Τρίτη, 03 Οκτώβριος 2023


The economic weakness breeds social discontent and political
extremism, which destroy faith in a united Europe and undermine the
European project. The crisis in which Europe and particularly the
Eurozone is enmeshed, contrary to a widespread belief, is not due to
excessive sovereign debt. It is rather due to the European leadership
that is loath to recognize the euro's flawed architecture and take the
steps in the direction of a federal European state, which are needed to
complete its unfinished construction. It is particularly Germany's self-
seeking stance, in preserving an institutional setup that serves her well
despite its dangers for European unity, which constitutes the main
obstacle to overcoming the crisis.

The present paper develops this thesis by posing and answering ten
relevant questions. The questions that serve in developing the argument
are the following: 1) What is the European sovereign debt? 2) Is there a
debt crisis? 3) Why is there talk (without evidence) of a debt crisis? 4)
What is the cause of the increase in debt? 5) What are the obstacles to
repairing Europe's failing? 6) Why is Germany complacent? 7) Does the
concept of 'competitiveness' make sense? 8) What is the distinction
between 'essential' and ''effective' competitiveness? 9) How does
membership of the Eurozone help Germany's competitiveness? 10) How
does Germany's complacency affect Europe?

1) What is the European sovereign debt?

The sovereign debt has reached 92.7% of GDP for the Eurozone and 87%
for the EU28 in 2014.2 The rise in the debt to GDP ratio begun in 2007,
after being seemingly stabilized and hovering at about 60% for the
previous ten years. To put this in perspective, the U.S. ratio is about
100% and the Japanese is over 240%, both having risen considerably
after 2007.3

A comparison with the debt levels reached in the aftermath of the Second
World War may also provide some perspective. In 1946, debt reached 121.3% of GDP in the U.S., 135,9% in Canada, 190,4 in Australia, and
237,1 in the U.K. (rising further to 237,9% in 1947).4 These very high debt
ratios were gradually lowered largely through inflation and GDP growth. It
may be noted that neither in the late 1940s nor in the U.S. and Japan
recently, has public discussion been fixated on a debt crisis and, in both
cases, the main concern has been about achieving growth.

A further perspective may be gained by contemplating the condition in
which new, especially young, home-owners find themselves in many
countries. The amounts they have borrowed exceed their annual income
by many times, yet they normally manage to service and eventually repay
their debt without considering themselves to suffer from a debt crisis.

In view of this evidence, it is not at all clear that the European sovereign
debt, which is still rising though at a much slower pace, is excessive and
that Europe is suffering from a debt crisis.

2) Is there a debt crisis?

A debt crisis arises when the debt to GDP ratio cannot be reduced by the
economy's growth (i.e., by the ratio's denominator increasing faster than
the numerator).5 Then, a reduction in the ratio necessitates hard choices
and certainly a reduction in the debt's rate of increase if not an outright
reduction in its absolute level.

The question is whether Europe's debt has reached or is close enough to
the point of being in a debt crisis. A reason for considering that this is
indeed the case, is provided by the work of C. Reinhart and K. Rogoff.6
Their influential book, which is notable for the large international database
on debt that they have compiled, reaches a striking conclusion: Growth
practically ceases when the debt/GDP ratio exceeds 90% or thereabouts.
On the basis of this, Europe can be seen to suffer from a debt crisis and its
stalling growth rate is easily explained as being due to its excessive debt.
There are, nevertheless, serious problems with Reinhart and Rogoff's
statistical analysis, which invalidate their conclusion.7 Apart from technical
weaknesses, there is doubt whether any clear correlation can be
established between growth and debt. Reinhart and Rogoff have accepted
some mistakes and repudiated the strict 90% debt/GDP watershed at which growth supposedly ceases but claim that, in general, growth tends
to slow down as debt rises.

Nevertheless, even this claim is doubtful as a causal relation. A negative
correlation between growth rates and debt/GDP does not establish the
direction of causation, which may go either way. Theoretically, high debt
may cause growth to falter by raising interest rates and lowering
investment. But it is also possible that faltering growth may cause debt to
rise, by reducing tax revenues and increasing government expenditure on
unemployment benefits (thus leading to budget deficits).

