Is Europe’s problem German strength or German weakness?

Angela Merkel once told the French President: "Nicolas, you will have to get used to the fact that I am slow". As the rest of Europe soon learned, Merkel is not prone to exaggeration. Uncertainty, prevarication and finger-pointing have dominated Europe’s ham-fisted approach to the crisis engulfing it.

The conflagration in the eurozone has profound implications for the wider European Union since significant political capital was invested in the creation of the single currency. Much of the European integration project is now staked on its success. Merkel’s prescient remark that "if the euro fails, then Europe will fail", is, again, no overstatement.

Initially limited to Greece, the crisis could have been contained with swift action to prevent a disorderly default and contagion to other rickety European neighbours. Alas, it took several months of fraught negotiations and market jitters to approve the first rescue package in May 2010, forever undermining the markets’ confidence in the eurozone’s crisis resolution mechanisms. What crisis resolution mechanisms, one may ask. Indeed, the "no bail-out" clause was firmly enshrined in the Maastricht Treaty in 1992 and no lender of last resort was ever designated, a role that has slowly fallen to the European Central Bank (ECB). However the monetary financing of debt is anathema to German policy-makers, who argue that that the burden of adjustment should fall on the eurozone members who pursued a spendthrift fiscal policy. Germany has consistently rejected any notion that it should address its own internal imbalances, such as its excessive current account surplus and low domestic consumption, as a means of resolving the crisis. "Economically, there is a perception that exporting is not a very bad thing as long as Germany isn’t doing it", said Steffen Kampter, parliamentary secretary to Germany’s minister of finance.

He has a point. Since reunification Germany clamped down on wages so that unit labour costs fell by an annual average of 1.4% from 2000-08, a significantly higher rate than America and other European neighbours. Thanks to its sound economic policies Germany’s share of exports in its GDP gained 25 percentage points from 1993 to 2008. It is easy to see why Germans are loath to see their country’s surplus lambasted as a source of imbalance within the eurozone. "If one is more competitive than others, then others have to become more competitive", continues Kampeter.

Germany’s success, however, owes much to the bedevilled single currency. Its exports became cheaper than they would have been under its treasured D-Mark as the euro reflected Europe’s competitiveness, not just Germany’s. The European Commission has estimated that the euro was around 10-12 percent undervalued for Germany in the first quarter of 2009. Furthermore, almost half of Germany’s exports go to its eurozone neighbours. Germany may be right in arguing that the rest of Europe ought to play catch up rather than force it to shift down a gear, but the message falls on rather hostile ears when bail-outs are accompanied by draconian austerity measures that have perpetuated Greece’s gruelling recession for five years. "There is frustration with Germany, [it] is moving ahead, but what are they doing for the rest of Europe?" says André Sapir, a senior fellow at Bruegel, a think tank.

German preponderance in Europe is not a novelty. Germany has outshone the continent since the 1980s, when the mark’s strength caused strains in the European Monetary System. As such, the Economic and Monetary Union project was born out of a desire to liberate other European countries from the dominant monetary policy of the Bundesbank. The current crisis is reminiscent of that situation, both because of the ECB until recently pursuing a rather conservative monetary policy which harmed heavily indebted countries, and because Germany’s deep pockets mean it calls all the shots. In the words of Tommaso Padoa-Schioppa, "German leadership of Europe is a fact, ignoring this would be the wrong way for Berlin to exercise its leadership."

Merkel seems to have grasped this, albeit belatedly, and has embraced her de facto leadership with the quasi-scientific meticulousness that characterises her political method. As Guy Verhofstadt, a former Belgian prime minister, once remarked, "she likes incremental steps, she has no vision for Europe." Germany’s skewed economic prowess may have been one of the factors at the heart of Europe’s travails, but with foreign assets worth some 6 trillion euros, consisting mostly of claims on eurozone members, Germany would be no winner in a break-up of the euro. In fact, the stress tests on European banks in 2010 revealed just how exposed Germany’s feckless banks were to Greek debt, which largely helps explain the reversal of Merkel’s position towards a Greek bail-out. Saving the eurozone was synonymous with saving the German banking system from collapse.

