Of all the examples of neoliberal policy failure since the Great Recession, the eurozone crisis stands out as a work of art. The European authorities who made this mess—the European Commission, the European Central Bank (ECB), and the International Monetary Fund (IMF)—known as “the troika”—provide one of the clearest, large-scale demonstrations in modern times of the damage that can be done when people in high places get their basic macroeconomic policies wrong. That it has happened in a set of high-income economies with previously well-developed democratic institutions makes it even more compelling.
It is necessary to say “previously well-developed” democratic institutions because the eurozone countries surrendered their sovereign rights to control their most important macroeconomic policies: first monetary and exchange rate policy, and then increasingly fiscal policy for the so-called PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain). As we will see, this was a profound loss of democratic governance, and one for which tens of millions of eurozone residents would pay dearly in the years following the world financial crisis and recession of 2008–2009, and for as yet untold years to come.
Most citizens of the euro area did not understand what they were losing when the Maastricht Treaty was signed in 1992, and the euro was introduced in 1999. You couldn’t see it until there was a serious recession — when the government really needed to use expansionary macroeconomic policies to restore growth and employment. Then we discovered that not only was the fate of most Europeans in the hands of people who were almost completely unaccountable to the electorate; it was worse than that. Power was now in the hands of people who had their own political and economic agenda, and who, as we shall demonstrate, saw the crisis as an opportunity to implement changes that could never be won at the ballot box.
To see the world of difference between unaccountable and partially accountable economic authorities, we need only compare the economic performance of the eurozone with that of the United States in the six years following the collapse of Lehman Brothers in October 2008. The United States, which was the epicenter of what would become a world recession, had a downturn that lasted officially 18 months; its recession was declared over in June of 2009. To be sure, it was the worst US recession since the Great Depression, and more than four years after the recession ended, employment levels were almost the same as they were at the depth of the recession. The US recovery was nothing to brag about; only the vastly worse results in the eurozone could make it look good. By February 2014, the eurozone was still close to record unemployment of 12 percent (as compared with 6.7 percent in the US); and GDP had fallen in both 2012 and 2013. And in the harder hit countries like Greece and Spain, unemployment had passed 27 and 26 percent, respectively, while youth unemployment surpassed 58 and 53 percent.
By 2013 more than 20 governments had fallen in the euro area, but austerity was still the order of the day. This could never happen in the United States, where even if the deficit hawk Republican Mitt Romney had been elected in 2012, he would not have dared plunge the US economy back into recession. His first goal, like that of most politicians, would be re-election, and there would be no external authorities that could force him to commit political suicide.
Then there is the vast difference between monetary policy in the two economies. Although by law the Fed and the ECB are both independent, there are degrees of independence and some would say, dogma; and the Fed turned out to act quite differently than the ECB in the past five years. The US Federal Reserve, which had lowered its policy lending rate to zero at the end of December 2008, kept it at or near zero for the next six years. As a way of providing further stimulus through influencing expectations, the Fed also made it clear that these “exceptionally low” rates would continue for “an extended period.”
By contrast, the ECB actually raised rates twice in mid-2011, to 1.5 percent, despite the weakness of the eurozone economy. But even more important was the Fed’s policy of more than $2.3 trillion of quantitative easing (QE), which the ECB had refused to consider, despite the fact that it was so drastically more necessary in Europe — given the vicious cycle of rising borrowing costs that threatened to spiral out of control in the weaker economies, including the “too-big-to-fail” countries of Italy and Spain.
With QE, as we will see, Europe could have recovered as quickly as the United States, and of course much more quickly if the member countries had the ability and the will to engage in expansionary fiscal policy. The ECB, like the Federal Reserve, controls a hard currency and can create money. As such, it had the ability to prevent the sovereign debt of eurozone countries from ever becoming a crisis in the first place. It actually had the ability to keep long-term borrowing costs for eurozone countries, including even Greece, as low as it wanted — as the Fed did in the United States while the US federal budget deficit soared to a post–World War II record of more than 10 percent of GDP.
