... if the eurozone were a properly functioning currency union with real labour market mobility and true wage and price flexibility
The real reforms needed to secure the euro’s future
Desmond Lachman, Financial Times 1/3 2007
The writer is a resident fellow at the American Enterprise Institute
At the time of the euro’s launch, it was hoped that the adoption of a single currency would force all member countries to become more disciplined in their public finances and more competitive in their labour and product markets. By depriving countries of the easy way out of restoring lost competitiveness through exchange rate devaluation, it was hoped that countries would be forced to reform their labour markets and to undertake sweeping market reform with a keen eye on their relative competitive position.
Looking at the continued wayward wage and price performance of Greece, Italy, Portugal and Spain since 1999, one might be forgiven for thinking that little has changed in these countries in spite of their having joined the euro. In the short space of seven years, these countries have managed to lose between 30 and 45 per cent of international competitiveness to Germany. This is already exerting a serious toll on Italian growth performance, and it does not bode well for growth prospects in Mediterranean Europe, especially if Spain’s housing market bubble bursts.
A further symptom that something is amiss in the working of the single currency system is the divergent external current account positions of individual countries. Whereas Germany now runs an external current account surplus of around 4 per cent of gross domestic product, Greece, Spain and Portugal all run external current account deficits of between 8 and 10 per cent of GDP.
The opening up of divergences in relative trade performance between individual European countries would be of little moment if the eurozone were a properly functioning currency union with real labour market mobility and true wage and price flexibility. After all, large differences in trade performance between individual states in the US do not lead to great unemployment variations between states as wages adjust and as labour moves.
Sadly, however, most studies reveal that the eurozone is as lacking today in those essential qualities for a successful currency union as it was at the time of the euro’s initial launch.
As a result, one must expect unemployment to rise to socially unacceptable levels in those countries that lag behind, which in time could seriously erode political support for the euro.
Despite the favourable global environment and the dramatic drop in Italy’s borrowing costs since joining the euro, Italy has not managed to rein in its public deficit. Given its political instability, it is unlikely to do so any time soon. As a result, Italy’s public debt has remained above 100 per cent of GDP.
Portugal will follow Greece and Ireland to failure
IMF and EU appear set to do so by prescribing for Portugal the same failed policy approach of savage fiscal retrenchment in the most rigid of fixed exchange rate systems that has had such dismal results to date in Greece and Ireland.
Desmond Lachman,FT March 31 2011
Top of page