Wolfgang Münchau wrote in The Financial Times that "with unification, Germany has become too large to be an ordinary European state, yet not large enough to be a superpower", thus neatly encapsulating the difficult relationship between Europe and Germany. The latter’s overbearing economic strength is part of the problem, but by failing to translate economic might into political leverage it has allowed the crisis to fester and the idea of Europe, esoteric though it may be for many voters, to fade into oblivion. Instead of rallying Europe around the vision that has guided the integration process hitherto, a harmful chasm between fiscal saints and sinners has been allowed to take root. Merkel has concentrated on demanding trenchant reforms in embattled countries and more intrusion on national sovereignty with the latest "fiscal compact", whilst dogmatically refusing to concede anything in return. Any attempts to set up Eurobonds as the sine qua non of increased budgetary surveillance have been stymied. If she is to emerge as a successful leader of the beleaguered old continent, she must bring out her "conductor’s baton". A concrete plan to restore growth and competitiveness in Europe which does not rely solely on self-perpetuating austerity would be a good start. Bring on the Merkel Plan.

Europe in Pieces: the new political and economic balances after the 2012-2014 crisis

In the Social Contract Rousseau asks himself: “If Athens and Rome collapsed which state can last forever?”. “The political body, as the human one, starts to die from the moment of its birth and has in itself the causes of its dissolution.”

The history of the decay of an endless number of European states – from the kingdoms of  Burgundy and Aragon to the Soviet Union – seems to confirm the theory of the French philosopher. The states, as all human institutions, sooner or later disappear. After 1989 the Deutsch Demokratischen Republik  united itself with West Germany. Czechoslovakia divided itself in two after the pacific divorce between Prague and Bratislava, while Yugoslavia has been dismembered between 1991 and 2006. In the last years the map of Europe has changed according to the birth or death of national states and to the expansion of the European Union. Today the discussion is about which state will be the next to fall. Some say Belgium, others say Italy.

The world is assisting to the collapse of the Eurozone, which is not a sovereign state, but still is a political body, therefore subject to the whims of fate. Born twelve years ago, the Eurozone could soon enter the list of the organizations who died at a young age. It does not have a tax administration or a political government, and if it will not be able to transform itself it is destined to disappear.

The threat of a conflagration torments the euro-lovers and fills the euro-skeptics  of schadenfreude, the pleasure given by others' misfortunes. The ones still hope in an intervention of the international cavalry, while the others wait with trepidation for the whole construction to blow into pieces. In the conservative British circles they are overjoyed and superbly maintain that the “The nosy bureaucrats of Brussels are finally getting what they deserve. Those Greek villains, that have falsified the numbers to get in the European Union, will do it again and hoping in other major rescues”. According to this analysis, in the European summits there is nothing but chatter going on. The piloted default is an illusion and the rescue fund of the Eurozone is half empty piggy-bank. The European Central Bank is impotent. There is no European treasury and the German tribunals are preventing any intervention. The politicians continue to quarrel and to defer the solution of the problems. Greece will also drag in its fall the French and German banks. And these will give the coup de grace to Italy, which will take Spain along with it in its downfall. Portugal will not wait long to follow the others and lastly it will be Ireland’s turn.

The banks of the old continent will shut down and the ATMs will be dry. Some volunteers will feed the hungry in the Roman squares, the Spanish plazas de toros will receive the indigent and the romantic Parisian bridges will pullulate with the unstable homes of the clochardes. Europeans will learn the art of bartering again and when the ATMs will start spitting out money again it wont be Euros anymore, but perhaps francs, marks, pesetas… or Dinhar.

One day history books will talk about the Euro crisis in this way: the disintegration of Euroland had led to dangerous political cracks and the refusal to approve a constitution for the whole EU had brought it to a paralysis.

When, in April 2012 Greece goes into default and exits the EU, a European Rescue Committee (ERC) meets in Luxemburg and suspends the treaties. Leaders of this committee are the polish premier Donald Tusk and the former chancellor of Germany Angela Merkel. With the approval of 16 states among the 27 of the Union, the committee claims to act in a democratic way. “We have already seen, more than once, a system fail”, claims Tusk “we will not let it happen again”. The president of the Commission Jose Barroso and the president of the European Council Herman Van Rompuy leave the scene. In the mean time a self-styled Committee of the free nations of Europe is called in London by the conservative William Hauge and challenges the ERC. The two organisms accuse each other of being illegitimate. The disintegration is happening: two separate single markets, three areas of free trade and twenty monetary regimes.

