Loukas Tsoukalis is Professor at the University of Athens and President of the Hellenic Foundation for European and Foreign Policy (ELIAMEP) and a member of the World Economic Forum’s Global Agenda Council on Europe.
Europe has taken an inordinately long time in dealing with the debt overhang after the bursting of the biggest bubble since 1929, and the resulting cost is very big indeed.
The reasons are many and complex: a highly decentralized decision making system having great difficulties in coping with a big crisis that criss-crosses national borders, growing economic divergence between member countries accompanied with a rise in populism within and a loss of trust between them, and the enormous difficulty in reaching an agreement on how to distribute pain in the adjustment to a post-bubble world among debtors, bank stakeholders and taxpayers, and even more so between countries. Who pays the bill?
This is the most difficult question of all. For the EU, a still half-baked political system at best, the difficulties are multiplied given the narrow limits of solidarity across borders.
In particular, the restructuring and re-capitalization of European banks has been unduly delayed with serious negative effects in terms of the liquidity available, especially in the embattled periphery of Europe.
Attitudes towards banks in trouble have much evolved from Ireland to Spain and Cyprus. But as the recent Cyprus deal demonstrates, evolution is surely one thing, while selective approach is another. The latter has been mainly a function of the degree of exposure of banks in the European core to banks in trouble in the periphery and the nationality of depositors. We are nowhere near the end of this process as yet.
A big taboo was broken when members of the Eurozone agreed to proceed with the ‘voluntary’ haircut of Greek public debt: risk-free sovereign debt was thus no longer. But the recognition of hard reality came with considerable delay: it had been clear for some time that the debt crisis concerning at least Greece was not one of liquidity but of solvency. Admittedly, it was a big taboo to break and neither the ECB nor most national governments were eager to draw the unpleasant conclusions and hence resort to the use of financial nuclear weapons. Perhaps, the financial system was not ready for it either at an earlier stage.
But yet again, delays have been very costly. And who can say for sure that this will be the last ‘haircut’ for Greece or other countries?
Fiscal consolidation and structural reform are badly needed in many European countries, most notably those countries that have already lost access to financial markets.
Only believers in extra-terrestrial economics may argue that the problems in those countries can be solved by simply pouring more money down the system. But while both public and private sectors are de-leveraging fast and the whole of Europe is entering deeper into recession, there is a legitimate question, raised among others by the IMF, about policy priorities and the sequencing of measures.
Without growth, more and more of the old debt will become unserviceable. And while populism (and extremism) is rising in the more vulnerable parts of Europe, a new kind of trade-off has emerged, namely the one between financial stabilization on the one hand, political and social instability on the other. Steering ahead regardless may not necessarily be a sign of resolve and courage; it may be just suicidal. The European Commission has recently shifted its position in a rather belated recognition of the risks involved.
With zero growth and close to zero inflation, coping with the big debt overhang is hardly an easy affair: this is meant to be a huge understatement. Fiscal consolidation in conditions of declining output is partially at least a self-defeating exercise. Output lost today cannot easily be regained tomorrow. And the unemployed become long-term unemployed. As for structural reform, much though it is needed, we know that it takes time to deliver the goods. If the burden of adjustment falls mainly (or exclusively) on the debtor countries, the consequence is likely to be a long period of economic stagnation for the latter.
True, the economic crisis is very big and we in Europe were totally unprepared for it. A currency without a state is a contradiction, especially in times of crisis. And although many ‘unthinkables’ have already become reality at both national and EU level, Europe can hardly be accused of too much consistency or coherence in its strategy nor of enormous foresight in its overall approach. We can surely do better. The stakes are very high and time is running out."