Mercutio: I am hurt. A plague a’ both your houses! I am sped. Is he gone and hath nothing? — Romeo and Juliet, Act 3, scene 1, 90–92
The eurozone crisis, which includes the Greek crisis but is not restricted to it, has undermined the credibility of the EU institutions and left millions of Europeans disillusioned with the European Project. The euro was either introduced too early, or it included countries that should never have been included, or both were true. High rates of inflation left countries in the periphery uncompetitive and the constraint of a single currency removed a key adjustment mechanism. Capital flows allowed this problem to be papered over until the global financial crisis hit.
The leaders of the international institutions, the European Commission, the European Central Bank, and the International Monetary Fund, together with the governments of the stronger economies, were asked to figure out a solution and they emphasized fiscal consolidation, which they made a condition for assistance with heavy debt burdens. The eurozone as a whole has paid the price, with real GDP in the first quarter of 2015 being about 1.5 percent below its peak in the first quarter of 2008, seven years earlier, and with a current unemployment rate of 11 percent. By contrast, the sluggish U.S. recovery looks rocket-powered, with GDP 8.6 percent above its previous peak and an unemployment rate of 5.5 percent.
The burden of the euro crisis has been very unevenly distributed, with Greece facing unemployment of 25 percent and rising, Spain 23 percent, Italy 12 percent, and Ireland 9.7 percent, while German unemployment is 4.7 percent. It is not surprising that so many Europeans are unhappy with their policy leaders who moved too quickly into a currency union and then dealt with the crisis in a way that pushed countries into economic depression. The common currency has been a boon to Germany, with its $287 billion current account surplus, but the bane of the southern periphery. Greece bears considerable culpability for its own problems, having failed to collect taxes or open up an economy full of competitive restrictions, but that does not excuse the policy failures among Europe’s leaders. A plague on both sides in the Greek crisis!
During the Great Moderation, it seemed that the Bretton Woods institutions were losing their usefulness because private markets could provide needed funding. The financial crisis and the global recession that followed it shattered this belief. The IMF did not foresee the crisis, nor was it a central player in dealing with the period of greatest peril from 2007 to 2009. National treasuries, the Federal Reserve, and the European Central Bank were the only institutions that had the resources and the power to deal with the bank failures, the shortage of liquidity, and the freezing up of markets. Still, the IMF became relevant again and played an important role in the euro crisis, although at the cost of sharing the unpopularity of the policy response to that crisis.
China’s new Asian Infrastructure Investment Bank is the result of China’s growing power and influence and the failure of the West, particularly the United States, to come to terms with this seismic shift. The Trans-Pacific Partnership trade negotiations have deliberately excluded China, the largest economy in Asia and largest trading partner in the world. Reform of the governance structure of the World Bank and the IMF has stalled with disproportionate power still held by the United States and Europe. Unsurprisingly, China has decided to exercise its influence in other ways, establishing the new Asian bank and increasing the role of the yuan in international transactions. U.S. policymakers underestimated China’s strength and the willingness of other countries to cooperate with it, and the result has been to reduce the role and influence of the Bretton Woods institutions.
Can the old institutions be reinvented and made more effective? In Europe, the biggest problem is that bad decisions were made by national governments and by the international institutions (although the ECB policies have been generally good). The World Bank and IMF do need to reform their governance, but it may be too late to bring China back into the fold.
This post originally appeared in the
International Economy: Does the Industrialized World’s Economic and Financial Statecraft Need to Be Reinvented?