The French and the Flemish pull up the draw bridge, the channel tunnel is closed. The ports and the airports controlled by the ERC confiscate the loads coming from Great Britain. The requests of London to the IMF for the reimbursement of the 75 billion pounds contribution for the third rescue of Ireland go unheard. The economy is paralyzed. The line of trucks exiting the country in the port of Dover is hundreds of kilometers long. Fuel is running out. London is devastated by riots and Barclays' headquarters are going up in flames. Hunger hits England. After the votes the Deputy prime minister Nick Clegg declares that there is no more EU whatsoever and that, therefore, England’s adhesion has no more reason of being. The ERC has not yet abandoned its plans for a monetary union and a European integration. To keep the nationalist sentiments under control the word “euro” is cancelled and the national governments can give a new name to the common currency. A Constitutional Commission is back to work.

To make matters worse, the day that Great Britain abandons the Union, the Scottish first minister, Alex Salmond, makes public that he has achieved a financial agreement with Poland, Germany and Luxemburg. Before the great depression of 2012-2014 it seemed as if Salmond only wanted more autonomy for Scotland, but the crisis pushes him to ask the referendum for independence. “Brave Scots”, says Salmond to his fellow citizens, “do you want to continue being subdued to London, as it has happened for Greece, Sicily and Latvia? Or do you want to revive the historic mission of Scotland, and be part, together with other European nations, to the Union, as a free, sovereign and proud reign?”. 

The Plagues of Europe

Yesterday’s package was hailed as a panacea to Europe’s problems by politicians and markets alike. This is a puzzling and short sighted reaction because the package conspicuously fails to address the problems that lie at the heart of the euro. One could justify this by saying that the plan is primarily intended to placate restive markets as it is close to impossible to implement cross-cutting structural reforms which are likely to cause unrest when the biting eyes of the market are on your back. However there is little evidence that European policy-makers have adopted such a long-term view; the likelihood is that this is yet another fudging attempt to suppress the symptoms of the crisis whilst ignoring the roots of it. The problems with the euro are specific to the foundations of the eurozone but are also embedded in the contorted fabric of European integration.

The first of these problems concerns the structural differences between members of the ill-fated eurozone. These cleavages are so vast now that Jamie Dannhauser of Lombard Street Research says it is not clear to see how you could fix them. For a start there is the ubiquitous competitiveness problem. Mediterranean countries, especially Greece, went on a spending spree upon joining the euro which was fuelled by the low interest rates. They thus accumulated a healthy dollop of public debt and placidly let wages balloon which led to a sharp drop in competitiveness compared to their ascetic neighbour Germany. Yet it is easy to infer from this that southern Europe reaped all the (temporary) benefits of the euro whilst the disciplined north observed fiscal responsibility only to be presented with a hefty bill when the floor caved in. On the contrary, Germany has been able to foster its export-driven economy largely thanks to the weaker and thus more competitive exchange rate afforded it by sharing a currency with the reckless southerners. This is compounded by the reality that if Germany decided to leave the euro its economy would be hit hard by the ensuing appreciation of its new currency as exports would become less competitive.

The second problem is one of political accountability, or the lack thereof. As the BBC says, there is no one who can credibly claim to speak for Europe as a whole. The integration process so far has been run from the top by national governments, with the tacit consent of the people. Decisions have been taken by eurocrats haggling behind closed doors and then presenting them to voters as matters of competing national interests. National leaders have been adept at taking the credit when integration has generated benefits and quick at using it as a scapegoat for their own failings. Thus Italian politicians play the Brussels card when announcing another round of austerity measures, as if they were being imposed on the country on the whim of a distant eurocrat whilst the past decade of political prevarication and stagnation fades into insignificance. How convenient. Furthermore, the decision-making process in Brussels is painfully slow and ill-suited for financial crises; one cannot hope to assuage the markets’ jitters when 17 national leaders have to agree on a solution and then present it for ratification in 17 different parliaments. The obvious solution to the lack of political efficiency is for the EU’s executive arm, the Commission, to take the lead as its equivalent would do on the national level. However, this merely brings us to the next wall, namely a lack of democratic accountability. If Jose Manuel Barroso were to take a much more prominent role in solving Europe’s problems, he would encounter the wrath of all those within the public who consider the idea of a political appointee dictating policy anathema. Again, the obvious solution to this conundrum is to make him an elected leader, but this raises the spectre of a European superstate which is an equally abhorrent idea for many.

