How Europe can stave off a crisis
By Gordon Brown
The views expressed are his own.
It was said of European monarchs of a century ago that they learned nothing and forgot nothing. For three years, as a Greek debt problem has morphed into a full blown euro area crisis, European leaders have been behind the curve, consistently repeating the same mistake of doing too little too late. But when they meet on Sunday, the time for small measures is over. As the G20 found when it met in London at the height of the 2009 crisis, only a demonstration of policy intent that shows irresistible force will persuade the markets that leaders will do what it takes. An announcement on a new Greek package will not be enough. Nor will it be sufficient to recapitalize the banks. European leaders will have to announce a comprehensive — around 2 trillion euro — finance facility; set out a plan to fundamentally reform the euro; and work with the G20 to agree on a coordinated plan for growth.
For three years it has suited leaders across Europe to disguise Europe’s banking problems and, citing the blatant profligacy of Greece, they have defined the European problem as simply a public sector debt problem. And it has suited Europe’s leaders to call for austerity (and if that fails, more austerity) and forget how the inflexibility of the euro is itself dampening prospects for growth, keeping unemployment unacceptably high and weakening Europe’s competitive position in the world today. Indeed, Europe’s share of world output has now fallen to just 18 percent. And it is a measure of how it is losing out in the growth markets of the future that just 7.5 percent of Europe’s exports go to the emerging markets that are responsible for 70 percent of the world’s growth.
When I attended the first ever meeting of the euro group of leaders in October 2008 there was astonishment when I reported that Europe’s banks had bought half America’s subprime mortgages and there was incredulity when I said that European banks were far more at risk than U.S. banks because they were far more highly leveraged. Since 2008, as American banks have tackled their toxic assets, they have written off 4 percent of their loans and raised the equivalent of another 4 percent in new equity. But euro area banks have written off just 1 percent of their loans, and have raised their capital base by only 0.7 percent, leaving them highly vulnerable even before their exposure to sovereign debt has become a central issue. Their vulnerability is increased because they have always been far more dependent for their funding on the short term and confidence-dependent wholesale markets, and countries within the euro zone are able to do far less in the face of capital flight than, say, Britain.
Of course in 2008, governments could fund the rescue of indebted banks; in 2011, indebted governments are finding that more difficult. For they know that even after they recapitalize the banks, they have still to deal with the even bigger financial problem of funding the borrowing needs of the most at-risk countries: Greece, Ireland, Spain Portugal and Italy, which could cost as much as $2 trillion in the years to 2014.
It is thus clear that the 400 billion euro rescue fund, the European stability fund, is wholly inadequate to address this profound failure across the European financial system, and that without a mechanism for fiscal coordination the euro cannot easily survive. A few days ago, U.S. Treasury Secretary Tim Geithner said that “the critical imperative is to ensure that the governments and the financial systems under pressure have access to a more powerful financial backstop.”
I believe that only an impenetrable firewall will show the determination of European leaders to head off the crisis and save Europe from a new recession. I know of all the doubts about a new but temporary role for the ECB, but it is unlikely that any other organization has the resources for quick action. But the IMF should back them up, funding their contribution through loans from the oil states and China. It may now be impossible to avoid hundreds of billions in bank de-leveraging and liquidations, but a coordinated approach with the support of the international community could provide the breathing space for what matters — the reform of the euro.
But radical as these measures are in staving off a financial crisis, they do not ensure a recovery. And once again Europe needs the support of the international community to grow. In 2011, no one continent on its own can reignite the world economy. But every country, from America to China, is trying to export its way out of trouble — and logically this strategy cannot work. A coordinated global growth strategy is the only sure way of maintaining high levels of employment and growth. And when the IMF examined the upside of coordination, compared with the downside if events took a bad turn, they discovered that world output would be 5.5 percent higher, employment would be 25-50 million higher, and there would be 90 million fewer in poverty.
Coordination is all the more necessary because we are at a unique historical juncture — in the transition to a new and more balanced global economy. For one hundred and fifty years, Europe and America produced the majority of the world’s manufactured goods, accounted for the majority of trade and were responsible for most investment and consumption. But in 2010 for the first time, America and Europe (the EU 27) were out-manufactured, out-produced, out-invested and out-traded by the rest of the world. Significantly, we were not out-consumed.
Only 40 percent of manufactured goods and even less investment may come from Europe and America, but they still consume 55 percent of the world’s goods and services. So today there is a precarious balance between producers and consumers. The West is the world’s majority consumer but not the world’s majority producer — and the rest of the world is the majority producer but not the majority consumer, so the West and the rest depend on each other. Ten years ago the West, then the world’s majority producer and consumer, could drive the world economy on its own. Ten years from now Asia may be able to do likewise. But for the moment at least, East and West either rise together or falter together.
This means that the G20 countries must do more than work with the ECB and IMF to smooth a euro rescue plan. At their meeting in November, they must push forward with a deal between the West and the rest of the world for growth. Of course there are other problems — exchange rates, trade restrictions, capital controls, and potential inflation — but these can be best addressed within a framework for growth.
By coordinated action, the G20 can push back on protectionist policies and give people confidence that the world economy can grow sustainably. None of this avoids the painful decisions that arise from the de-leveraging by the banks, nor can they be a substitute for tough debt reduction plans. But if China increases consumption, and Asia opens its markets; and if America and Europe spend on infrastructure, (not least because Asia is out-building, out-investing and, perhaps soon, out-educating the West) then we can create a self reinforcing cycle of growth. Indeed if China were confident its export markets would not collapse and if the West were confident it could export more, then the world economy would move forward again. With inflation still relatively low, the time is right for a G20 growth and employment pact. It is not only the way forward for Europe but the right path for the whole world.
PHOTO: Civil servants march in front of the parliament during an anti-austerity rally in Athens October 21, 2011. REUTERS/Yiorgos Karahalis