In conclusion, there is no reliable basis for claiming that rising debt damps
growth and, of course, there is no basis at al for considering that Europe
is in a debt crisis. On the contrary, there is reason to believe that in a
depressed economy, expansionary fiscal policy necessitating greater
government debt is beneficial in restarting growth and possibly in reducing
the debt/GDP ratio.8

3) Why is there talk (without evidence) of a debt crisis?

The belief in a European debt crisis may have little basis in reality but it is
decidedly useful in making the policy of austerity acceptable. Austerity is
the policy of restraining and curtailing the government budget, aiming at
achieving a balanced budget (or even one in surplus) by reducing public
expenditure and increasing taxes. It must be remembered that a policy of
near-austerity, prohibiting budget deficits exceeding 3% of GDP and
aiming at a balanced budget over time, has been enshrined (largely at the
insistence of Germany) in the Maastricht Treaty and the constitution of the

The policy of austerity or balanced budget, when elevated to a principle,
makes little economic sense. The government budget is not like the
budget of a private individual or firm but should be viewed as a social
instrument for controlling the magnitudes of aggregate demand and
employment or, more generally, the level of economic activity.

Nevertheless, it has to be recognized that 'austerity' is a concept that
holds sway over the public imagination, which is not used to differentiate
the validity of a principle according to whether it relates to the whole or to
the parts of a social entity.9 Consequently, the potential of 'austerity' for
political exploitation is not to be underestimated and this is presently in ful
evidence. Today, it constitutes the dominant policy across Europe and is
championed primarily by Germany but also by other, mostly German-
influenced, northern European countries. It is accepted by the rest, which
happen to be on the whole more indebted (and southern), because it is
generally believed that it is the only appropriate response to the debt
crisis. Belief in the debt crisis is, therefore, essential to the acceptance of
the austerity policy.

It may, of course, be asked: Why does Germany champion austerity? This
question will be answered in section 6 below. Suffice to say here, that it
allows Germany to continue being in a particularly advantageous position
(albeit by imposing a heavy burden on the indebted countries) rather than
face squarely Europe's failing and assume the cost of repairing its flawed
constitution. But first, the nature of the European failing needs to be
explained in some detail, starting with the cause of the increasing debt.

4) What is the cause of the increase in debt?

The increase in debt was caused by the preceding banking crisis, to
which it is inextricably linked. This requires some elaboration.
The rapid rise in public debt, not only in Europe but also in the U.S., is due
to the global financial crisis that began with the bursting of the bubble that
had developed in the American subprime mortgage loans market, in
August 2007. The crisis became global in October 2008 with the
bankruptcy of Lehman Brothers, a major global bank, which followed
in close succession the bankruptcy of the internationally active Icelandic
banks. These events, and particularly Lehman's rather unexpected
collapse, caused a huge shock to the banking world, leading to an all-
round loss of confidence and a freezing of the global financial system.

In these circumstances and in order to avoid a total financial catastrophe,
it became imperative for the American and European governments to
guarantee that no other financial institution of systemic importance would
be allowed to fail. Both sides fortunately understood the grave threat to
the world economy and, in effect, the European finance ministers made
the necessary pledge to intervene to the extent required in November
2008, thus avoiding widespread panic and calming the financial markets.

Mrs. Merkel made it absolutely clear that the guarantee to save a
country's systemic banks, agreed by the finance ministers' meeting in
November 2008, was the sole responsibility of each individual state and
that there was no question of the European Union or the Eurozone acting
collectively as a whole.

Mrs. Merkel's declaration ensured that the markets' attention would be
concentrated on whether each individual country's public finances could
support its own banking system.10 After this, it was inevitable that
eventually the countries with the weakest banks needing the greatest
public support, as well as those with the least healthy public finances,

would see the risk premium they had to pay shooting up and find it
increasingly difficult to borrow. Saving a country's banking system
implies, in these circumstances, rapidly increasing public debt and
possibly government insolvency.