The third, and perhaps most intractable problem, is that of growth. Italy has been growing sluggishly for over 10 years and since the 2008 crisis growth in the rest of the eurozone has ratcheted along at a similar pace. Manufacturing output in the eurozone fell at its fastest pace in two years in September whilst Germany’s economy grew by just 0.1% in the second quarter of this year. More importantly, if the heavily indebted countries like Greece fail to foster growth they stand close to no chance of extracting themselves from the current quagmire. As Stephanie Flanders has said on the BBC, “we might get a ‘deal’ to save the Euro on Wednesday, but it does not look as though we will get a deal consistent with reasonable economic growth”. European leaders have instead focused zealously on austerity to cut deficits and debt which is showing few tangible results save for a conspicuous lack of growth. As tax receipts dwindle due to plunging profits and unemployment rises, governments are forced to borrow more to repay previous debts and thus find themselves back at square one. Moreover, Alen Mattich argues that the growth problems afflicting the eurozone’s periphery are so politically, culturally and legally entrenched that the solution does not lie in buying a few months’ respite from the fickle markets. He says that even with a 60% haircut on Greek debt, Greece would have to endure a semi permanent situation of austerity and recession, something which would be unpalatable to the population. Daniel Ben-Ami argues that fiscal deficits are merely symptoms of an underlying economic weakness rather than its cause, namely a low growth economy. It thus follows that fervently tackling deficits will not solve the eurozone’s economic problems but simply postpone the next economic crisis, which is exactly what has happened hitherto.

Another oft-ignored issue is the interconnectedness of the eurozone economies. It is apparent that Germany is convinced that Greece can slash its debt and return to growth without a currency depreciation (out of the question for obvious reasons). For this to happen Greece’s domestic prices and wages must fall sharply (which is already happening thanks to a hefty dollop of austerity) so as to become more competitive and its net exports must increase with respect to domestic consumption (the icky bit). This entails an increase in external demand, a luxury that Greece unfortunately does not have. Germany’s finance minister Wolfgang Schauble seems to think there is no symmetry between debtors and creditors so all this is perfectly feasible without Germany’s current account surplus having to fall. Whilst the rest of the eurozone was busy indebting itself by buying Germany’s exports (almost half of which go to the eurozone, incidentally), Germans were saving and running up a huge trade surplus at the expense of their neighbours.

The Economist points out that in a single currency zone habitual surplus countries tend to be matched by habitual deficit ones. In the eurozone sharp differences in labour productivity and fiscal policy flexibility led to the creation of a two-tier monetary union with a core of net exporters and a periphery  with constant trade deficits; both layers fed off each other in a relationship that was mutually beneficial. It would be crass to argue that Germany is responsible for the current mess in which the periphery finds itself, but it would be equally obtuse to depict the Germans as the virtuous victims bailing out the venal spendthrift countries.

It is a political and economic conundrum that no leader would ever want to have to face. Mattich is discerning in describing the euro as a “political enterprise that keeps stumbling over economic fundamentals”; policy-makers naively believed at the inception of the single currency that they could achieve monetary union without investing the necessary political capital, however the flawed economics have now caught up with them. Ultimately, the eurozone’s woes stem from a common illness that has afflicted much of the developed world, namely a lethargic growth that has been countered primarily by high state spending. To depict the scenario facing European policy-makers as a two-sided coin with disintegration of the euro on one side and the creation of a European superstate on the other is to ignore the problem of sluggish growth. More political integration will not automatically engender growth, but rather a string of further all-nighters for our tired politicians.

Europe is Closer to Resolving the Eurozone Crisis...with an Outline of a Plan

“I’ve said it before and I’ll say it again, this is a marathon not a sprint”. Thus spoke Jose Manuel Barroso, European Commission president, after unveiling the latest rescue package designed to solve the euro crisis once and for all. Yet the fact that the details of the rescue package were agreed upon after the general summit during an all-nighter of fraught negotiations paints a picture of prevarication, uncertainty and lack of political leadership which evokes harrowing memories of the US’s responsible politicians engaging in political brinkmanship over the debt ceiling this summer. 

