THE eurozone crisis seems to be reaching its climax, with
Greece on the verge of default and an inglorious exit from the monetary union,
and now Italy on the verge of losing market access.
But the eurozone's problems are much deeper. They are
structural, and they severely affect at least four other economies: Ireland,
Portugal, Cyprus and Spain.
For the last decade, the PIIGS (Portugal, Ireland, Italy,
Greece, and Spain) were the eurozone's consumers of first and last resort,
spending more than their income and running ever-larger current account
deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and
France) comprised the producers of first and last resort, spending below their
incomes and running ever-larger current account surpluses.
These external imbalances were also driven by the euro's
strength since 2002, and by the divergence in real exchange rates and
competitiveness within the eurozone. Unit labour costs fell in Germany and
other parts of the core (as wage growth lagged that of productivity), leading
to a real depreciation and rising current account surpluses, while the reverse
occurred in the PIIGS (and Cyprus), leading to real appreciation and widening
current account deficits.
In Ireland and Spain, private savings collapsed and a
housing bubble fuelled excessive consumption, while in Greece, Portugal, Cyprus
and Italy, it was excessive fiscal deficits that exacerbated external
The resulting buildup of private and public debt in
overspending countries became unmanageable when housing bubbles burst (Ireland
and Spain) and currentaccount deficits, fiscal gaps or both became
unsustainable throughout the eurozone's periphery. Moreover, the peripheral
countries' large current account deficits, fuelled as they were by excessive
consumption, were accompanied by economic stagnation and loss of
So, now what?
Symmetrical reflation is the best option for restoring
growth and competitiveness on the eurozone's periphery while undertaking
necessary austerity measures and structural reforms. This implies significant
easing of monetary policy by the European Central Bank (ECB); provision of
unlimited lender-of-last-resort support to illiquid but potentially solvent
economies; a sharp depreciation of the euro, which would turn current account
deficits into surpluses; and fiscal stimulus in the core if the periphery is
forced into austerity.
Disorderly breakup could be on cards
Unfortunately, Germany and the ECB oppose this option, owing
to the prospect of a temporary dose of modestly higher inflation in the core
relative to the periphery.
The bitter medicine that Germany and the ECB want to impose
on the periphery – the second option – is recessionary deflation: fiscal
austerity, structural reforms to boost productivity growth and reduce unit
labour costs, and real depreciation via price adjustment, as opposed to nominal
exchange rate adjustment.
The problems with this option are many. Fiscal austerity,
while necessary, means a deeper recession in the short term. Even structural
reform reduces output in the short run, because it requires firing workers,
shutting down money-losing firms, and gradually reallocating labour and capital
to emerging new industries.
So, to prevent a spiral of ever-deepening recession, the
periphery needs real depreciation to improve its external deficit. But even if
prices and wages were to fall by 30% over the next few years (which would most
likely be socially and politically unsustainable), the real value of debt would
increase sharply, worsening the insolvency of governments and private debtors.
In short, the eurozone's periphery is now subject to the
paradox of thrift: increasing savings too much, too fast leads to renewed
recession and makes debts even more unsustainable. And that paradox is now
affecting even the core.
If the peripheral countries remain mired in a deflationary
trap of high debt, falling output, weak competitiveness and structural external
deficits, eventually they will be tempted by a third option: default and exit
from the eurozone. This would enable them to revive economic growth and
competitiveness through a depreciation of new national currencies.
Of course, such a disorderly eurozone breakup would be as
severe a shock as the collapse of Lehman Brothers in 2008, if not worse.
Avoiding it would compel the eurozone's core economies to embrace the fourth
and final option: bribing the periphery to remain in a low-growth uncompetitive
state. This would require accepting massive losses on public and private debt,
as well as enormous transfer payments that boost the periphery's income while
its output stagnates.
Italy has done something similar for decades, with its
northern regions subsidising the poorer Mezzogiorno. But such permanent fiscal
transfers are politically impossible in the eurozone, where Germans are Germans
and Greeks are Greeks.
That also means that Germany and the ECB have less power
than they seem to believe. Unless they abandon asymmetric adjustment
(recessionary deflation), which concentrates all of the pain in the periphery,
in favour of a more symmetrical approach (austerity and structural reforms on
the periphery, combined with eurozone-wide reflation), the monetary union's
slow-developing train wreck will accelerate as peripheral countries default and
The recent chaos in Greece and Italy may be the first step
in this process. Clearly, the eurozone's muddle-through approach no longer
works. Unless the eurozone moves towards greater economic, fiscal and political
integration (on a path consistent with short-term restoration of growth,
competitiveness and debt sustainability, which are needed to resolve
unsustainable debt and reduce chronic fiscal and external deficits),
recessionary deflation will certainly lead to a disorderly breakup.
With Italy too big to fail, too big to save, and now at the
point of no return, the endgame for the eurozone has begun. Sequential,
coercive restructurings of debt will come first, and then exits from the
monetary union that will eventually lead to the eurozone's disintegration.
* Roubini is chairperson of Roubini Global Economics and a
professor of economics at the Stern School of Business of New York University.
He is also the co-author of the book Crisis Economics. The opinions expressed
are his own.
This piece comes from Project Syndicate.