It is clear that the pledge to save the banking system meant that there
would be, as needed, a substitution of public for private debt. The state,
which is financially stronger, more trustworthy and less liable to go
bankrupt than the banks, would save them from bankruptcy by
guaranteeing their debt obligations and fortifying them with the provision
of additional capital. The recapitalization of the banks was crucial for the
restoration of their economic health and the public's all important

The Americans began immediately (even before Lehman's collapse) to
recapitalize their systemic banks by, of course, running budget deficits
and increasing public debt. But the Europeans on the whole did not. The
main reason was that they were subject to the constraints imposed by
the Maastricht Treaty. They were not supposed to run deficits exceeding
3% of GDP and, in addition, they were not allowed to borrow from the
European Central Bank (ECB).

Consequently, their ability to raise funds was circumscribed by their
credit rating and the financial markets' assessment of their credit
worthiness. This assessment was based until then on the assumption that
governments in the Eurozone would be able to turn to the ECB in case of
emergency and, therefore, the risk of defaulting on their debt obligations
(at least those in euros) was practically non‐existent. But this assumption
was declared to be unfounded by Mrs. Merkel.

In conclusion, the public debt crisis was caused by the banking crisis,
which was itself aggravated by the fundamentally flawed constitution (or
architecture, as it has come to be known) of the European Monetary
System. There is little doubt that the Maastricht Treaty rules hindered
rather than helped the provision of a proper response to the banking
crisis. If evidence is needed, it is clear in the much better handling of the
potentially far more severe banking crisis in the case of Britain. Not
being subject to the Maastricht constraints, the British government could
recapitalize its highly exposed and vulnerable banking system relying on
the backstop assured by its central bank.

The lesson to be drawn, is that the Eurozone's imperfect architecture
needs to be completed in two crucial ways: First, with the creation of a
common European Treasury and, second, with an enlargement of the
ECB's warrant, enabling it to act unfettered as a lender of last resort for
both financial institutions and the European Treasury.

5) What are the obstacles to repairing Europe's failing?

There are two types of major obstacles (undoubtedly intertwined and
interdependent) to the completion of the Eurozone's architecture and
the advancement of European integration. The first pertains to the realm of ideas and the proper understanding of what is required and the second
has to do with the sphere of economic and political interests.
As regards the understanding of the present European ailment, which is
the first obstacle, it has already been argued that the emphasis on public
debt rather than banking frailty is mistaken. The belief that the basic
problem requiring urgent attention and appropriate institutional reform is
the containment of public debt, though prevalent, is quite misguided. Its
wide acceptance is due to two factors.
The first was the mindset behind the design of the Maastricht rules, which
considered that the risk to the euro could only come from irresponsible
and unbridled public spending. The rules were all directed to protect the
Eurozone from such an eventuality.

The second is due to an historical accident, which was crucial in
creating a strong, though false, impression about the causes of the
European crisis. This was the fact that Greece was the first country in
trouble, which signaled to the international public opinion the onset of the
crisis. Greece was the exceptional country that fitted the expectations of
the Maastricht Treaty, since it was the only one where the
weakness of the public finances was greater than that of its banking

There was nothing inevitable about Greece being the first country to
default; it was the contingent calling of early Greek national elections
in October 2009, as a result of boundless political strife, combined with
the exposure of the inexcusable falsification of national statistics for
political advantage and the post‐ election disclosure of an excessively
high budget deficit,11 that caused Greece's insolvency before any
other country. If Ireland had defaulted first, as seemed quite possible
at the time, irresponsible public spending could not have been blamed
and the nature of the crisis would have been clearly revealed.12
The second obstacle to necessary reform is the most difficult to
overcome. Germany, which has been indisputably from the start in the
forefront of European integration and is today the only country that can
be the leader in the construction of a united Europe, is quite comfortable
with the present situation and is against any reform that may involve cost
for her. Even reforms, like the banking union, which Germany has
accepted in principle are delayed by Germany in practice. Similarly,
with initiatives by the ECB to arrest the tendency to disinflation,
Germany tends to find problems with and accepts only half-heartedly
in the end.

