After Hollande's victory: austerity or stimulus?

Beyond the prism: Decade after creation of eurozone, an economic, monetary union of 17 European Union member states, it is facing its biggest crisis yet.

Hollande and Obama 370 (photo credit: REUTERS)
Hollande and Obama 370
(photo credit: REUTERS)
A decade after the creation of the eurozone, an economic and monetary union of 17 European Union member states, it is facing its biggest crisis yet.
The euro is used daily by 350 million people. It has become the second-largest reserve currency as well as the most traded currency in the world after the US dollar, and the eurozone is now the second-largest economy in the world. Therefore the implications of the euro crisis reach well beyond Europe’s borders.
In this election year, the stakes for President Barack Obama are huge as the European situation could threaten the US’s economic recovery and consequently Obama’s chances at reelection.
Governor of the Bank of Israel Stanley Fischer has warned that despite the strength of the Israeli economy, the effect of the debt crisis in Europe could cause serious problems. “Our exports will be affected by the situation in Europe. If there is a financial crisis and weakness in European banks, it will affect us too – and it’s on the way,” he said. “Exactly how it will affect us is not clear.”
Since its establishment, the biggest difficulty for the eurozone has been the adoption of common fiscal policies, as the economic conditions of the countries differ significantly. There has been fear that with a single currency, irresponsible financial behavior by one member country could cause suffering to all the others by raising the cost of borrowing. This fear led to the introduction of budget deficit caps. However, strict budget deficit regulations can deny a country the option to borrow when borrowing could boost its economic growth.
DESPITE HAVING adopted strict criteria regarding budget deficit and public debt, the European Union has always been tolerant of deviations. The German magazine Der Spiegel recently revealed documents from German state archives that prove that “Italy should never have been accepted” into the common currency zone and the decision “was based almost exclusively on political considerations at the expense of economic criteria.”
The same lack of fiscal discipline that was already present before the introduction of the euro continued to be present during the entire decade. It was the eurozone’s largest economies, France and Germany, which continuously violated these requirements, starting in 2003 by breaching the 3 percent annual budget deficit ceiling, claiming that flexibility is necessary in order to boost economic growth.
In Greece, irresponsible government spending led to a large increase of the government’s debt level. This caused concerns among investors concerning Greece’s ability to meet its debt obligations and led to a crisis of confidence and danger of default. In May 2010, the eurozone countries and the International Monetary Fund agreed on a 110 billion euro bailout loan for Greece, conditional on the implementation of austerity measures. In October 2011, Greece received a second 130b. euro bailout loan.
In addition to the difficult economic situation, Greece has suffered from political instability and street riots. The coalition talks after the May elections fell apart and elections will be held again in June, where the far-left Syriza party, which came in second in May, has good chances of winning.
Syriza refuses to continue with the austerity terms of the Greek bailout, which has led to strong speculations about whether Greece will have to leave the eurozone. There is a European consensus about maintaining the country’s membership, but European countries have said that Greece must accept the terms of the bailout package. It is uncertain what a Greek exit, or “Grexit,” would mean for the economies of Europe and the world.
Despite this, public debt has risen substantially in only three eurozone countries: Greece, Ireland and Portugal. There is a misperception that a high increase of government debt characterizes all of the eurozone, whereas these countries collectively account only for 6% of the eurozone’s GDP. The euro has also remained stable throughout the crisis.
It’s true that public debt is often high elsewhere in the eurozone, however it hasn’t increased as sharply, and a bigger challenge is how to tackle the lack of economic growth and the growing unemployment.
In Spain, the eurozone’s fourth largest economy, unemployment has reached 25%, while the economy shrank by 0.3% in the first quarter. Italy, the eurozone’s third largest economy, slid further into recession in the first quarter of this year, as data show a 0.8% contraction, while unemployment rose to a 12-year high.
Several countries do not suffer from high public debt and are desperate to generate more growth. Despite these differences between eurozone countries, German Chancellor Angela Merkel strongly believes, perhaps due to past violations, that priority should be given to the reduction of public debt. Merkel’s efforts led to the adoption of a fiscal agreement that would force European countries to have national budgets that are in balance or in surplus.
However, since the signing of the fiscal treaty, parties opposing the measures gained considerably in elections throughout Europe. The biggest challenge to the fiscal treaty came from France. With François Hollande’s victory against Nicolas Sarkozy, Merkel lost her closest supporter in Europe. Hollande is interested in reviewing the agreement, and if his party succeeds in the parliamentary elections in June, French ratification may be jeopardized.
The latest declaration at the G8 summit in Camp David could be indicative of the future direction of fiscal policies. “We commit to fiscal responsibility and, in this context, we support sound and sustainable fiscal consolidation policies that take into account countries’ evolving economic conditions and underpin confidence and economic recovery.”
Obama’s closing statement at the G8 indicates that he sides with Hollande and those who are interested in pursuing a different approach to the German one: “But the direction the debate has taken recently should give us confidence,” Obama said. “Europe has taken significant steps to manage the crisis. Individual countries and the European Union as a whole have engaged in significant reforms that will increase the prospects of long-term growth. And there’s now an emerging consensus that more must be done to promote growth and job creation right now in the context of these fiscal and structural reforms. That consensus for progress was strengthened here at Camp David.”
Merkel has until now been categorically against opening up the fiscal agreement, and claimed that “growth through debt would throw us back to the beginning of the crisis.” However, due to changing political circumstances and her increasing isolation, she might consider accepting some of Hollande’s proposals.
In any case, there is an inherent structural difficulty in applying common financial policies to 17 different countries. Nevertheless, in such a globalized economy, the restoration of confidence in Europe is important for us all.
The writer is project coordinator at the Jerusalem Center for Public Affairs.