Tipping Point For The European Union?

Originally published on June 26, 2011 6:26 pm

When European Union leaders met in Brussels last week, they faced some difficult decisions. For the past year, the EU has continually bailed out its debt-ridden member countries to keep the bloc and its currency afloat. Despite this assistance, Greece may yet default on its obligations, plunging Europe and much of the world into another financial crisis.

This is just the latest challenge for the euro zone, the group of 17 countries that banded their financial destinies together since 1999.

Even if Greece can be saved, there are other euro zone members — Ireland, Portugal and Spain — struggling to keep their economies afloat.

A Call For Help

When Greece nearly defaulted on its debt in May 2010, it received bailout funds from the European Central Bank and the International Monetary Fund. But these funds came with strings attached — Greece had to drastically cut spending and raise taxes, using that new revenue to pay off its obligations.

The result? Greece plunged further into recession. Unemployment surpassed 14 percent. Angry citizens took to the streets in protest.

Many economists, including Mark Weisbrot of the Center for Economic and Policy Research in Washington, D.C., foresaw these negative consequences.

"They did kind of the opposite of what we did here in the United States where we had a fiscal stimulus," Weisbrot told Rachel Martin, guest host of Weekend All Things Considered.

So why did the ECB and IMF demand these austerity measures?

"They're looking at it more from a creditor's point of view," he said. "And from a creditor's point of view, a government that they think has engaged in bad behavior has to be punished."

If the ECB and IMF were to give Greece no-strings-attached bailout money, Weisbrot says, then there would be a strong precedent to do the same for Ireland, Portugal and Spain, which also facing debt crises. The punishment of austerity is a warning for other countries to keep their financial houses in order.

"They're not really concerned that it's a collective punishment of the entire population," Weisbrot said.

Exporting Panic

The Greek parliament is set to vote next week on the newest round of austerity measures in order to get the next installment of bailout funds. If parliament votes down the measures and the IMF and ECB withhold the bailout, Greece could enter into a chaotic default.

Weisbrot says the U.S. government has not adequately prepared for such a scenario. Greece's near-default last May sent the U.S. stock market plummeting. A chaotic default could do even more damage.

"It could lead to a crisis of the kind that followed the Lehman Brothers' collapse," Weisbrot said. "And where is our government right now preparing for it?"

Rewrite the Rules

This lack of preparation for crisis goes back to the very beginning of the EU. When the euro, the bloc's single currency, was created, none of the "founding fathers" laid out a plan of action for the type of crisis we see now.

They didn't create an emergency exit or even rules to follow for when countries like Greece are on the brink of default.

"They have to rewrite the plans," says Simon Johnson, former chief economist at the IMF and current professor at the Massachusetts Institute of Technology.

Johnson explains that allowing Greece an orderly exit from the euro would risk creating a dangerous precedent. If other struggling countries, such as Spain and Portugal, see Greece drop out, they could choose to do so as well and make it more difficult for those countries to borrow.

The alternate route for EU member states is to come closer together than ever before, which is exactly what ECB President Jean-Claude Trichet proposed last week. He called for an EU that would be a "confederate of sovereign states of an entirely new type," and suggested creating a European ministry of finance.

Johnson says such a ministry would create a fiscal authority that could levy taxes and completely change the dynamic of the EU.

A Lesson From The United States?

The EU's predicament is well understood by America's Founding Fathers.

"The United States, before the Constitution was written, was a confederation, in which the Continental Congress didn't have the ability to tax," Johnson explains. "It actually could issue money but it couldn't tax. It couldn't raise revenue and the result was not good."

America's Founding Fathers had to make a decision: either disband or bring the 13 colonies together and create a fiscal union. They chose the latter, and accepted a proposal by Alexander Hamilton to consolidate the colonies' financial power and create a central bank

"If you're going to stay together, you need to make the same type of decision the United States made in 1787 to have a fiscal union," Johnson said.

It is possible to prevent countries like Greece from defaulting without creating an even more united EU, but Johnson says the long-term health of the euro will remain at risk.

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RACHEL MARTIN, host: Welcome to WEEKENDS on ALL THINGS CONSIDERED from NPR News. I'm Rachel Martin, in for Guy Raz.