Unfortunately, the fact seems to be that following the effort for her
re‐unification, Germany does not any more seem interested in leading
towards a federal Europe or even in furthering European integration,
unless it serves her national interests. Gone are the days that Germany
could declare that she had no national foreign policy, only a European one. Today, Germany seems to be concerned with pursuing above all her
own interests with Europe being only a means to this end.

6) Why is Germany complacent?

Despite the claims of eurosceptics and the belief of large segments of her
public opinion, Germany has gained considerably from the existence and
membership of the euro. It is this gain that happens to be abetted by the
present problems of Europe, which accounts for its complacency. Taking
any of the steps that are required to get Europe out of the present rut,
would necessitate an abandonment of the particularly comfortable position
enjoyed by Germany today and an inevitable reduction in her gains.

Germany's gains are perversely served and further magnified by the
Eurozone's difficulties. The euro crisis emanating from the global financial
crisis, benefits Germany by augmenting its productive potential and
economic strength while correspondingly weakening further the weaker
economies, which are suffering the most from the crisis. This wayward
effect (which is contrary to any notion of solidarity), is produced in at least
two ways. First, there is a considerable benefit from the inward
movement of savings and capital out of the risky sovereign bonds and
shaky banks of the indebted southern countries. This reduces Germany's
cost of borrowing, which is anyway the lowest in the Eurozone, even
further while raising the borrowing cost not only for the government but
also the private sector of the weaker economies. Second, Germany's
economy benefits greatly from the immigration of skilled and educated
young labor force from the indebted countries, where youth
unemployment has reached unprecedented high levels. This is of great
importance in sustaining high productivity and productive potential,
as Germany is an aging country with an extremely low rate of population

It should be noticed that the above perverse effects of the crisis, reinforce
Germany's competitiveness and weaken further the low competitiveness
of the indebted countries. It is this differential in competitiveness, which
has enabled Germany to reap the greatest benefit from the euro.The
common currency has made it easier for Germany, the
competitiveness of which is superior to that of most other countries in
the Eurozone (and particularly to that of the South), to increase its
exports to them. This is the effect that has drawn most public
attention, since it is immediately noticeable in Germany's increased
market share in their home markets. But this is not the main cause of
their own loss of home market share nor is it the most important part
of Germany's gain from the euro. After all, most of Germany's
exports are not to the Eurozone but to the rest of the world. It is in
relation to the rest of the world that the euro has given Germany a
great advantage and has correspondingly disadvantaged the
southern countries.

The fundamental reason for Germany's gain is to be found in the euro's
exchange rate. The euro's exchange rate has allowed Germany to have a
stronger export performance than would have been possible if Germany
had a national currency, such as the mark. At the same time, the euro's

exchange rate has made the less competitive southern countries even
less competitive in their trading with the rest of the world.

The way that the euro's exchange rate has in effect leveraged Germany's
inherent or essential competitiveness will be examined in section 9 below.
But before such an examination, it is important to meet a possible
objection to the concern with and use of the notion of competitiveness.

7) Does the concept of 'competitiveness' make sense?

Despite the widespread use of the notion of competitiveness in public
policy discussion and the regular compilation of an international
competitiveness index, there is a certain reluctance among academic
economists in accepting the coherence and legitimacy of the concept.13
The reason is that it makes an odd fit with the economic theory of
international trade. There is no question that it has a mercantilist
provenance and, from Adam Smith onward, economics has consistently
rejected mercantilism as a norm of economic policy.

There is no question that trade is generally beneficial for all parties
concerned, even though the benefit may be unequally shared. In fact, a
trade deficit confers a greater immediate tangible benefit than a trade
surplus, since the former raises the standard of living and/or investment
potential of a country while the latter lowers it. In contrast, the surplus
provides claims on future production of uncertain real value. It would seem
then that the deficit is clearly preferable. But things change in a setting of
unemployment and spare capacity. In these circumstances, the surplus
also increases profits and, through higher profit, encourages production
and employment. On the other hand, the deficit reduces profits and tends
to lead to lower production and employment.

