Current Policy Path Dooms The Eurozone

by: Ranga Chand

The Eurozone is at a breaking point and, given its current economic policy path, it is unlikely to survive intact for long. Several economies including Greece, Ireland, Portugal, and Spain are mired in a deep recession and it is not at all clear when or how they will return to growth. As one can see from the table below, the statistics make for grim reading. These economies are shrinking dramatically, demand is spiraling down, unemployment rates are shooting up and debt levels are in the red zone where alarm bells are ringing the loudest.

Greece in particular is stuck in a severe economic depression. Since 2008, domestic demand has fallen by 25.8% and the jobless rate has tripled to 25.4%. By way of comparison, during the Great Depression domestic demand in the United States fell by 24% between 1929 and 1933 and the unemployment rate peaked at 24.8% in 1933.


Budget Deficit

Debt-to-GDP Ratio

Domestic Demand1/



























1/Cumulative change, 2/September 2012 except Greece July 2012. Source: IMF, OECD, Eurostat

Click to enlarge

The economic and social cost of the 2008/09 global recession and the subsequent imposition of austerity measures to rein in budget deficits have been profound. Buried in debt and unable to borrow to meet their financing needs from international credit markets, Greece, Ireland and Portugal have each been bailed out by the Troika (European Union/European Central Bank/International Monetary Fund). But, in return for the bailouts, the Troika has demanded a host of structural changes ranging from labour market reforms to deep cuts in government spending. These austerity measures have included across-the-board cuts to public sector wages and pensions, a reduction in welfare benefits and higher taxes.

The problem is that these measures have not only failed to shore-up confidence in financial markets but they have ended up destroying any potential for growth. As households have been forced to drastically cut back their spending, businesses have followed suit and slashed employment and investment. This, of course, is driving up the unemployment rate which further shrinks the tax base, pushes up the deficit and further adds to the level of debt. It's little wonder then that the bailout recipients have been unable to meet their debt repayment targets.

Despite all the efforts to stabilize the financial markets and revive the economy, what the austerity measures have achieved so far is that they have succeeded in pushing these countries into an economic depression. Moreover, the situation is getting worse. As the level of debt continues to climb, the imposition of further austerity measures will only compound the problem and deepen the pace of the contraction.

These economies are caught in a vicious circle with no escape route from the straightjacket that they find themselves in. The fundamental problem is that they are basically uncompetitive and cannot grow their way out of the debt crisis. Moreover, being members of the currency union, they can't devalue the currency in order to restore competitiveness and boost export demand.

These countries are unraveling, not just economically but politically and socially as well. Confidence among the electorate has been shattered and they face a stark choice: either they stay in the euro, accept the bailout conditions and cede their economic sovereignty to Brussels or they abandon the euro, re-establish their own currency, take control of their own economic destiny and face the consequences of being shut out from international markets for years. Either way it is going to be very painful.

But, there is another option. However, it would necessitate a complete policy rethink.

The top priority for the governments should be to stabilize the economy and provide a more predictable economic environment so that growth can resume. But this requires a new approach to tackling the crisis. This can be achieved by a combination of measures including, for example, imposing a moratorium on any additional austerity measures for a minimum of, say, three to five years and instigating a multi-year freeze on public sector wages and pensions.

To avoid outright defaults a large scale restructuring of debt is called for. This could include a lengthening of the term structures, delaying interest rate payments and some level of debt forgiveness.

On the trade front the imposition of a special tax on imports would achieve two goals. It would help boost domestic demand by redirecting spending towards the domestic economy and at the same time help to correct the balance of payment deficits that these countries are running.

By sticking to the current austerity measures, it is difficult to see how Greece, Portugal and Spain can escape from the current Euro straightjacket. The combination of tight fiscal policy, volatility on the interest rate front, and an overvalued euro from the perspective of the southern euro-zone members has resulted in pushing Greece et al into an economic depression.

Saddled with huge debt loads that continue to climb and with GDP shrinking, these economies are unable to generate enough tax revenues to service their debt. To all intents and purposes they are well past the point of debt saturation and are in effect bankrupt.

Given these facts, it is difficult to understand why Europe's policy makers are persisting with such a doctrinaire-based policy that has clearly failed to put Europe back onto a path of steady growth.

As Winston Churchill once famously noted: 'However beautiful the strategy, you should occasionally look at the results'. With a devastating economic depression that currently is spreading across the Eurozone it is high time for Europe's policymakers to change course. The very future of the Eurozone hangs in the balance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.