Growth without rebalancing is not enough

Economist
October 1, 2012

My colleague writes that the turmoil in the euro zone will persist until growth resumes. In particular, he sensibly notes that beleaguered treasuries will not be able to prevent sovereign debt burdens from spiraling out of control unless tax revenues rise. Given how much taxes Europeans already pay, this means that the size of the pie has to grow. There is no arithmetically realistic alternative. I believe it is worth stressing, however, that the source of this growth is at least as important as its magnitude. As long as the peoples of Europe view themselves as separate nations sharing a single currency rather than a unified federation with centralized deposit insurance, unemployment benefits, and pensions (and why should they not?), the crisis cannot be resolved by returning to the pre-crisis pattern where Northerners flood the South with capital to finance trade deficits with the rest of the world and domestic spending booms (via Paul Krugman, see this IMF paper on the subject). This created claims that investors now suspect cannot be repaid. Right now, the people, nonfinancial corporations, banks, and government of Spain owe a staggering 950 billion euros to the rest of the world, mainly other countries in the euro zone like France, Italy, and Germany. If the single currency is going to be held together, these piles of claims have to shrink. There are three ways to do this.

First, the claims could be “Europeanised” by creating the kinds of programs mentioned above. In the United States, no one ever questioned whether retirees living in Florida and Arizona would get their Medicare and Social Security checks despite the collapse of those states’ economies. If Florida and Arizona were responsible for making those payments rather than the federal government, it is quite likely that there would have been a crisis similar to what is currently transpiring in Europe. This option is not realistic, however, since most Europeans believe that their national identities are more important than any concept of “European-ness.” The Germans have repeatedly denounced the idea of a “transfer union” on these grounds. It is unlikely that the crisis is making anyone besides a few bureaucrats in Brussels feel any great enthusiasm for an expansion of federal power at the expense of national governments.

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