Sunday, July 31, 2011
A hapless union has lost its direction
July 31, 2011
There are many economic challenges around the world today. The US teeters on the brink of default, deleveraging continues across the west, cracks are appearing in China’s fixed asset investment boom, Japan remains stuck in the deflationary doldrums, while inflation is picking up in emerging markets. None of these problems, however, is as intractable as those facing the eurozone.
It is common to view Europe’s woes in terms of a crisis of public finances. Greece, after all, owes a lot of money to its European neighbours. The markets have also started to question Italy’s sovereign debt, which is currently around 120 per cent of GDP. Yet rising credit spreads among the periphery of Europe are a symptom of deeper troubles within the monetary union.
After all, other nations have proven capable of sustaining larger public debts. Britain’s ratio of government debt to GDP exceeded 250 per cent after the Napoleonic Wars. More recently, Japan’s large domestic savings have supported a public debt that now exceeds 200 per cent of GDP.
By contrast, Europe’s stricken periphery is characterised by low savings. The savings rate in Greece and Portugal in recent years has been insufficient to sustain economic growth let alone finance their fiscal deficits. Italy’s savings rate appears to be in structural decline as its population ages. Spain and Ireland have a better record on this front, but they frittered away a great deal of their savings on their housing bubbles. Countries which save too little and invest poorly are likely to experience weak economic growth.