Europe’s done well

Most Americans, and probably most other non-Europeans, view the eurozone’s handling of its crisis with something between dismay and disdain. The authorities’ endemic failure to get ahead of events has continually roiled markets, and fosters deep doubt that Europe can avoid prolonged recession or, worse, widespread default, euro exits or even a breakup of the single currency. The cacophony among—and frequently within—the member countries prompts confusion and understandable charges of ineptitude. The Greek flip-flops of recent months, and the latest Italian turmoil, have exacerbated this negative impression.

Yet Europe has performed much better than it has talked. Each phase of the crisis has been resolved effectively, albeit without yet dealing definitively with its fundamental causes. The politicians and the voters, not least in Germany, scream—but carry out the required policies.

Of at least equal significance, European institutions have demonstrated that they can both mount successful crisis responses, and evolve rather dramatically toward plugging the huge gaps in the economic and monetary union. The European Financial Support Facility (EFSF) is rapidly becoming a European monetary fund that, along with the European Central Bank (ECB), can attach tough conditions in return for the money provided to troubled countries and institutions. The EFSF also represents the embryo of the eventually inevitable fiscal union of the eurozone. The European Banking Authority is en route to becoming a eurozone-wide financial regulator and superviser. Most importantly, for a long period of time, the ECB lent without limit as needed to quell each successive round of the crisis.

International perceptions of Europe’s ability to cope with, and ultimately overcome, the crisis would be far more positive if they focused on the region’s actions, rather than its statements. This dichotomy is consistent with the entire history of the European integration project. It has faced numerous crises over the past half century, but has always responded with two steps forward, after one or more steps back. It is not much of an overstatement to suggest that Europe moves forward largely through crises rather than architectural planning. As Jean Monnet, the famous French diplomat, presciently proclaimed: “Europe will be forged in crises, and will be the sum of the solutions adopted for those crises.”

The chief problem today, then, is that the eurozone leadership cannot say what the markets want to hear—despite being virtually certain to deliver the desired outcomes, albeit sometimes later rather than sooner, and often in convoluted format. This is partly because Europe’s leaders genuinely cannot be sure how far they will have to go to deal with each phase of the problem; nor, despite the encouraging history and recent record, can they ever be absolutely sure that the proper views will prevail. It is also because each player wants to avoid undermining his leverage in the next round of negotiations: the creditors vis-á-vis the debtors, and the different creditors (national sovereigns, European institutions, private lenders, the IMF) vis-á-vis each other. Most importantly, it is because politicians who have to answer to voters cannot publicly commit to taking steps in advance, even when they know they will have to take them eventually. Hence uncertainty prevails, and the “perils of Pauline,” that iconic damsel in distress, will continue.

This dissonance is most pronounced in the case of the European Central Bank (ECB). The ECB has demonstrated its willingness, grudging as it is, to do whatever is necessary to prevent a sovereign or bank failure on the scale of Lehman Brothers, that could trigger another deluge. Yet the ECB, and the German government as its ultimate backer, are understandably unwilling to say that they will continue to do so indefinitely. If they did, this would only foster moral hazard—encouraging governments, institutions and traders to act irresponsibly, because they expect to be bailed out—as well as relieving the pressure on eurozone governments to fund the necessary bailouts themselves (as they should). The ECB and, by extension, Germany, needs to occupy the moral high ground in order to insist that the debtor countries make effective reforms.

To be fair, one must be a reasonably experienced observer of the history and evolution of the EU to distinguish reality from rhetoric. Moreover, the market pressures that result from the prevailing confusion are often useful in galvanising constructive responses from the most beleaguered actors in the drama—or in making some problems go away, as we saw with the eventual resignation of Silvio Berlusconi, the Italian prime minister (although this did not have the immediate effect of calming the bond markets). But there is little reason to expect any cleaner separation of intent from cacophony in the immediate future, so perceptions of a Europe lurching from crisis to crisis, without clear vision of the endgame, are likely to persist.

The eventual resolution of Europe’s crisis—both perceived and real—will require two fundamental components: successful financial engineering and real economic recovery. The above analysis applies primarily to the former, which I believe is well underway and will play through to a successful conclusion. There is much greater uncertainty about the latter, however.

To help boost growth, the ECB needs to cut interest rates further; it is the only major central bank with rates remaining much above zero. Germany and the other strong “core” countries—including, outside the eurozone, Britain—continue to pursue austerity measures while the markets, far from pressing them to display fiscal rectitude, are flocking to their bonds and rewarding them for superior performance. What needs to happen now is that the Germans and other northern Europeans should buy more Greek products (including tourism) so they (and the ECB) will need to spend less on buying Greek government bonds. One way to do this would be through a truly European growth strategy for large infrastructure and green energy investments, like the Helios Project in Greece, the EU-funded project to develop micro-electronic computer technology. Such projects could be financed by project bonds issued by the European Investment Bank (which the Chinese and other outsiders would surely flock to buy).

But slow economic growth does not present an immediate crisis for Europe, so fixing this is not, as yet, central to the survival of the euro and the integration project itself. For this reason, one cannot be nearly as confident of satisfactory outcomes on this front. This is short-sighted, as it will eventually become an essential element of any definitive resolution to the crisis. In the meantime, the eurozone will be condemned to sluggish growth—even if it avoids the financial meltdown that has preoccupied world attention for so long.