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MARTIN: That's the sound of Greece at a turning point. Unless it gets a second financial bailout from the European Union, the country will default on its massive debt. But the EU says the only way it'll help is if Greece makes dramatic spending cuts. The parliament there will vote on this so-called austerity package this week. But such cuts have riled up protesters who have taken to the streets in Athens.

UNIDENTIFIED MAN #1: (Foreign language spoken)

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MARTIN: This is the latest challenge for the European countries that have linked their financial destinies since 1999. Even if Greece can be saved, there are other countries using the euro as their currency - Ireland, Portugal and Spain - that are struggling to keep their economies afloat. That's our cover story today: A closer look at the euro: Growing pains or painful demise.

Later, we'll talk with economist Simon Johnson about what EU politicians might learn from America's Founding Fathers. The 2009 global recession was tough for most of Europe, but it was devastating for Greece. I asked Mark Weisbrot of the Center for Economic and Policy Research why the recession created such a crisis there.

MARK WEISBROT: Well, it's partly because the policy changes that they adopted made the recession worse. They did kind of the opposite of what we did here in the United States where we had a fiscal stimulus. And Greece did this for a bit but then was forced to do the opposite.

MARTIN: This past week, EU leaders said we will help you out, Greece. They reaffirmed their commitment to help the country get out of its debt crisis, but only - there's a big catch - only if Greece agrees to help itself first, right?

WEISBROT: Well, if you call that helping yourself, but I wouldn't. I mean, they've laid off 10 percent of their government workforce and now they're pledging, if they pass this vote on Tuesday, to lay off another 20 percent.

MARTIN: So this is part of the austerity package that Greece has been presented with - some cuts and tax increases.

WEISBROT: Yes. But imagine if we laid off millions of workers here in the United States and the federal government cut about $800 billion out of the federal budget and then unemployment soared to more than 16 percent and then the government pledged to cut another 400 billion and lay off another 20 percent of the federal workforce along with a number of other regressive measures, what the economy would look like today? Probably something like Greece.

MARTIN: Since these kinds of requirements - pension freezes, tax hikes - have exacerbated economic issues in the past, like Argentina in 1999, why has the European Central Bank continued to insist on them?

WEISBROT: They're looking at it more from a creditor's point of view. And from a creditor's point of view, a government that has engaged in what they think is bad behavior has to be punished. And they are not really concerned that it's a collective punishment of the population. They feel like if they give Greece a break, then Spain, Ireland, Portugal would want something similar, and they want to squeeze as much out of these countries as they can.

MARTIN: This crisis can seem very remote to us here in this country. Why does it matter to Americans and our bottom line?

WEISBROT: Actually, I think it matters quite a lot. And I think our government is being somewhat irresponsible because there could be a financial contagion from this if, for example, the parliament votes to reject the medium-term austerity package, then there will be some kind of financial crisis. There was already in May of 2010, there was a financial crisis over Greece and the stock market plummeted severely here, and that's when the European Bank really changed its position. So it could lead to a crisis of the kind that followed the Lehman Brothers' collapse. And where is our government right now preparing for it?

MARTIN: So you're saying a Greek default is essentially inevitable.

WEISBROT: That's what the markets and most observers believe at this point.

MARTIN: So what happens then? What are Greece's options?

WEISBROT: Well, a default can be orderly. It can be a restructuring of the debt with the creditors taking some write-down, or it can happen chaotically, which would possibly happen, for example, if the vote goes against the austerity package and the IMF and the European authorities say, well, you don't get the money. That could be very chaotic and that could cause a financial crisis.

MARTIN: That's Mark Weisbrot. He's the co-director of the Center for Economic and Policy Research in Washington. Mark, thanks very much for coming in.

WEISBROT: Thank you.

MARTIN: When the European Union was created, none of the architects prepared for the kind of crisis we see today. They didn't build an emergency exit or even rules to follow for when countries like Greece are on the brink of default. I asked economist Simon Johnson what options that leaves for EU leaders.

SIMON JOHNSON: Well, they have to rewrite the plans, obviously. And they could allow an orderly exit from the euro, but they don't want to do that because that would create a precedent. And then you would think, well, perhaps, other countries, such as Portugal or Spain, might want to exit from the euro, and that would then effect the ability of those countries to borrow.

The other way to go, though, is a path proposed by Jean-Claude Trichet, who's the head of the European Central Bank. And he has pointed out that they should really have more of a fiscal union. They should have a unified minister of finance, they should have unified debt jointly guaranteed by all the governments, and that would change the dynamic completely within the eurozone.

