Why America is recovering, but Europe is not - Part II
It is the differences in the way the United States and Europe tackled the global financial crisis that explain why the US economy is recovering, whereas the eurozone is in a lost decade.
Why US crisis policies worked
In the United States, the global financial crisis was unleashed by real estate markets and the financial sector, which caused a dramatic contraction and massive mass unemployment.
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But even as the Obama administration and the Congress initiated deleveraging and tried to repair the devastation of the subprime markets and the colossal excesses of the too-big-to-fail banks, Washington used substantial fiscal adjustment as a cushion.
The administration’s stimulus package, which was later revised to $831 billion, included spending in infrastructure, health and energy, federal tax incentives, expansion of unemployment benefits and other social welfare provisions. It boosted innovation and supported competitiveness.
Meanwhile, the Federal Reserve, in just weeks, subverted monetary policies that had endured three decades. Under Ben Bernanke, the Fed reduced the federal funds rate to 0-0.25 percent in autumn 2008 and,since that proved inadequate, it turned to non-standard monetary instruments, including rounds of massive large-scale asset purchases.
Most importantly, the United States did not suffer from “institutional deficits.” Through the crisis, it was able to rely on common fiscal and monetary policy. When one state got into trouble, it could turn to others for support. Of course, the crisis supported some states and hurt others, but the common institutions worked.
Then, there were the advantages associated with the US dollar. In autumn 2008, it translated to €0.80. Today, it amounts to €0.74 euro. Currently productivity is increasing 20 percent faster in the US than in Europe. Yet, the US dollar remains 25 percent behind euro.
Mysterious are the ways of the currency markets.
Why European crisis policies did not work
When the 2008/9 crisis hit Europe, the core economies relied on their generous social models, but structural challenges were set aside. That ensured a timeout but boosted threats. In spring 2010, the crisis was still seen as a liquidity issue and a banking crisis. So Brussels launched its €770 billion “shock and awe” rescue package to stabilise the eurozone.
As the consensus view grouped behind Brussels, I argued that the rescue package was inadequate and the austerity policy too strict. Further, it ignored multiple other crisis points. And it was likely to result in demonstrations and violence in southern Europe.
That’s what followed as smaller economies – Greece, Portugal, and Ireland – suffered deep contractions.
In Brussels, the crisis economies were seen as “exceptions” until the eurozone crisis spread to Spain, Italy, and even France. At the same time, the European Central Bank (ECB), led by its then-chief Jean-Claude Trichet, moved too slowly and hiked rates instead of cutting them. When the ECB finally reversed its approach, precious time and millions of jobs had been lost.
Subsequently, Trichet’s successor, Mario Draghi, cut the rates and pledged to defend euro “at any cost.” Markets stabilised, but not without huge bailout packages, which divided the eurozone.
As Barroso and his commissioners began to argue that “the worst was over,” Brussels hoped to reinforce the trust in euro and the EU and deter the rise of the eurosceptics. But hollow promises resulted in a reverse outcome.
What’s worse, both Brussels and the core economies failed to provide adequate fiscal adjustment amidst the global crisis and the onset of the eurozone debt crisis, which made bad mass unemployment a lot worse and continues to penalise demand and investment.
Further, neither liquidity support nor recapitalisation of the major banks has mitigated the worst insolvency risks in the region.
Unlike in the US, many European economies, including Nordic ones, also continued to cut their innovation investments, thus making themselves even more vulnerable in the future.
As the crisis spread to Italy and Spain, which together account for almost 30 percent of the eurozone economy, bailout packages could no longer be used. Rather, structural reforms became vital but since they were seen as a political suicide, delays replaced urgency.
Meanwhile, the euro has been a heavy burden in the eurozone. Although Europe remains significantly behind the US in productivity growth, the euro was 1.45 to the dollar in autumn 2008 and 1.34 today – a third higher than the US dollar.
How has deleveraging succeeded? Well, it hasn´t. General government gross debt as percentage of the eurozone GDP soared from 70 percent to 93 percent in 2013. In Italy, the ratio has increased by a third to 133 percent. In Spain, it more than doubled to 94 percent; in France, by a fourth to 94 percent. In small crisis economies, the debt - Greece (175%), Portugal (129%) – remains at threat levels.
Perhaps it is not coincidental that the eurozone is “changing” its budget accounting method, while Italy is postponing the release of its autumn budget.
The Russian sanctions threat
But it is the sanctions on and by Russia that pose the greatest downside risk to Europe, Russia´s greatest trade partner.
Last year more than 50 percent of Russia’s exports of goods went to EU countries, where Russia also purchased almost 50 percent of its imports. In the financial sector, European banks had some 75 percent of Russia’s foreign bank loans in late 2013.
It is for this reason that Germany’s Chancellor Angela Merkel recently rushed to Kiev to pave the way for peace talks between president Putin and Ukrainian president Petro Poroshenko.
Her balancing act was designed to sustain Europe’s positive economic development, despite sanctions. While Moscow does not want to see Ukraine in Nato, Merkel indicated that she did not see “membership” on the agenda but that Kiev could continue its “co-operation” with Nato.
Then came reports from Kiev suggesting a “Russian invasion” is under way.
As the eurozone core economies – Germany, France, and Italy – began to ponder extra sanctions on Russia, Nato said Ukraine can pursue membership. As Merkel’s cautious recalibration was undermined by real and alleged events, EU leaders opted to wait how Russia will respond to Poroshenko’s new “peace plan.”
If the West will tighten current sanctions incrementally, global economic prospects remain tolerable. If, however, the West takes the sanctions to still another level, the downside risks could push Europe into a triple-dip recession – and the weakest euro countries into the shadow of the abyss.
The writer is a researcher at the India, China and America Institute in the US and a visiting fellow at the Shanghai Institute for International Studies in China