Consequently, in a world of monetary production for profit, often
characterized by unemployed resources, a trade surplus makes a lot of
sense. This, admittedly, may be a second-best policy but in the real world
the first-best policy may, for various reasons, not be feasible. It is in such a
context that competitiveness, understood as the ability to consistently
achieve surpluses, becomes a useful policy aim.

Competitiveness is a notion, borrowed from microeconomics and
competition among firms, that becomes rather complex and hazy when
applied to a country. For this reason, a distinction is made below
between 'essential' and 'effective' competitiveness.

8) What is the distinction between 'essential' and 'effective'
competitiveness? 'Essential' competitiveness is, to begin with, analogous to its
usage in microeconomics, where it denotes firms' relative ability to
compete, and refers mainly to sales cost (including production, finance
and marketing costs) but also to other elements, such as product
characteristics (including quality, reputation and image), distribution
networks, accessibility to markets and any other factor that contributes to
a firm's ability to achieve sustained profitability and do consistently better
than its rivals.

In the case of a country, in addition to the above, it includes institutional
elements, such as the quality and performance of the education
system, the legal system, labor relations and the functioning of the
labor market, market structure and the degree of monopoly, as well as
any other institution that contributes to the country's better economic
performance relative to other countries sharing the same currency (or
having a long‐standing stable exchange rate).

It is evident that 'essential' competitiveness may be affected by changes in
any of the above elements. Consequently, it may also be affected by
changes in monetary and fiscal policy (as well as other policies and
conditions, such as a minimum wage or incomes policy or even prospects
regarding political developments), which can have an effect on the level of
prices and in the financing conditions and borrowing rates, (in the latter
case, either directly or through changing perceptions of country risk).

'Essential' competitiveness can be compared and contrasted to a related
but somewhat different notion, that of 'effective' competitiveness.
'Effective' competitiveness refers to the ability of a country to compete in
international markets with countries that do not share its currency, which
depends crucially not only on its 'essential' competitiveness but also
on the exchange rate.

'Effective' competitiveness generally changes in the opposite direction to a
change in 'essential' competitiveness, when countries do not share the
same currency. This is because a change in 'essential' competitiveness
tends to be compensated by a change in the exchange rate. Thus, for
example, an increase in a country's 'essential' competitiveness tends to
increase the exchange rate of its currency, which makes its exports more
expensive and its imports cheaper. The result is a reduction in exports and
an increase in imports, which is tantamount to a fal in its 'effective'
In trading within a currency union, the member countries' 'essential'
competitiveness is al important in determining the intra-union trade
balances. But since members also trade with countries outside the
currency union, their 'effective' competitiveness is also important in
determining their trade balance vis a vis their trading partners outside the
currency union. How does an increase in 'essential' competitiveness affect
'effective' competitiveness within a currency union? Within the union, a
member country's increase in 'essential' competitiveness increases its
intra-union export share. But it also increases its 'effective'
competitiveness and export share in its trading with countries outside the
union. This is because the exchange rate of the currency union is
determined by the 'essential' competitiveness of all its members, in trading
as a bloc with the rest of the world.

It may be concluded that, unless the particular country's trade is large
enough to weigh heavily on the determination of the currency union's
exchange rate, the exchange rate is hardly affected and the country's
increase in 'essential' competitiveness is accompanied by an increase in
its 'effective' competitiveness. In other words, the compensatory change in
the exchange rate, which causes the 'effective' competitiveness to move
contrary to any change in 'essential' competitiveness, is practically absent
when a country is a member of a currency union. This is more likely to be
the case, the smaller the country share of the union's external trade and
the greater the differences in the 'essential' competitiveness of the
currency union's members.