MARTIN: You're saying the eurozone could be tethered together even closer so people's financial futures were even more dependent? This sounds like maybe not the right political climate for something like that.

JOHNSON: Well, it's never the right political climate for saying that you're going to help each other in this big way with fiscal transfers and so on. But the parallel I would draw is with the beginning of the United States. The United States before the Constitution was written was a confederation in which the Continental Congress during the war and after the War of Independence didn't have the ability to tax. It actually could issue money, but it couldn't tax. It couldn't raise revenue and the result was not good.

And when people looked at that, they said, well, either we get together more closely with the fiscal union or we back away and become 13 or more independent states. And when you put it like that, then coming together with a fiscal union is not such a bad choice.

MARTIN: So you're saying that one of the fixes out there is this proposal to create a European ministry of finance. Breakdown what that person would be responsible for and how that leads to some kind of fix down the road.

JOHNSON: Well, of course, it's not just about creating a ministry of finance, a title and an office. It's about having an authority to issue debt on the part of the European Union, which you don't have right now. You just have the individual countries issuing debt, and you have the right to raise tax or get a slice of the tax collected by individual states in order to service that debt.

MARTIN: Because right now, the Central Bank doesn't have that authority.

JOHNSON: Absolutely right. The Central Bank actually can't issue debt. It can issue money, of course, and that's part of the problem. They all share the same courtesy, but they don't share any kind of definite fiscal authority. And if you're going to stay together, you need to make the same kind of decision the United States made in 1787 to have a fiscal union.

MARTIN: So when we talk about this potential fix, this creation of a ministry of finance, what's in it for countries in the eurozone who are financially stable? What's in it for France and Germany?

JOHNSON: That's a great question. I think, ultimately, the decision comes down to them because they have the fiscal firepower. They have the ability to raise tax revenue, and they have the ability to just cede some of that revenue owed to this unified ministry. And the question is, do they want to go back to a more fractious Europe, a Europe that had a lot of conflict, a Europe that did not trade as much, and I don't think they do. I think the French and the Germans, in particular, have convinced themselves correctly that working together and making Europe more unified creates a basis for prosperity and for peace.

MARTIN: So you don't imagine a future 25 years down the road or even less than that when we return to the French franc and independent European currencies, the Italian lira. You don't see that happening.

JOHNSON: No. I think there's going to be a euro. It's going to be a strong euro. It's going to be a viable competitor to the U.S. dollar, by the way.

MARTIN: That's Simon Johnson, former chief economist at the IMF, the International Monetary Fund, current professor at MIT. Thanks so much, Simon.

JOHNSON: Thank you.

MARTIN: Now, just because most members of the European Union have adopted the euro doesn't mean everyone is giving up on the idea of a national currency or the identity that can come with it. That's what Brooke Harrington says. She's a professor of economic sociology at the Copenhagen Business School in Denmark. She witnessed this kind of currency nostalgia when she was in France several years ago.

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BROOKE HARRINGTON: I was on vacation in the Champagne region of France. And I decided to indulge in a little trip down Memory Lane and try to find the toothpaste that I had really liked as a senior in high school when I lived with a French family. So I walked into a pharmacy and I bought all that they had, which was two tubes. And I got this register receipt that had the price in euros, of course, because France has been on the euro since 1999. But then I took a closer look and was a little startled to find that it had a conversion rate, stating that one euro was equivalent to 6.5597 francs.

MARTIN: OK. So convenient if you're dealing in francs, but no one is. It's been over 10 years since France switched to the euro. So Brooke wondered why vendors are still printing prices in francs.

HARRINGTON: Maybe the machines the pharmacy had to print out their receipts had been programmed to do this and it was just inconvenient or expensive to change it. But what began to strike me as even more important was the cultural value, the national identity that goes into these currency systems.

MARTIN: And like economist Simon Johnson, Brooke Harrington draws a connection between how Europe is dealing with its financial identity and American history. Specifically, the Civil War.

HARRINGTON: When you see people who put Confederate flags on their clothing or in their dorm rooms or bumper stickers on their cars that say the South will rise again, these conflicts and tensions between local allegiance and national allegiance are still unresolved for a lot of people, and that's true in Europe as well.

MARTIN: That was Brooke Harrington, professor of economic sociology at the Copenhagen Business School.

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