Last night’s plan is comprehensive in many respects, perhaps more so than previous plans have been, such as the one agreed last July. The fact that shares in European markets rose when news of the deal emerged is reassuring and helped assuage fears that eurozone leaders had fudged the task yet again.  It touches upon the three main points that I deemed essential for resolving the crisis in my last article, namely imposing a significant haircut on private holders of Greek debt, adding to the European Financial Stability Facility’s (EFSF) firepower and recapitalising European banks which are severely exposed to Greek debt. Banks holding Greek debt have accepted a 50% loss which should cut Greece’s debt from a projected 180% to 120%; this is close to Italy’s level and thus should prove more manageable. The EFSF will see its firepower boosted to about €1tn from its present paltry €440bn, with the current remaining €250bn leveraged around 4-5 times. There are two main options for achieving this. One entails the EFSF acting as an insurer on eurozone members’ debt so as to lower borrowing costs for countries in trouble, such as Italy and Spain. The alternative is to set up a special investment vehicle which could receive contributions from big public and private investors (notably China). However, the details have not yet been finalised so it is unclear where exactly this money will be coming from for now. Finally, banks have been asked to raise €106bn in new capital by June 2012 so as to protect them from any ensuing losses from government defaults and to protect larger economies such as Italy and Spain from market jitters. Again, how the banks are expected to raise this amount of capital is left unclear.

The package can therefore be said to have achieved one of its principal aims, namely to buy the eurozone precious time so that Greece may concentrate on fixing its finances and countries like Italy and Spain can implement structural reforms to avoid being sucked into the quicksand. To claim that the dilemmas lurking over the Eurozone have been solved though is flippant at best. Alen Mattich, writing for the Wall Street Journal, claims that Europe’s latest generation of politicians have been trying to build a pig out of sausage as they wrestle with half-measures rather than having a fundamental rethink of the project itself. He believes that unless the European Central Bank (ECB) takes on a prominent role in the solution, politicians will simply stumble from eurofudge to eurofudge. The ECB is the only institution with the wherewithal to shore up Europe’s banks and countries such as Italy and Spain which need to refinance their debt as they work towards rectifying their crooked finances. It can do this directly or indirectly by giving the EFSF access to its mighty “printing presses”, but the intransigence of its previous president, Jean-Claude Trichet, seems likely to persist as the new incumbent, Mario Draghi warns that it is up to European countries to solve the debt crisis. Yet even Mattich states that the ECB’s role is merely a stopgap for much deeper problems which have stalked the eurozone since its inception.

Gavin Hewitt, writing for the BBC, does not cast doubt on the ambition of the European leaders to extract themselves from the mess that is the eurozone, but is wary of the technical details of the plan which are yet to be unveiled. The Greek haircut is all very well but even a 50% write down looks rather paltry if one takes into account that its economy is shrinking fast and years of austerity loom, hardly a prognosis for growth. Furthermore, a public debt to GDP ratio of 120% is still regarded as twice what is deemed to be economically healthy, let alone when the economy is seemingly contracting inexorably. With regards to the EFSF, many experts regard €1tn as too little to protect bigger economies like Italy and Spain should they run into trouble. The technical details have been left vague yet they are crucial in determining whether the EFSF really will be strengthened this much. Furthermore, it may pass the test by lowering their borrowing costs, but does not even come close to tackling the underlying problem of growth. Uncertainty also looms over how Europe’s banks will raise the amount of capital that has been required of them, with many suggesting that national governments will have to step in entailing what is effectively another bailout.

The fundamental problem, however, remains growth, and this latest package does precious little to tackle it. It is intended to provide breathing space for Europe’s leaders as they attempt to find another plan to kick start growth, but it remains unclear to me how they are supposed to do this if they cannot even finalise the technical details of the interim plan. Jose Manuel Barroso ought to stop his political grandstanding by announcing bullishly that “Europe is closer to resolving its financial and economic crisis and to getting back on a path of growth”. Europe will not resolve its financial and economic crisis until it gets back on a path of growth; however it will not get back on a path of growth until it resolves the financial and economic crisis. The 50^th anniversary of Joseph Heller’s Catch-22 is ironically pertinent when it comes to the euro crisis.