9) How does membership of the Eurozone help Germany's

Given that the Eurozone's current account is roughly in balance (or small
surplus), the euro's exchange rate tends to roughly reflect the
Eurozone's overall competitiveness relative to the rest of the world. The
euro's exchange rate has resulted in large surpluses for Germany and, to
a lesser extent, some Northern European countries and equivalent
deficits for mostly Southern European countries. Consequently, the
exchange rate has augmented the effective competitiveness of Germany
and the North, which had higher essential competitiveness than the
South, and weakened the latter's effective competitiveness. In other
words, the euro's exchange rate was too low for balance in the current
account of Germany and the North, while being too high for balance in
the current account of the South.
More generally, it may be stated that, membership in the currency union
tends to reinforce the effective competitiveness of a country that has
higher essential competitiveness than the union average and to lessen
the effective competitiveness of a country that has lower essential
competitiveness than the union average. To put it differently,
membership enables those countries which are more essentially
competitive than the average to have an exchange rate that is lower
than would have been the case if they were not members, thus leveraging
their effective competitiveness vis a vis the rest of the world.
Conversely, membership obliges countries with below the union
average essential competitiveness to have a higher exchange rate than
what would be the case outside the union, thus reducing further their
effective competitiveness vis a vis the rest of the world.14
Moreover, a currency union with a balanced foreign account shields its
members from correction by market forces and allows surpluses (by the
most competitive countries) and deficits (by the least competitive
countries) to develop and be sustained without hindrance. Such
imbalances may in fact continue practically indefinitely, so long as the
associated capital flows are not blocked and allowed to go on.

This effect becomes evident if we imagine Germany outside the
Eurozone. Then, its exchange rate against the $ would tend to be higher
and, as a consequence, she would be effectively less competitive. More
importantly, unlike what has been the case whilst she was a member of
the Eurozone, she would find that a surplus in its foreign account is not
sustainable. If she attempted to manipulate the exchange rate and fix it
at a lower level, she would provoke protest and retaliation from its
trading partners. Conversely, if Greece or Portugal were outside the
Eurozone, their exchange rate against the $ could not fail to be lower
than it is today in the Eurozone, thus rendering them effectively more
competitive. Market forces would ensure in this instance that their
exchange rate is corrected so that their foreign account deficit is
10) How does Germany's complacency affect Europe?

In conclusion, it has to be recognized that the euro buttresses and further
reinforces Germany's essential competitiveness and, for this reason,
Germany has an interest in preserving it. But, unlike the period
before the reunification, Germany seems to be distancing herself from
assuming the responsibility of European leadership, signaling that she is
contented with the present European course and is prepared to pay for
the preservation of the euro only the minimum possible price. Germany's
complacent stance is that there is no serious flaw in the euro
construction, other than the poor implementation of the Maastricht rules.
What is needed, for Europe as a whole, is strict adherence to fiscal
discipline and structural reforms. The belief is that, in this way, all
countries can improve their competitiveness (both essential and effective)
and become like Germany. But this, even if feasible (which is doubtful),
certainly requires considerable time and is not a serious policy option for
the pressing needs of the less competitive countries.
The fact is that the euro crisis, emanating from the global financial crisis,
has left the less essentially competitive countries in a weak state and
heavy debt, from which they are unlikely to soon recover without bold
reforms of the European architecture. Without a banking union
making the ECB a true lender of last resort, without a common treasury or
some scheme to enable sovereign borrowing at a low cost comparable to
Germany, and without a European investment program in infrastructure
sufficiently large to jumpstart growth, they are condemned to
stagnation at best. Reduction of public debt tends to lead to fiscal
strangling of the private sector and discourages growth. The burden of
debt can only be reduced (in proportion to GDP) if there is growth
but, without such reforms, growth is unlikely, if not impossible.

The prospect of continued protracted stagnation is politically very
dangerous. It breeds the politics of populism, xenophobia and extremism,
which have already strengthened euroscepticism and are bound to
threaten not only the survival of the euro but even the cause of a
united Europe. This is a critical time for Europe and urgently calls for
broad‐minded and benevolent leadership, which can effectively be
provided only by Germany.


Thanos Skouras
Professor Emeritus – Athens University of Economics and Business

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