The Fed’s QE also provided some funding for the government to stimulate the economy through spending and tax cuts, without increasing its net debt burden. This is not magic but just the rules of accounting, combined with the economics of a weak economy. When the Fed creates money through QE, and uses it to buy long-term US Treasury bonds, it refunds the interest payment on these bonds to the Treasury. This means that the government is getting the equivalent of an interest-free loan, and its net debt burden does not rise. It can then use this money for anything — building a more energy-efficient infrastructure, for example, or any kind of expansionary fiscal policy. Unfortunately, in the United States, the federal government did not take advantage of this “free money” as much as it could have. And yes, it really is free money — with consumer price inflation at 0.8 percent for 2014 in the United States and negative 0.2 percent in the eurozone, there is no downside to this money creation, since there is no significant risk that inflation will become too high.
I remember speaking about these matters with a group of German members of parliament, from all of the major political parties, in September 2011. One of them objected that it would be impossible to sell the idea of expansionary macroeconomic policies, and especially those involving money creation, to a German public that still had historical memories of the devastating hyperinflation of the 1920s. I couldn’t speak to that—not being an expert on German public opinion — but my response was that if this was indeed the case, it indicated a problem of public education, not an economic problem.
And public education is a big part of this story. It is a story in which most of the public — in Europe, the United States, and much of the world — has been continually misled as to the nature and causes of a festering economic problem. How else to explain how a crisis that originated from over-borrowing by the private sector was sold to the public as a problem caused by governments refusing to live within their means? It was then exacerbated by fiscal tightening, to the point of pushing the regional economy into years of recession and stagnation. The worsening crisis was then used to justify still more neoliberal policies — including cutting public pensions, shrinking the public sector, privatizations, and making it easier for employees to be fired. This sequence of escalating misery caused by government policy — accompanied by regressive structural reforms — can only happen if a broad swath of the public, including many journalists and politicians, is seriously confused as to what has gone wrong and what feasible economic alternatives are available.
But to understand how it happened we must also look at how the decision-makers — in this case the so-called troika — made their decisions, in large part independently of the citizenry’s views of what is right and wrong. For that we must turn to the financial crisis that began in early 2010.
Crisis as Opportunity: The Troika Seizes the Moment to Reshape Europe
The crisis in eurozone financial markets began as a problem with Greek sovereign debt that could have been easily managed. Greece’s economy is less than 2 percent of the GDP of the now 19-member eurozone, and the other euro countries had set aside vastly more than enough resources to resolve Greece’s problems in early 2010 when Greek debt first began to disturb the financial markets. But before it was over, the crisis would push the eurozone into its longest recession and record-high unemployment, and make Europe the biggest drag on the world economy.
By the end of 2011, the so-called BRICS countries — Brazil, Russia, China, India, and South Africa — were being recruited to help Europe by buying some of their bonds or with contributions channeled through the IMF. What is wrong with this picture? India has a per capita income of $3,400, less than one-ninth of the eurozone; Brazil has 42 million people living on less than $4 a day. Even China, although it has more than $3.6 trillion in reserves, has only about one-fourth of the per capita GDP of the euro area. And as noted above, a eurozone recovery has always been feasible without any outside help.
The eurozone crisis is most commonly described in the media as a “debt crisis,” or more specifically as a “sovereign debt crisis.” But this is very misleading. If we look at the numbers and recent history, we see a crisis that has been fundamentally caused and deepened by bad policy. Of the PIIGS countries, only Greece can be said to have built up a potentially unsustainable debt burden before the financial crisis and world recession of 2008–2009 hit Europe. The others actually reduced their debt-to-GDP ratios during the boom years of 2003–2008. Spain’s net public debt, for example, fell from 41.3 to 30.6 percent of GDP during these years. Italy’s was larger, at 89.3 percent of GDP, but with a low budget deficit and low interest rates there was not any reason for such debt to be seen as unsustainable until the mismanagement of the eurozone economy sent Italy’s borrowing costs much higher.
