The Eurozone Crisis

The agreed ‘solution’ for the Eurozone Crisis could actually worsen construction and minerals prospects, as Jerry McLaughlin, chief economist with the Minerals Products Association, explains

When David Cameron vetoed a new European Treaty on 9 December 2011, virtually all UK media coverage was about the politics of the decision – either a demonstration of bulldog Britain or cutting us adrift from mainstream Europe, depending on your point of view. This debate somewhat obscured consideration of the agreement signed up to by other EU members. At the time, the main features of the ‘Fiscal Compact’ seemed pretty improbable, both politically and economically, and a few weeks of additional information and opinion has not altered this perspective.

Einstein defined madness as doing the same thing over and over again and expecting different results. The previous EU Stability and Growth Pact tried to impose fiscal disciplines on members and was a spectacular failure. The Fiscal Compact does the same thing, but apparently everyone is more serious about it now. So, madness or not? There are some strong arguments that the more you look, the madder it becomes.

Everyone knows there are outstanding economic problems in Europe and the Eurozone. Our problems are near the top of the league table, but as we control our own currency and make our own economic decisions, there is a general view that we will not default on our sovereign debt. The combination of countries with vastly different economic performances within the Eurozone, the different political positions and the presence of a central bank that does not want to act like a central bank makes the Eurozone problems more difficult to resolve. The Fiscal Compact attempts to do this by committing member countries to meet key fiscal ratios, notably that national structural deficits (the underlying difference between government revenues and spending) will be limited to 0.5% generally and certainly no more than 3%, and government debt should be no more than 60% of GDP.

Countries signing the Treaty will have to enshrine the deficit target within their legal systems and have this verified by the European Court of Justice, with automatic correction mechanisms to be introduced if the ratios are exceeded. In other words, national governments will have no power to run deficits. If a ‘bad boy’ country hits a 3% deficit it will have to introduce measures recommended by the European Commission and will have to submit budget plans for approval by the Commission.
Similarly, national governments with debt levels above the 60% GDP ratio will have to reduce that ratio to less than 60% at a prescribed rate. The various sanctions may not be imposed if there is qualified majority voting against their imposition, but presumably as the intention is to present a hard line, there should be little wriggle room in practice.

Whether or not you are happy with the principle of shifting this economic and political power from national governments to the Commission, the reality of any rapid shift to the agreed ratios can be put in context by the figures shown in tables 1 and 2.

As can be seen from the sample of Eurozone members shown in these tables, there will have to be some rather radical action to achieve the prescribed ratios, and if national governments are not prepared to act there will be a legal requirement for Commission proposals to be introduced.

There are, in theory, two ways of eliminating deficits: either rapid and preferably export-led growth which increases tax revenue and reduces social security costs; and/or austerity policies that increase taxes and cut spending. The problem is that with European and international growth prospects both looking very poor, the focus will be very much on austerity. This is bad enough if a country has a substantial deficit of up to 5% for example, but for the more peripheral countries the implication is massive and sustained austerity. And even if the deficit ratio is not particularly high – as in Italy for example – the huge ratio of debt to GDP means severe public spending cuts. Spain has the opposite problem – relatively low public debt but a high deficit – also creating a substantial austerity legacy. It is noticeable that even the recent historical figures in Germany exceed the required Treaty ratios. For comparison, the November Autumn Statement indicated that in 2011/12 the UK had a deficit/GDP ratio of 6.4% and declining, and a public sector debt/GDP ratio of 68%, rising to a peak of 78% in 2014/15.

It is difficult to imagine how the more poorly performing countries will be able to improve their circumstances. The common currency means devaluation is not an option, leaving peripheral countries with an overvalued currency and the more successful countries with an undervalued currency, perpetuating the economic imbalances. Adding fuel to this fire, the refusal to fully integrate fiscal and monetary policies, and the unwillingness of the European Central Bank to issue Eurozone bonds – using the strength of stronger countries to, in effect, support the weaker countries – sustains the risks of sovereign debt defaults and very high borrowing costs for the most indebted countries. It may not be politically palatable in Berlin, but economic logic suggests that the current Eurozone is a ‘dead duck’ unless there is a much greater transfer of resources from the stronger to the weaker countries by one means or another.  

Looking beyond the economics, how likely is it that the populations of the weaker Eurozone members will be prepared to accept long-term grinding austerity imposed by Brussels diktat? There is no doubt that some countries have lived well beyond their means – albeit partly as a result of the failure to police the earlier EU Stability and Growth Pact – and that major structural changes are required, but we have to deal with the economic and political problems which exist now.

Fundamentally, is the existence of the current Eurozone and the implementation of the Fiscal Compact compatible? It is very difficult to see how.

Why does this matter to us? All mainstream forecasts assume the Eurozone will be patched up and struggle on. If the Fiscal Compact cannot work the implications are more severe recession and lack of confidence and a much slower recovery of UK construction and mineral products markets. What are the alternatives? Either a more realistic Fiscal Compact with more integrated and mutually supportive fiscal and monetary policies, or a smaller Eurozone.

The views expressed in this article are those of the author and not those of the Mineral Products Association.