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Tuesday, May 08, 2012

Europe founders in rough financial seas

The economic crisis gripping Europe has cost prime ministers their jobs from the Netherlands to Italy.Protests, sometimes violent, against deep spending cuts have wracked European capitals. Recession has returned to Britain.


Financial markets are reluctant to lend to Spain. Princeton University’s Paul Krugman and Harvard’s Lawrence Summers agree that efforts to end Europe’s crisis through government austerity programs have not only failed, they are making things worse.

Troubled nations like Greece complain that it is the reluctance of more solvent nations like Germany and France to spend that is holding the continent hostage.

From the perspective of European Union economists, austerity isn’t optional, growth is the only objective and major restructuring of Europe’s economy, especially its labor markets, is essential.

The solutions to Europe’s troubles — which will have serious implications for the U.S. economy — are to be found in reforming member nations’ taxation and their public-sector employment practices and in completing the construction of the union.

That’s the opinion of Antonio de Lecea, economic and financial affairs minister at the European Union Embassy in Washington, D.C. De Lecea was in Albuquerque late last month to address the Albuquerque International Association.

He sat for a 90-minute Journal interview before his speech. Austerity unavoidable “We’re in a mild recession overall,” de Lecea said of the European economy.

“Clearly, we want to reach our potential growth. At the same time we want to reach higher growth than in the past, the crisis has shown us the importance of financial stability.”

The austerity effort — for example, forcing countries to cut government benefits and sell state-owned enterprises in return for bailout money — is unavoidable in part because no one will lend to some countries, such as Spain, for anything like a reasonable interest rate, he said.

Germany, which some critics say should buy more goods from other European countries or subsidize borrowing by other governments, spent enormous amount of money in the 1990s bailing out East Germany when it was reunified with West Germany.

A bailout of the rest of Europe would cost many times more than that, de Lecea said. Investors, including stronger countries, just don’t have the confidence to write blank checks to Spain, Ireland, Italy, Greece and other countries, he added. Finally, de Lecea said, some European nations are in trouble precisely because of the way their governments spent.

“Some countries lived above their means for some time. There is no choice but to tighten the belt. Public spending is crowding out private investment.”

Wage reform needed Austerity may be necessary, but major changes in how European countries and workers behave is where the continent will find growth, he said. “We know some things that are necessary,” de Lecea said.

“We are not sure that they are sufficient.” If the public sector offers excessively high wages, the private sector is at a competitive disadvantage when it comes to hiring labor.

If the state owns enterprises, those enterprises tend to be inefficient and lose money, they tend to operate at an advantage against private-sector competitors, they crowd out labor and capital, and they can promote corruption.

“If you want growth you have to address these problems,” he said. The European Union needs to cap public-sector wages and employment, push divestiture of state-owned enterprises and review the licensing of professions, which tends to keep wages for some workers artificially high by preventing new members to join some professions.

Unemployment subsidies are too generous and operate as a drag on the economy. “Removing those obstacles are necessary conditions for growth,” de Lecea said.

Early retirement issues “We know having people retire at 55 reduces the supply of labor and in some ways pushes up wages,” he said. “We know too many taxes on labor reduces demand for labor.

We know collective bargaining at the national level creates distortions” in the supply and demand for labor. Fixing those problems “will not necessarily lead to growth,” de Lecea said.

The European Union also wants to issue bonds to finance infrastructure projects across borders, such as transcontinental highways, railroads and communications projects.

The EU wants to transfer funds to state budgets to guarantee loans for small businesses and improve access to capital. It wants to fund young entrepreneurs. “This may work, but it may not be enough,” he said. De Lecea says the EU itself is also in need of repair – perhaps it would be more accurate to say it is in need of completion.

The EU traces its origins to a 1958 economic cooperation treaty among six European countries. The union was created in its current form by a 1993 treaty. Today the EU is composed of 27 countries, 17 of which have also agreed to share a common currency, the euro.

“When we created the European Union, we knew it was incomplete,” de Lecea said. “It was like moving into an unfinished house. We knew that for some time it would be uncomfortable.” EU members had identified problems before the current crisis began in 2007 with the failure of some European financial institutions.

Fiscal discipline wanting It was clear that while the EU’s central bank could set monetary policies, individual countries’ fiscal policies (how their governments tax and spend) could work against the interests of the union.

EU rules require members to control their debt, but, de Lecea said, there were “significant problems in terms of enforcing fiscal discipline.”

Banks had global reach, but regulation of banks among the EU members was inconsistent. There was no common mechanism to help banks stay solvent in tough times or to let them fail without taking down the European economy with them. Countries like Germany were very competitive economically.

Countries like Greece were not. At the same time, the euro has been “a big success in terms of stability, development of financial markets, development of a quite integrated financial market. The price stability has been remarkable.”

The EU’s efforts to complete its house was overtaken by the global financial panic that followed Lehman Brothers’ collapse in 2008. “It was a perfect storm,” de Lecea said. The problems already known to the EU surfaced all at once. The Bank for International Settlements saw that something was coming before the panic hit.

The European Commission “repeatedly had warned about competitive divergences, inadequate compliance with fiscal rules and the lack of financial backstops for banks,” de Lecea said.

Caught off guard The private sector was also caught off guard. Investors kept “lending to countries with persistent deficits, both to the private sector and the public sector, without pricing risk accordingly.

“Clearly, the banking supervisors were looking somewhere else,” he said. It’s possible that everyone just bought the idea that spreading risk across investors and assets lowered risk. What really happened was that risk was just transferred.

Since there was not nearly enough transparency in financial institutions and some governments, no one knew if the people and institutions taking the risk could handle it or if they were even aware of it. Creating a common solution to such big problems is very difficult.

“What is intrinsic to the European Union is there are no full plans,” de Lecea said, because before plans can be created and executed member countries have to agree they want to attack a problem collectively.

abqjournal.com

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