When the European Monetary Union was created in the late 1990s it was assumed that the ensuing convergence of interest rates would also lead to economic convergence across Europe. This has clearly not been the case, with the countries of the Eurozone periphery now forced into implementing austerity measures. Aidan Regan argues that these countries are paying the price for the ‘myth’ of convergence, and that Europe’s policymakers must learn that the current “one size fits all” market solution will only fuel further political discontent.
Given the monetary constraints of the European Monetary Union, and the absence of exchange rate adjustments, the entire burden of adjustment to the crisis has been shifted on to national fiscal and labour market policy. In Ireland, Italy, Spain, Portugal, Greece and Cyprus the main focus is on structural reforms of the labour market. Yet in Germany and the Netherlands, one of the core factors in explaining their economic success is coordinated collective bargaining. Can a narrow focus on liberalizing the labour market actually improve economic and employment performance of weaker member states? The empirical evidence suggests otherwise.
The EMU (shared currency across 17 member states of the EU) was created to remove the risk of devaluation and to embed the single market in Europe. It was assumed that market convergence in interest rates would lead to economic convergence. This was the fundamental mistake of the Euro.
A core insight of comparative political economy, working within a historical institutional framework, over the past twenty years is that ‘varieties’ of capitalism exist. What this means is that institutional and political differences between nation-states (and regions) produce divergent economic and employment growth patterns. Italy would never become Germany even within a currency union.
This reality was completely overlooked by financial markets. A one size fits all monetary policy did not lead to economic convergence (economies are always a complex relationship between labour market institutions, the state and market). It simply fuelled reckless investment, leading to credit and housing bubbles in Ireland, Spain, Portugal and Italy. In Greece it led to reckless fiscal policy by successive corrupt governments. Two years ago, the difference between Greek and German bonds was 2 basis points. It is now growing beyond 22 points.
This is not to say that the problems in Ireland, Greece and Spain can be traced to external monetary policy, associated with the EMU. Domestic policy choices (particularly the laissez-faire approach to the housing and banking market) in all of these countries contributed to the crisis. But the general point is that convergence in interest rates fuelled rather than removed economic divergences within the Eurozone. This can be traced to institutions, culture and politics.
To pay the price for this ‘myth’ of convergence, the ‘GIICPS’ (Greece, Italy, Ireland, Cyprus, Portugal and Spain) are now being forced into radical retrenchment of the welfare state, aggressive liberalisation of labour markets, and continued drying up of domestic bank lending. Hence, a simultaneous recession in the private and public sectors is taking place. None of which will solve the core problem of the Eurozone: a continued divergence in the economic and employment performance of north and south Europe.
Private cross-border capital flows have dried up in the Eurozone, leading to a significantly changed role for the ECB. The ECB is lending money (based mainly on German deposits) to Italian and Spanish banks. In turn these banks are using this money to buy the debt of their domestic governments. These banks are also imposing high interest rates in their lending to domestic small and medium-sized enterprises. It costs a Spanish SME more than four times the rate to borrow than a German SME.
Financial markets control the democratic states of weaker EMU countries. This can only be reversed by these countries either pulling out of the Euro currency or creating a fiscal transfer system within a United States of Europe. Both options will cost the German taxpayer a lot of money. The German government needs to be honest with their electorate about this. But neither an exit from the Euro or a United States of Europe will solve the employment and labour market crisis of Ireland, Italy, Greece, Spain, Portugal and Cyprus.
It might be time for policymakers to approach comparative political institutional scholars rather than neoclassical economists for solutions. A one size fits all ‘market’ solution such as ‘structural reforms’ in the labour market will simply fuel political discontent within Europe. Learning from institutional legacies and tailoring political reforms to the policy needs of each member-state is required. This can only occur through building political coalitions capable of structuring market outcomes.
Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.
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Aidan Regan – University of Amsterdam
Aidan Regan has a Max Weber Postdoctoral fellowship at the Department of Political and Social Science in the European University Institute (EUI), Florence, Italy. His research interests include the comparative political economy of labor relations, varieties of capitalism, welfare states, income inequality and processes of institutional change in the European Union.