The euro crisis casts its wintry gloom. Yields on Spanish bonds are rising dangerously, and Italian ones are close behind. Portugal may need fresh support. The euro zone’s recession may be mercifully mild. But budget pressures are pushing economies into recession. The IMF is warning against over-zealous austerity. But the 17 countries making up the Eurozone has a combined unemployment rate of 10.9%, the highest percentage rate since the euro was launched in 1999. Beyond these economic considerations, political uncertainty fumes. Greece and its anti-austerity party are getting all the headlines, and French presidential election results make France’s future quite opaque. Unless politicians deal with the euro’s underlying flaws, it could become a long and painful death march, not unlike Napoleon’s return from Moscow after the war of 1812.
History is littered with currency unions gone bad. Unable to devalue ones currency makes the option of breaking up, too easy. Why not release the yoke? What holds the euro together presently is the fear of the ensuing financial and economic chaos. At its root, the impulse to defend the euro is the investment made by its constituents. So the euro remains vulnerable to new shocks. Leaders should be thinking about how to manage a break-up. Leaving the euro would help troubled countries recover quickly, if expensively. The real problem is that many countries face large imbalances and high debts. The fate of the euro will probably be determined by politics, not economics. But government needs to think the unthinkable.
France, the swing country in the Euro crisis, went for Monsieur Hollande, the first Socialist since Mitterrand in 1981. This casts the prosperity of France and the survivability of the euro currency in doubt. France desperately needs reform. Public debt is high and rising. Its government has not run a surplus in over 35 years. Its banks are undercapitalized. Unemployment is persistently high. At 65% of GDP, the French state is the biggest in the euro zone. Mr. Hollande is all about social justice but nothing about growth or about how to create wealth. He plans to raise taxes, but plans to make no cuts to spending. He wants to add 60,000 teaching jobs which means actually increasing spending, not reducing it. He is antibusiness. His own Socialist Party needs reforming too. It hasn’t caught up with the 21st century yet.
Markets are unforgiving and his policies will show France how unrelenting they can be. His election appears to be the worst solution to France’s traditional desire to preserve its social model. A rupture between France and Germany would come at a dangerous time. A French president so hostile to change would undermine Europe’s willingness to pursue the painful reforms it must eventually embrace for the euro to survive. A Frenchman named DeToqueville, in his “Democracy in America”, wrote of the ‘Tyranny of the Majority’. French voters may ultimately prove his case. While everyone is calling for growth, no one agrees how to create it. Make markets more flexible, encourage entrepreneurship, Mrs. Merkel echoes this. Mr. Hollande is against such ideas. The biggest boost would come from removing the uncertainty of the survival of the euro. Boost domestic demand through higher spending or lower taxes; accept higher inflation; recapitalize banks and guarantee deposits; create some form of joint Eurobond, though the Germans are staunchly opposed, would stop countries being pushed into insolvency. Most importantly, Eurozone countries may end up having to accept more reform and more budget discipline.
American economy is growing at an unimpressive rate. Unemployment down to around 8% and inflation, now around 2% are moving in the right direction. Yet economic growth has averaged 2.5%, a rate typical of the economy at full employment. The recent economic crisis stunted the main ingredients of growth: capital, labor, and innovation. The crisis killed credit and sales, depressed investment and productivity. Prolonged unemployment lowers worker skills and paradoxically lowers their inclination to work; finally, the rhythm of innovation was reduced. Combined, these factors reduced the path of potential GDP. A major factor in the slower rate of growth was the failure of the labor force to participate in the rebound since the recession ended. The potential labor force was reduced nearly 3.5%, from 160 million workers to 154 million. The difference represented permanent departures from the work force. How much potential was damaged will depend on how well demand can be sustained. American policymakers must more vigorously to apply structural reforms and fiscal stimulus. It is time for the American economy to prove its prowess.