Euro’s Last Chance: An SOS Call to the European Leaders

Dear Leaders of the European Union,
The euro-zone might soon be trapped in a poisonous mix of austerity and recession. Pessimism is the inevitable consequence of this mix, as well as the cause for making it even more poisonous. This spiral risks to drive us down dramatically and increasingly fast. Procrastination of action is no longer tolerable, and hoping that something from the outside can rescue us is delusional: the rest of the world is at best fatigued, and there is no exiting the spiral through a higher sustained demand of our exports.
The only way out is by letting internal demand and output potential grow steadily. How?
Three things must be soon put in the agenda for the new Treaty. They would signal a much needed shift in European policymaking – without compromising its necessary rigor – and would re-orient expectations and help defy pessimism.

• First, the Stability and Growth Pact (SGP) must provide for a symmetric external adjustment rule, whereby the responsibility to adjust structural external imbalances would fall upon both deficit- and surplus-countries. At the same time that the deficit-countries adjust their economy, countries running persistent surpluses take measures to invigorate domestic demand, thus re-injecting stimuli in the economy. The symmetric adjustment rule should be designed also to encourage surplus-countries to use their surpluses to finance investments in the Union where they are most needed, and to encourage domestic structural reforms to increase economic efficiency and support higher consumption.

• Second, public investment must be excluded from the fiscal deficit rule under the SGP. This is not an invocation for a benevolent act of flexibility to deflect from financial orthodoxy, it is the retrieval of good economics. Investment creates income, and always generates an identical amount of saving out of the income created: there cannot be shortage of savings once investment-led income generation has taken place. What matters for sound public finances is that: i) public investment projects be good enough to produce adequate future streams of (economic and/or financial) returns to repay for their own funding, and ii) governments commit to recovering inter-temporally through revenues the current expenditures generated by investments. Subjecting investment to fiscal deficit rules that do not account for its effects has unnecessary deflationary consequences and diminishes the long-term growth potential of the economy.

• Third, Eurobonds must be created to finance trans-European public investment with high economic and/or commercial potential (such as in network infrastructures, energy, research and development), with a view both to stimulating demand in the Union over the short term and to increasing its competitiveness in the longer run. Eurobonds should be issued by an independent agency or a EU institution, and the European budget should be used to improve their rating in order to attract funding from private sector investors. Eventually, the EU budget will have to be expanded; this will also permit a broader and deeper fiscal action at the Union level.

Yet there will be no end to the emergency, and to the risk of collapse it portends, without allowing the ECB to act as lender of last resort by purchasing the debt of member states that lose market access. However indigestible, there is no alternative to this measure – least the breakup of the system.
We regret that the rules our policymakers are writing for the new Treaty are only intended to reinforce rigor, without attempting to revitalize the economy.
It is time to act differently, and to act fast and decisively.

January 2012
The Group of Lecce

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