Posted by: Dirk | June 30, 2010

Letter from Brussels

right, as the world goes, is only in question between equals in power, while the strong do what they can and the weak suffer what they must.

Thucydides, 431 B.C.

I spent last week in Brussels, “capital” of the European Union, with our students for a 3-day seminar. Out topic was the social system of the EU countries, and the EU 2020 strategy. Some things became clear to me during that time. Let me just explain what I personally think is going at the EU regarding the euro zone crisis.

The introduction of the euro has been and still is a conservative project with the goal of establishing a political union by building a currency that lack s a fiscal dimension, without which the euro cannot work. Of course nobody foresaw that problems would get this big, but now it’s too late.

Adjustment in the EU before the euro was by devaluation. A devaluation of Italy created something like an 30% unemployment rate in parts of Baden-Württemberg where exporting firms were located. The costs of adjustment thus fell on the surplus country, with the deficit country getting away easily. This created all sorts of exchange rate troubles in the EU, with exchange rates falling prey to speculators, like when George Soros famously attacked the pound in 1991. To solve these problems, the euro was dreamt up.

The new adjustment mechanisms was supposed to be the financial market. It would surely never allow to let a country move into debt too deep, not in the public sector, and not in the private sector. However, a real estate boom developed in some countries in the periphery because of the historically low real interest rates. Since the banks in Germany needed to invest the export proceedings somewhere, they chose to invest it in the periphery. When it noticed in 2007 that firms and households of some countries would have difficulties paying back, it was already too late. Hypo Real Estate had already lost billions in Dublin via a subsidiary, and German banks had lent many millions to Spanish banks, etc. (Remember that governments still looked good in the early crisis.)

Now the idea of conservative Europe is that of the two choices – killing the euro and continuing with political integration – Europeans would choose the latter. However, in the meantime thinks got complicated. Nobody foresaw that a fully fledged financial crisis would happen, with the neo-classical economists struggling to explain what was going on in a replay of the US in 1929-1932 under Hoover. Now it seems everybody is determined to stay the course, in the sense that George W. Bush used the phrase.

This would explain why European politicians are so tight-lipped about the whole crisis: the plan B is to escape with achieving a politically united European Union, at least to the biggest extent possible. Therefore, Greece and other countries are now bullied into submitting under more and more strict European rules, like the proposed European Monetary Fund. Some politicians have already proposed to take away voting rights from countries that are not able to repay its debt. Under the current rules of the euro zone, Germany is the big net exporter and will be. Therefore, the draconian rules would probably never apply to herself.

A hint on this is also the sentence To deliver rapid and lasting results, stronger economic governance will be required on the EU2020 website. It seems that what is planned is to ensure some income for the EU in order to transform it into a US-style federal government. If this can be achieved, so some seem to think, it will have been worth all the trouble. After all, it was impossible to unite all Europeans behind a  constitution.

Well, that’s my impression on how things stand in Brussels. Last week on Wednesday I have seen Barroso talk in front of the parliament (transcript of the speech), and what he said sounded like a confirmation of what I wrote above, I believe. On the opposite side the left wing parties accuse the conservatives of leading Europe astray. Instead of evaluating the Lisbon Strategy which has been a horrible failure (“aimed at making the European Union (EU) the most competitive economy in the world and achieving full employment by 2010”) the new EU2020 would be like the younger sister of that strategy.

As an academic economist, it’s always very insightful to go to Brussels and talk to the people there. It’s a whole different world. (This text contains no quotations from people I have talked to or listened to except where I mentioned them together with a source, and it is my personal opinion.)

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Responses

  1. […] this is a further confirmation of the EU government’s intentions that I voiced yesterday. The economic problem of imbalances in trade between the countries, which are caused by diverging […]


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