Time to act: euro collapse would define our era

by Lawrence Summers

Financial Times
June 18, 2012

Once again good news has had a half-life in the markets of less than 24 hours. Just as news of Spain’s bank bailout rallied markets and sentiment for only a few hours, a Greek election outcome as good as could have been hoped did not buoy markets for even a day. There could be no clearer evidence that the strategy of vowing that the European system will hold together, doing the minimum to address each crisis as it comes and promising to build a system that is sound in the long run has run its course.

Nor is the Group of 20 leading economies, whose leaders conclude their meeting today, likely to change anything soon. Europe’s troubled economies will demand more emphasis on growth, lower interest rates on their official debts and more transfers. The Germans will show sympathy with the aim of reform but will insist that financial integration coincide with political integration. The rest of the world will express exasperation with Europe’s failures and demand more be done. Officials blessed with more diplomatic than economic insight or courage will produce a communiqué expressing a measure of satisfaction with the steps under way, recognising the need to do more and looking forward to continued dialogue. The only good thing is that expectations are so low this will barely disappoint markets.

The truth is that Europe’s debtors and creditors are both right. The borrowers are right that austerity and internal devaluation have never been a successful growth strategy, certainly not when major trading partners are stagnating. In the few cases where fiscal consolidations have preceded growth, they have either involved stagnation relative to previous levels of income (as in Ireland and the Baltics) or buoyant demand associated with surging exports, increasing competitiveness and low borrowing costs (many euro members in the early years). The borrowers are also right to claim that even a previously healthy economy will quickly become very sick if forced to operate for several years with interest rates far above growth rates, as is the case across southern Europe. And experience clearly shows that structural reform is always harder when an economy is contracting and there is no sector to absorb those displaced by reform.

More