Restoring European Growth

by Jim Leitner, Nuno Monteiro and Ian Shapiro

Project Syndicate
December 27, 2011

Europe’s sovereign-debt crisis has rumbled on for so long that some people are beginning to take it for granted that eurozone leaders can continue to stumble from one non-solution to the next without risk of cataclysm. But if any troubled southern European economy fails to roll over its debt in the coming months, the resulting contagion will spread quickly from the eurozone throughout the global financial system, with consequences far more grave than what followed Lehman Brothers’ collapse in September 2008.

Despite the new agreement reached at the European Union’s summit in December, strengthening financial markets’ confidence in the eurozone remains an elusive goal. In the aftermath of the summit, the euro’s exchange rate sank to its lowest level of the year (around $1.30), while yields on Italian five-year bonds hit a new high (almost 6.5%). In France, Socialist presidential candidate François Hollande flatly declared that the latest agreement “is not the right answer,” because “without economic growth we will achieve none of the targets on deficit reduction.”

Hollande was right. Since the crisis erupted in Greece almost two years ago, EU leaders have failed to propose a solution that balances austerity with economic growth. Whenever the markets signal skepticism about the euro’s viability, European leaders rush to restore confidence through austerity measures, while ignoring the underlying need to reestablish the conditions for growth. The urgent crowds out the merely important. But, without growth, the EU’s long-term prospects are grim.

Since the crisis began, the need for economic growth in Europe’s debt-distressed countries has been portrayed as their problem. For creditors, especially German lenders, the main priority has been to impose austerity and discipline on the eurozone’s profligate south. Because German banks hold much of the debt owed by peripheral banks and governments, officials have focused on this financial link between Germany’s economy and those of troubled eurozone members. But German Chancellor Angela Merkel’s understandable desire to discipline the spendthrifts entails sawing away at the last remaining branch on which Germany’s bankers and taxpayers are perched.

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