Cause and Effect in European Politics and Law

The stakes of the euro: economic integration

Adelina Marini, May 14, 2010

On May 18 the ministers of finance of the European Union will gather together again but this time for their regular Ecofin meeting to discuss the situation with Spain and Portugal. Both countries are too in a terrible economic and budgetary crisis, although not in the catastrophic scale of Greece. And though Spain and Portugal actively participated in the search of a rescue for Greece and the eurozone in general by undertaking numerous measures to put their huge fiscal deficits under control, the danger for them has not passed yet.

It is hard to find time with all the news from the decisions of the EU and the Eurogroup the actual situation to be deeply analyzed. Earlier we presented to you the opinion of Simon Tilford regarding the problems in the euro area in general because it has no future unless these problems are solved. Now we are presenting the opinion of the economic experts with the Carnegie Endowment for International Peace Uri Dadush and Vera Eidelman.

The basis of their thesis is that Spain's problems stem from the same source as Greece - a huge misallocation of resources and loss of competitiveness that began with the adoption of the euro. Spain’s non-tradable sectors—housing, the government, and a broad array of market services—had grown far too big. The debt-to-GDP ratio of the country is half that of Greece and gives some reasons to hope that there is still time for Spain to solve its problems.

Nevertheless, the authors write, the large deficits and the collapse of its post-euro growth model imply that its public debt could, if remedial measures are not taken, follow an exploding path. And another very important thing which Uri Dadush and Vera Eidelman highlight and is good taking into account by all similar economies - Spain has to effect a profound structural transformation and it cannot look to a cyclical recovery to reignite growth and reduce its mass unemployment.

What the government in Madrid can do is reverse the imbalances piled for decades by restoring competitiveness, reallocating resources to production and other sectors which can help stimulate trade. And as devaluation of the currency is not a solution (because this is the single currency of an entire monetary and economic union), reforms can be realised only if prices of labour, of housing and services drop to some relativity to Spain's European partners. Separately, the government sector must be reduced together with other deeper reforms.

The analysts explain that in fact the housing sector's boom and bust (by the way something that happened in Bulgaria too) was only one indicator showing deep structural imbalances. It caused a huge increase of prices of all tradables as well as wages increase. Now when construction is practically in stagnation and cannot be used as an engine to take the country out of the crisis, Spain must tackle competitiveness losses.

Over the last decade, because of the excessive focus on construction, Spain’s exports have lost a significant share in world markets. For example, exports as a share of GDP fell by 3 percentage points from 2000 to 2008 in Spain, compared to a rise of nearly 14 percentage points in Germany. While Germany grew its current account surplus, Spain’s plunged into deep deficit. In this regard, Spain shared the experience of Greece, Ireland, and Portugal, which also became excessively dependent on domestic demand and non-tradables such as telecommunications.

The medicine for the Aegean fever, as the authors call it, is well known but the pharmacist has yet to deliver it. For a start government spending cuts is recommended, freezing of public wages, combined with a benchmark for wage-setting in the private sector. All bonuses and privileges must be removed, structural reforms must be enhanced, increasing of competitiveness of back-bone sectors like transport, finance, communications, energy - indeed, very familiar pieces of advice.

We can hardly say that the governments of the countries in serious budgetary and economic crisis did not know or do not read such pieces of advice by influential economists and analysts. On the contrary, they have known and they do read. The problem is however that politicians often prefer media and rating comfort instead of longterm perspectives of their countries.