With Ireland voting on the European Fiscal Treaty on Thursday, a primer on the euro crisis might be helpful. The Fiscal Treaty (sometimes referred to as the Fiscal Compact) would create a permanent European bailout fund (the European Stability Mechanism (ESM)) to replace the European Financial Stability Facility that European leaders established at the beginning of the euro crisis to bailout illiquid countries. The ESM is Europe’s most signature response to the sovereign-debt crisis, and as such it suggests the broad themes of European leaders’ thinking on the causes of, and steps needed to resolve the crisis.
The origins of the current crisis lie in the structural problems of the single currency’s design and the contingent features which brought these problems to the fore. As Andrew Moravcsik has explained, the euro always hinged on a gamble: “the deficit-prone countries of southern Europe would adopt German economic standards–lower price inflation and wage growth, more savings, and less spending–and Germany would become a little more like them, by accepting more government and private sector spending and higher wage and price inflation.” In this sense, the very heterogeneous economies that signed the Maastricht Treaty would converge somewhere in the middle. The problem is that this convergence hasn’t happened. Over the past decade, deficit countries like Greece and Spain have become less competitive, as unit labour costs have outpaced average inflation across the eurozone. At the same time, Germany has suppressed wages below inflation. This divergence between excessive wage rises and wage suppression has led to a roughly 25% gap in competitiveness between Greece, Italy, Portugal and Spain, and Germany.
The only things that really converged over the past decade were borrowing rates across European countries. Continue reading