Even Greece, when it was negotiating its first agreement with the IMF in May 2010, had a debt of 130 percent of GDP, which could have been manageable with low interest rates, and with the debt burden reduced over time with reasonable growth. Seventeen months later, after shrinking its economy at the behest of the European authorities, its debt had increased to 170 percent of GDP. By this time, even when the European authorities reached a tentative agreement on October 26, 2011, for a 50 percent “haircut” for bondholders — that is, a 50 percent reduction in the principal of the Greek public debt held by private bondholders—it was still not enough to put Greece on a sustainable debt path. A problem that could have been resolved with—at most—just a few percent of the funds that the European authorities had set aside for this purpose had morphed into a financial crisis that threatened the health of the whole European economy. This was one result of what economists call pro-cyclical macroeconomic policy—shrinking the economy when it was already weak or in recession.
From the beginning of this crisis, the European authorities had the power, resources, and ability to bring about a robust recovery of growth and employment. It was the will that was lacking. Most commentators and analysts have emphasized the difficulties of coordinating fiscal policy — especially the spending that would be needed to put the eurozone economy back on track. A narrative of hard-working, thrifty Germans and other northern Europeans reluctant to subsidize the lazy and indulgent habits of their southern neighbors became a common theme in the media. Of course most of this has no basis in reality. For example, Greeks, on average, put in considerably more hours on the job than their German counterparts — about 2,037 per year as compared to 1,388 in Germany. Greeks also retire later than Germans do. And if we look at the problem in terms of who has benefited most from the good years of the euro, it is not so clear: more than 100 percent of Germany’s growth in the expansion from 2002 to 2008 came from exports, the majority of which went to Europe. Germany’s export-led growth also enabled them to increase productivity and competitiveness in manufacturing. Over the long run, this is much better than the bubble-driven growth that countries like Spain and Ireland experienced in the run-up to the crisis.
This is not to deny that there are serious problems of tax evasion for high-income earners and business owners in Greece and Italy, or that popular sentiments in countries like Germany or Finland can make it more difficult to assist other eurozone countries in crisis. But the eurozone crisis was not brought on by public sector over-borrowing. And even “anti-bailout” sentiment in the richer countries is often oversimplified — much of it is not just national prejudice against southern Europeans, but also includes more legitimate popular resentment against bailing out European banks.
But all of these problems are secondary compared to the fundamental and deeply misunderstood problem of flawed macro-economic policy. If not for the economic damage inflicted by the European authorities in 2010–2013, the Europeans could have had a number of years to try to correct the structural and political problems of the eurozone — if that was what the people and their elected representatives wanted to do. It is of course possible that the political will would not be there to make the changes that would be necessary to preserve the common currency over the long run. But for more than four years (and still going), the European authorities successively implemented policies that slowed the eurozone economy and, for most of that time, additional policies that caused serious financial crises. This would make it increasingly difficult, if not impossible, to address problems of policy coordination or other structural problems of the eurozone.
As noted above, Greece’s debt situation was transformed from something that could have been resolved relatively simply, and with few resources, into an intractable and contagious mess. And the acute crisis that the eurozone suffered from July 2011 until August 2012 was based on the worries in financial markets that the European authorities might do to Italy what they did to Greece. When the IMF had to lower its growth projections for the Italian economy, between its April and September forecasts in 2011,12 it was a direct result of the $74 billion austerity package that the European authorities forced on the Italian government.
In May 2010, the Greek government was the first to receive money from the European authorities to finance the rollover of its debt because it was no longer feasible to borrow from financial markets. “Together with our partners in the European Union, we are providing an unprecedented level of support to help Greece in this effort and — over time — to help restore growth, jobs, and higher living standards,” said IMF managing director Dominique Strauss-Kahn in announcing the agreement for 110 billion euros to be disbursed over the next three years.
