The European: Mr. Legrain, the eurozone has grown by just 0.7 percent over the past 12 months, compared with 3.2 percent in the UK and 2.4 percent in the U.S. None of the bloc’s three largest economies recorded growth: France stagnated, Germany contracted, and Italy fell back into recession. Have the crisis policies failed?
Legrain: Yes. The catastrophic policy mistakes of eurozone policymakers, largely driven by Merkel and Schäuble, caused an unnecessarily long and deep recession – and now the eurozone is stagnating. The eurozone is performing worse than the United States, which has been growing since 2010, and worse than Europe was at this point in the 1930s. It’s tragic.
The European: German Finance Minister Schäuble heavily contests this view.
Legrain: He would do. Schäuble is one of the main engineers of the EU crisis response and therefore has a vested interest in claiming that those policies are successful.
“Drained of life by zombie banks”
The European: How would you then assess the current situation of the eurozone?
Legrain: The eurozone is nowhere near achieving its pre-crisis GDP, employment, and real wage levels. Relative to the 2% a year growth one might have expected in normal times, the shortfall since 2008 is even greater. Instead of growing by roughly six times 2%, so 12%, some economies are down by 10% and in the case of Greece by 25%. Germany’s performance isn’t that impressive either: it has grown by only 3.6% since early 2008, whereas Sweden, Switzerland, and the United States have all managed to double that.
The European: Why is the eurozone not recovering from the crisis?
Legrain: Seven years after the first bank in the eurozone failed and was bailed out by the German government, Europe’s banks still haven’t been fixed. And by embarking on collective, excessive austerity at a time when households and companies were also trying to cut back, policy makers caused such deep recessions that, perversely, public debt soared while the private sector was unable to reduce its debts. Now, weighed down by often unpayable debts, drained of life by zombie banks that refuse to lend on affordable terms to sound businesses, and hampered by a lack of investment without which economic reforms cannot deliver growth, the eurozone is stagnating and risks sinking into a deflationary debt trap.
The European: Policy makers seem eager to fix the problem by introducing new regulatory legislation such as the Banking Union. Can such measures be effective?
Legrain: It remains to be seen how tough the European Central Bank’s assessment of the balance sheet of larger European banks is and whether it prompts the decisive action that is necessary. The recent bailout of Portugal’s biggest bank, Banco Espírito Santo (BES), with taxpayers’ money, shows that the financial sector is not yet fixed and that governments are still inclined to bail out banks.
The European: You argue that policymakers misdiagnosed a financial crisis as a fiscal one and that the push towards austerity was misguided. German politicians, however, seem firmly convinced that austerity is the right strategy.
Legrain: German politicians tend to assume that the eurozone’s current plight is similar to the one Germany faced at the turn of the century – but it isn’t. Back then, Germany was not suffering a banking crisis. It did not have huge private and public debts. And it was surrounded by booming economies to which it could readily export more. So when Merkel repeats like a mantra that Germany’s earlier experience shows that austerity in the eurozone now can be compatible with growth, she is comparing apples and oranges. Far from generating growth, the lurch into collective, front-loaded austerity across the eurozone from 2010 onwards caused a deep slump. Households, businesses, and governments were all trying to cut back at the same time – and since European economies primarily trade with each other, one country’s depressed domestic market was another’s emaciated export market. For what it’s worth, a study by a European Commission official using its own economic model concludes that this collective, excessive austerity resulted in a cumulative loss of nearly 10% of eurozone GDP.
“Germany’s economy is not particularly successful”The European: Why was austerity then implemented?
Legrain: The misdiagnosis of the crisis and the subsequent policy response was partly deliberate. Politicians, who for a long time wanted to trim the government sector, embraced the crisis as a perfect opportunity to do so. And after policy makers’ successive mistakes sparked panic in government bond markets, many panicked and thought ever greater austerity was needed, when in fact ECB intervention was. The misdiagnosis of the crisis as fiscal rather than financial also conveniently relieved Germany and France of responsibility for the crisis through the recklessly bad lending of their banks in the pre-crisis years.
The European: France and Finland plan to tighten their fiscal policy. Germany plans to have a balanced budget in 2015. When everyone tightens their budget despite overall weak demand and investment, where should the growth impulse for the eurozone come from?
