The debt and financial crisis in Europe has accentuated three major areas in need of reform. The most important of these is the excessive national debt of some euro countries, above all Greece. Here, the main focus is on the efforts undertaken by the crisis countries themselves, who will have to make short-term cuts to their budgets and implement long-term structural reforms to make their economies more competitive, thus increasing revenue. Together with the International Monetary Fund (IMF), the EU supports the crisis countries – above all through stop-gap loans and supporting measures for economic and fiscal reform. On the other hand, the EU appears to be rather tentative when it comes to tackling the general framework of debt reduction.
Only once it was no longer possible to turn a blind eye on the fact that a reduction of Greece’s and other countries’ sovereign debt would be impossible to achieve, as long as all cuts were being more than offset by rising interest rates on the bond markets, the European Central Bank (ECB) got the go-ahead to purchase government bonds. Further measures, such as a sinking fund suggested by the German government’s expert commission, were opposed by Germany – and this is even more the case with a permanent communitarisation of debt through the introduction of Eurobonds (1). The approach of cutting debt has also been discredited, as most perceive of the first debt waiver for private creditors, as negotiated by the troika of European Commission, IMF, and ECB, as a major mistake, because the partial failure to repay made the scenario of a sovereign default more likely – and the financial markets consequently reacted by raising interest rates on government bonds. Thus far, the alternative, that is, to let public creditors waive some of the outstanding debt, is flatly opposed by the German government, which argues that it would be legally impossible to grant Greece new credit after having waived some of the outstanding debt.
Stability of the financial system
The second area in need of reform is the stability of the financial system. Here, after initial enthusiasm, action has petered to a halt. The main focus of crisis policies is to create a European banking union that bundles national oversight and fall-back systems and implements stricter rules in certain areas. The European Commission’s proposal rests on three pillars: a common European banking supervisory authority, a unified deposits guarantee scheme, and a restructuring fund backed by private banks. In addition, the German and other EU governments are planning to introduce a financial transaction tax to make the financial markets contribute their share to the costs occasioned by the crisis.
The financial transaction tax leads us to the third area in need of reform – the structural causes of the crisis and the question of how such an overextension of public and private debtors has come about. One shared trait of the real estate bubble in the US and Spain as well as Greece’s excessive debt burden is that creditors failed to thoroughly assess borrowers’ financial capabilities. The financial institutions took on the risk involved not least because they – correctly – assumed that they were “too big to fail,” and indeed, during the financial crisis the large majority of hard-hit banks was bailed out by politics. The reforms proposed as part of a European banking union could play a role in preventing the future occurrence of such predicaments. A restructuring fund backed by private banks and a deposits guarantee scheme they would have to underwrite as well may limit their willingness to take risks, especially if, as demanded by the Greens and others, the amount of deposits necessary were made conditional on the risk profile of the respective bank. Further proposals that are, as yet, not part of the reform plans put forward could make an even greater contribution towards greater stability, for example the introduction of debt limits for banks, the splitting of investment from deposit banking, an earlier stake of banks’ creditors in financial institutions threatened by bankruptcy (through so-called debt-for-equity swaps), and the regulation of the shadow banking system (2).
Inequitable distribution of wealth as structural cause of the crisis
However, we will also have to focus on another cause of the crisis – the connection between an inequitable distribution of wealth, the accumulation of financial assets, and the resulting risk-friendly behaviours of actors in the financial markets. The current situation is paradoxical: On the one hand, many countries (as well as individuals) are overburdened with debt; on the other hand, financial markets do not know where to channel their funds, as the real economy is unable to absorb the capital coming its way and many government bonds seem to be increasingly unsound (3). In this, many observers see a weighty cause for the emergence of high-risk financial products that, for a long time, absorbed huge amounts of investment capital – which, in turn, caused the financial crisis. This also goes to show why, in the long term, it is highly questionable to draw a line between countries with current account deficits and surpluses: If a national economy is unable to permanently absorb surpluses, they will have to be invested elsewhere – thus backing phenomena such as the sovereign debt crisis in Greece or the real estate bubble in Spain.
A review of the three areas in need of reform shows that there is no easy way out of the crisis. Nevertheless, a number of proposals that go beyond debt reduction and the stabilisation of financial markets may contribute to resolving issues in all three areas.
A look ahead: shared investment and synchronised tax policies
Part of such an approach is a common European investment policy that clearly focuses on sustainability, something that has, for some years, been debated under the header of a “Green New Deal.” Especially in the countries hit hardest by the crisis, a Green New Deal may stimulate economic activity and reduce debt levels by creating more revenue. If such measures come with clearly defined goals and parameters for renewable energies and a social as well as ecological transformation, a Green New Deal may also provide private sector investment security, thus calming the financial markets. Thirdly, in order to tackle the structural causes of the crisis, politics will have to make such investment security conditional on a sustainable orientation of the financial markets – instead of just contenting itself with stabilising an unsustainable system.
A second major area of reform is tax policy. Measures in this area are always unpopular, yet they may contribute to solving problems in all of the three areas discussed. For one, the question of sovereign debt is not just an issue in the countries hit hardest by the crisis – the economies of the United States, Germany, and Japan are also burdened by excessive levels of debt. Globally, over the last few years, state revenue has dropped to a much greater degree than spending has risen. In Greece, too, it was less excessive spending and rather dwindling revenue that caused the meltdown. Once and for all, the financial crisis has shown that capital gains will have to be taxed more comprehensively. Europe has the opportunity to better synchronise its tax policies, thus banning the spectres of capital flight and outsourcing. A targeted taxation of capital gains will also contribute to reforms in the other two areas. In addition to stabilising financial markets by introducing a financial transaction tax, a tax on capital gains could replace the shaky system of financing state expenditure via the financial markets. On top of that, synchronised tax policies and a capital gains tax could have the effect that economic competitiveness is no longer mainly based on low wage levels. This would not only allow for greater distributive justice, it would also address one of the pivotal problems facing Europe’s economic development – the gap that has opened up in the development of real wages.
(1) Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung: Verantwortung für Europa wahrnehmen. Jahresgutachten 2011/12, November 2011.
(2) Cp. for example Peer Steinbrück: Vertrauen zurückgewinnen: Ein neuer Anlauf zur Bändigung der Finanzmärkte, September 2012; Grüne Bundestagsfraktion: Europäische Bankenunion: Beschleunigen statt bremsen! Resolution of the Green parliamentary party group, 6 November 2012
(3) One result of this is that Germany has to pay extremely low rates on its government bonds.
Translated from the German by Bernd Herrmann (German version).
Simon Wolf is head of the economics and finance desk at the Heinrich Böll Foundation.