The key words were “over time.” The IMF and its partners knew that the fiscal tightening would make things worse. “Real GDP growth is expected to contract sharply in 2010–2011,” said the Fund, but it added that “from 2012 onward, improved market confidence, a return to credit markets, and comprehensive structural reforms, are expected to lead to a rebound in growth.”
The first part of that prediction came true, with GDP falling by 11.7 percent during 2010–2011. But the second part was a pipe dream. By December 2011, the Organisation for Economic Co-operation and Development (OECD) was forecasting a further decline of 3 percent for 2012, which turned out to be 7 percent.
It was not surprising, given that the Greek government commit- ted to cutting $28.3 billion, or 12 percent of GDP, from its budget through 2015, and laying off 20 percent of its public sector workforce over the next four years. Who is going to invest in a country that has committed to years of recession?
The IMF justified these measures partly on the grounds that the alternative — a debt restructuring — carried too much risk of contagion to the rest of Europe, where banks held hundreds of billions of dollars of Greek debt. But because the “bailout” package destabilized the Greek economy and thereby increased the risk of a chaotic default, their preferred solution actually worsened the contagion.
Fears that Greek bondholders would end up taking losses, and that Portugal, Ireland, and possibly even Spain would follow the path of Greece began to seep into financial markets. On May 9, 2010, the ECB said that it would intervene in sovereign bond markets, reversing a decision just four days earlier that had sent markets tumbling. It was a concession by the ECB, but it was much too small to arrest the financial crisis that the European authorities had set in motion. Fears that a Greek default and its aftermath would result in a breakup of the euro began to move the markets.
The next day, the European authorities (including the IMF) reached an agreement on a trillion-dollar fund that was intended to “shock and awe” the financial markets into believing that default by any of the eurozone governments on their bonds was not possible. Stock and financial markets initially soared in response, but there was a terrible hangover as reality set in the next morning. At this point the debt of Italy, which was considerably larger than that of all the other troubled eurozone economies combined, was not yet considered to be at risk.
But even for the others, including Spain, it was already clear to many that without a commitment by the ECB to keep borrowing costs down to sustainable levels, a “bailout” fund would only enable the governments to pile up more debt, on which they would eventually have to default. The European authorities were still not ready to consider any practical solution. By establishing fiscal tightening as a requirement for access to any European/IMF funding, they had guaranteed that the debt problems would only grow worse.
At this point, even the bond markets, which traditionally rally when governments commit to budget tightening, started to become strangely Keynesian: bond prices would sometimes fall on news that Greece, for example, would implement further austerity. In November 2010, the Irish government became the second eurozone economy to sign an agreement with the IMF and the European authorities, after their 10-year bond yield had passed 8 percent. Portugal would be third, in May 2011.
The dreaded agreements that had been, in past decades, the punishment meted out to low- and middle-income countries with balance of payments problems, had now become the fate of high-income European nations. It was an artificial and unprecedented kind of “balance of payments” crisis: these were, after all, governments with a hard currency that could be created by “their” central bank. But the central bank wasn’t really theirs, unfortunately, and it wasn’t going to do what the central bank of the United States or even the United Kingdom was willing to do in order to contain the crisis: most importantly, contain the sovereign borrowing costs of the vulnerable countries. The crisis scenario that began in July 2011 went like this. The austerity, in combination with the slowing regional economy, was causing the Italian economy to grow slower or even shrink.
Slower economic growth causes government revenues to fall (and some spending to automatically increase), and so the promised deficit targets are even more difficult to reach. The government is then pressured to take more steps to cut spending (and/or increase taxes). This further reduces economic growth. The process continues in a downward spiral, as happened in Greece. And Italy’s debt, then at $2.6 trillion, was more than five times the size of Greece’s. The European authorities had not managed to put together the resources to deal with a possible default of this magnitude; hence the series of crises in financial markets.
Mark Weisbrot is co-director and co-founder of the Center for Economic and Policy Research. He is co-author, with Dean Baker, of “Social Security: The Phony Crisis” (University of Chicago Press, 2000), and has written numerous research papers on economic policy. He is also president of Just Foreign Policy.