Legrain: Policymakers are mostly relying on exports to the rest of the world to pull the eurozone out of stagnation. But the eurozone is too big and demand elsewhere in the world too weak for this to lead to a strong recovery. The U.S.’s recovery is stronger than the eurozone’s, but still relatively weak. China’s economy is weakening. Only the UK is growing fast – for now. And this growth strategy is also self-limiting: as the eurozone’s current-account surplus grows, the euro tends to strengthen, damping exports, and ultimately it invites a protectionist response from the United States and elsewhere.
The European: But hasn’t this growth strategy worked for Germany? Germany used to be the sick man of Europe and is now considered a role model.
Legrain: Germany’s economy is not particularly successful. Since 2000, its GDP growth ranks 13th out of 18 eurozone countries. Its productivity growth averaged only 0.9% a year over the past decade, less than in Portugal. Yes, exports boomed, but now that southern Europe has crashed and demand from China is weakening, Germany’s share of world exports has fallen. And that earlier export growth has been at the expense of German workers, whose wages have stagnated for 15 years. Is an economy where real wages don’t rise successful? Pressing down on wages has boosted corporate surpluses, but those have not been invested domestically. Is an economy where companies don’t want to invest really that successful? Germany’s surplus savings have instead been invested abroad, most badly, with German banks gambling on American subprime mortgages and lending recklessly in southern Europe. Wage compression is neither a desirable growth model nor a sustainable one.
“Four things need to be done”
The European: The Bundesbank now calls for higher wages in Germany to fight off deflation and increase domestic demand. Do you think it will help the eurozone to recover if wages in Germany start to rise?
Legrain: Let us forget about the eurozone for a moment and look at this purely from a German perspective. Real wages in Germany are lower than 15 years ago even though German workers are 18% more productive. They deserve to be rewarded for their increased productivity. And boosting wages will also have a positive effect on the eurozone.
The European: How?
Legrain: Higher wages would boost domestic consumption, including imports. A larger domestic market would furthermore boost investment, which would also spill over into faster European growth.
The European: What needs to be done in the next five years in order to generate a robust sustainable economic recovery?
Legrain: Four things need to be done. Banks in the eurozone need to be restructured, with unviable ones closed down and viable ones recapitalized so they can lend more to sound businesses. Unbearable debts, both public and private, need to be written down. And we need to combine reforms that open up future growth with the increased investment needed to make it happen. Germany too needs to change: Investment is extremely low, and according to the World Bank’s “Doing Business” rankings, it is harder to start a business in Germany than it is in Russia or Sierra Leone.
The European: But the current fiscal rules make it difficult to expand public investment.
Legrain: That is why the rules need to be relaxed. It is shortsighted to restrict borrowing for investment, which generates future growth and tax revenues. At a European level, the European Investment Bank (EIB) should receive a further €10 billion capital increase together with instructions to use the additional capital to increase its lending.
The European: What should Germany do?
Legrain: The German government can borrow for ten years at an interest rate of less than 1% – in effect, for free, after allowing for inflation. When the cost of borrowing is zero, any project with a positive rate of return is worth doing. Given Germany’s huge investment needs – such as better infrastructure, improved education, energy – the government is mad to pass up this opportunity. It is selling younger generations short and undermining future growth.
The European: You always have been a critic of the policy response to the crisis and argued for an alternative approach even while you were an economic adviser to President Barroso. However, the policies have not changed so far. When is it time to give up?
Legrain: Never. Albert Hirschman once argued that when a polity is in trouble, people have two options: exit or voice. Many people, understandably, are choosing to leave Europe and seek work elsewhere. I intend to continue arguing for a different policy approach.
The European: Why?
Legrain: Because what’s at stake is not just conditions in Europe right now, it’s also the future Europe we want to live in. If we continue with stagnation, high unemployment, and crushing debts, we are going to destroy support for the European idea. The European Parliament elections showed that xenophobia and extremism are already rising to worrying levels, threatening our open societies. We need to change Europe in order to save it.
Did you like the conversation? Read one with Barry Eichengreen: “An unaddressed crisis puts strain on democracy”