Confounding fears that the European project was moribund, the European Union came through last weekend with a massive bailout fund for Greece, and possibly other heavily indebted EU members. But although the Europeans were able to agree on the bailout, the road forward will not be easy. Europe now has to do three things. First, it must improve the economic governance of the euro area. Second, it must figure out how to grow its economy faster. Third, it must move toward greater political integration among its members.
Let’s take these points in order. Despite all the progress made in integrating Europe’s national economies, European economic governance remains firmly national. While the European Union provides broad policy outlines, implementation remains the task of the member states and their national legislatures. Furthermore, a kind of good cop/bad cop game has evolved, wherein the national governments are responsible for the things people like (such as healthcare, education and unemployment insurance), while EU directives often require unpopular measures, like privatization and the introduction of competition in formerly protected spheres. National leaders have little incentive to change the situation, since they remain in charge of the meaty part of political life, and they can always blame “Europe” for whatever is unpopular. Europe’s current budget rules probably insure that this will never change, because the EU budget is limited to 1 percent of the EU’s GDP. This guarantees that the individual states remain in charge of the lion’s share of money—and hence power.
The countries that use the euro—which represent a subgroup of the EU—are subject to rules that limit government deficits and debt. But, paradoxically, these rules might very well weaken rather than strengthen economic governance by putting countries in a fiscal straitjacket designed to achieve low, or no, inflation, at the cost of growth and full employment.
This leads to the second point: European economies need to grow more, both to solve the underlying problem of high deficits and debt and as a matter of social justice. Unfortunately, the EU has focused much more on maintaining fiscal and monetary orthodoxy than it has on creating broadly shared prosperity through growth. When French President Nicolas Sarkozy and German Chancellor Angela Merkel released a joint letter before the bailout agreement detailing their solutions to the current crisis, it spoke volumes that they never said anything about economic growth. They focused exclusively on calming financial markets and complaining (perhaps justifiably) about rating agencies and speculators. But this omission was not surprising, given that the European Central Bank—unlike the US Federal Reserve—has low inflation, not growth, as its explicit and exclusive mandate.
This exclusive focus on price stability is due in large part to Germany’s well-known fear of inflation, which is rooted, we are always told, in the historical trauma of the hyperinflation of the 1920s and the currency reform that created the German mark in 1948. But more important than historical memory is Germany’s underlying economic strategy over the past decade or so, which has been to decrease its own consumption, hold down wages in the name of competitiveness and then export like crazy. This strategy has been wildly successful: Germany’s unit-labor costs have been pushed down, domestic consumption has long been the weakest component of what little economic growth Germany has produced, and the country has built up a big trade surplus—exporting more manufactured goods than any country in the world, including China and the United States, every year from 2003 to 2008.