Helped by the ECB’s huge liquidity boost, launched last December, the financial markets have recently become more optimistic about the prospects for the Eurozone. There has even been talk that the Eurozone crisis may be on the way to being “solved”. Alas, this can only be, as ever, a false dawn. The grinding realities of the Eurozone’s dysfunctional economy are never far from the surface. And, as if on cue, a leaked paper from the IMF containing some depressingly predictable downgrades to the Eurozone’s growth prospects appeared in the press towards the end of last week.
The IMF now expects Eurozone GDP to fall by 0.5% this year compared with an increase of over 1% last September. Indeed the currency bloc is probably already in recession. Even Germany’s GDP fell back by about 0.25% in the fourth quarter of 2011 as recovery petered out. The IMF now forecasts falls in output for both Spain (1.7%) and Italy (2.2%), instead of September’s expectations of modest growth, whilst the contraction in Greek and Portuguese GDP can only be expected to worsen. The southern European economies, uncompetitive and struggling with demanding austerity packages, are trapped in a vicious downward spiral of falling output, rising debt and worsening growth prospects. Joseph Stiglitz has recently commented that austerity packages are “suicides pacts”, akin to medieval “blood-letting” which left the patient sicker than before. The language may be melodramatic but the sentiment is fair. Faced with catastrophe the EU’s leaders continue to insist on austerity whilst doing little to help the patient onto his feet.
Aware that insufficient attention has been paid to growth, a Franco-German document emerged last week allegedly entitled “Ways out of the crisis – strengthen growth now!” (Please note the exclamation mark.) But the policy prescriptions amounted to little more than a reiteration of the need for the Financial Transactions Tax (aimed at the City of course), the convergence of corporate tax regimes (threatening Ireland’s tax competitiveness), more energy taxes (to save the planet from dangerous global warming), Commission-administered regional funds and, quite sensibly, lower labour taxes (though it is not clear how they would be funded). One can be forgiven for concluding that these policies would, on balance, harm rather than hinder growth. One can also be forgiven for concluding that EU leaders inhabit a parallel universe.
At least, and at last, the IMF now appreciates the gravity of the situation in southern Europe, after seriously misjudging their deteriorating prospects. But they seem determined to support the euro as a currency bloc, as indeed do the EU’s leaders – come what may. Perhaps the EU’s leaders can be forgiven. Any reconfiguration of the euro will be a politically devastating, given the political capital sunk into the project, as well as economically disruptive. But the IMF should not be, never be, in this position. The IMF has to date loaned very substantial sums to Eurozone countries: Greece (€30bn), Ireland (€22.5bn) and Portugal (€26bn). And the implication of the IMF’s latest request for up to $600bn of extra firepower, a huge sum, is that it is preparing for possible bailouts for Spain and/or Italy. Frankly, if Spain and/or Italy do get into the position of needing bailouts to stay in the Eurozone, the EU leaders would be failing in their duty if they did not declare “time” on the whole project.
There are two other reasons for questioning the IMF’s latest request. Firstly, there is the unpalatable fact that when relatively rich European countries are bailed-out by non-European countries, many of the non-European countries are substantially poorer than the countries being bailed out. And let us note that they are still relatively rich despite the catastrophic policy position they are in. Ireland’s Gross National Income (GNI) per capita in 2010 was $41,000, Greece’s nearly $27,000 and Portugal’s about $22,000. In comparison the global average was $9,000, China’s GNI per capita was about half the global average ($4,300) whilst India’s was just over $1,300. The Eurozone is still one of the wealthiest parts of the global economy. One has to sympathise with the view that “they got themselves into this mess and they can afford to get themselves out of it”. Secondly, it is increasingly obvious to many observers that the Eurozone’s current configuration is unviable. Moreover many donors suspect that extra funds for the IMF will merely serve as a conduit to the Eurozone. Why throw more good money after bad? The US Administration has already indicated it will provide no more money for the IMF to lend to European countries and Canada is similarly cool.
The IMF’s policy approach to the Eurozone crisis has been damagingly inconsistent. The IMF’s usual approach to countries with fiscal and competitiveness problems is austerity combined with a sharp devaluation and sovereign debt restructuring to put debt back on a sustainable footing. In this crisis the IMF has insisted on austerity but the single currency, of course, prevents devaluation and concerns over the banking sector have acted as a drag on sovereign debt restructuring. All that is left for the southern European countries is IMF-inflicted pain which, mirroring the EU’s policies, is resulting in austerity traps.
The IMF should now draw back from supporting the Eurozone. It was a mistake to become involved in the first place, given that the Eurozone’s configuration meant that it was in no position to draw on its usual menu of policy prescriptions for the troubled countries. It would now be better preparing for the day when the Eurozone begins to unravel, which will be disruptive but, if handled correctly, not catastrophic. Catastrophe scenarios are propaganda to frighten the horses. Britain should draw back too, even though I recognise that the chances of losing money by lending to the IMF are vanishingly small. The IMF’s policy of continuing to support the Eurozone is flawed and, as such, we should have no part of it.