconnected.
Making the private sector bear more responsibility for its lending is also long overdue. The repeated bail-outs of banks around the world (and the bail-outs in Latin America, east Asia, Mexico, etc) have encouraged reckless lending. The socialisation of losses accompanied with the privatisation of gains that occurred in the 2008 bail-outs in Europe and the US leads to a perversion of the market economy. The private sector once again tried to blackmail governments – saying that the consequences of not bailing out the lenders would be disastrous – and Europe should be congratulated for not giving in, even if the ECB did what it could to give this argument support. The details of the private sector involvement are not yet clear, but what is clear is that they should have a significant “haircut”.
With all these kudos, I have four cautionary comments. The European Union has once again reiterated its resolve to a quick return to fiscal rectitude (at least for those countries not in crisis). Europe’s recovery, however, is still frail and excessively quick cutbacks will slow growth, and even risks a double-dip recession. Lower economic growth will be bad even from a narrow view of deficits and debt. Moreover, Ireland and Spain both had budget surpluses and low debt-to-GDP ratios; that should serve as a reminder that these restrictions are neither necessary to ensure future growth and prosperity. Unfettered markets – and especially under-regulated banks – were central in causing the crisis; and too little has yet to be done.
Secondly, revenues from Greece’s privatisations may help address the country’s financial difficulties, but not if privatisation is pushed too rapidly, with a rigid timescale. Fire sales worsen a country’s balance sheets – and the market responds to these rigid time frames with lower prices. Greece should be committed to rapidly preparing its assets for sale, but the timing of the sales themselves should be sensitive to market conditions.
Thirdly, the greater flexibility given the EFSF is important, but some of the proposals being bandied around need to be treated with caution. One entails moving to variable rate loans. Ask America’s homeowners about the wisdom of that! Better risk instruments – including the appropriate use of GDP bonds – could improve risk sharing and enhance the likelihood of a strong recovery.
Finally, the commitment to growth is essential. Evidently, references to a “Marshall plan” contained in earlier drafts of the communiqué, were eliminated. I hope that this does not signal a move away from a strong commitment, requiring potentially significant resources.
Europe has, at last, been forced to do a cold calculation of the costs and benefits of taking the next steps to create a successful euro, and not doing so. Any rational calculation showed that the benefits of doing what it has done vastly outweighed the costs. As I wrote earlier, the question was not one of economics but of politics. The politics finally came together. There is more to be done, but these were critical steps.
The writer is a recipient of the 2001 Nobel Memorial Prize in economics and University Professor at Columbia University