The Euro: What to Do?

Yet another summit, yet another vague plan. France’s finance minister Francois Baroin said the EU summit due to be held later this month will agree “decisive” measures to tackle the crisis that is engulfing the euro zone. “Decisive” however, does not seem like the right word to use after European politicians delayed the disbursement of the next €8bn tranche of the rescue package for Greece until November, thereby disseminating even more uncertainty in the markets. Furthermore, all the public talk about a possible further restructuring of Greek debt has done precious little to soothe investors’ frazzled nerves.

The decision to postpone the next disbursement of money is the least of problems however, and was probably taken in an attempt to push Athens into further reforms as there are no big bond payments due in the next weeks. The medium and long-term decisions are the ones that European leaders are proving unbelievably loath to take, such as agreeing on a partial write-down of Greece’s debts, recapitalising European banks and bolstering the European Financial Stability Facility (EFSF). Yet everyone seems in agreement that the more European leaders prevaricate, the more entrenched and harder to resolve the crisis becomes.

Most experts agree that some kind of haircut on Greek bonds is necessary, as long as it is combined with bank recapitalisation and a significant increase in the size of the EFSF. In July, European leaders had suggested a voluntary debt restructuring on the part of private banks coupled with fresh inflows of official money, but both The Economist and Martin Wolf from the Financial Times argue that the deal fell short of helping Greece whilst providing excessive relief to the banks. Raoul Ruparel of Open Europe, a think tank, claims that around 50% of Greek debt ought to be restructured and that European banks ought to be able to weather the ensuing storm thanks to a recapitalisation program through the EFSF. However, the European Central Bank (ECB) has long been adamantly opposed to any form of write-down which also raises implications for how exactly the EFSF would be able to build a firewall around endangered economies Italy and Spain without ECB funding. Gavyn Davies, writing on the Financial Times, explains that in order for Greece to reach an ambitious debt target of 80% of GDP by 2016, the rescue package would have to amount to €200bn. A 50% haircut on Greek debt that is held in private hands and which currently amounts to €240bn would thus raise €120bn, which still leaves a hole of €80bn. Furthermore, it is highly unlikely that the 50% haircut could be implemented voluntarily, thus raising the spectre of a technical default which is anathema to the ECB.

A corollary of the debt write-down is the problem of banking liquidity (or lack of it). Martin Wolf explains that the debt overhang impairs both solvency and liquidity in the banking sector, and proposes financing through capital injections and central bank support as the solution. However, as Gavyn Davies rightly points out, the amount of recapitalisation needed depends on the size of the write-downs on Greek debt and on the market’s expectations of possible future write-downs on other sovereign debt because of a loss of confidence. This is why it is absolutely vital to protect Italy and Spain from being engulfed in the crisis by putting Europe’s banking sector on sound footing. George Magnus, a senior economic adviser at UBS Investment Bank, believes that the ECB ought to be prepared to stand by and buy any amount of Spanish and Italian bonds to prevent banking contagion.

Unfortunately, the need to build a firewall around Italy and Spain entails a bolstering of the EFSF, which at its current €440bn capacity, is insufficient to ring-fence the crisis. Policy-makers have been bending over backwards to get around the ECB’s unwillingness to buy struggling economies’ bonds and to lend to the EFSF, touting various ideas which involve borrowing from public institutions that already have a banking license and that therefore have access to ECB funding. Another option would be for the EFSF to guarantee the first 20% loss on any new bonds issued by ailing countries; it would be able to implement this without requiring money from the ECB but the prospect of a bank recapitalisation will sharply deplete its reserves rendering this harder. Gavyn Davies argues that the EFSF however could use its remaining capital, estimated at €200bn after various rescue packages and possible recapitalisation programmes, to insure about €1000bn bond purchases in Spain and Italy which would cover their bond issuances for the next three years. This would soothe markets’ nerves and more importantly, buy European leaders a window frame in which they could tackle the euro zone’s underlying problems, namely lack of competitiveness and growth in the periphery countries.

Fostering growth in Greece and its neighbours is a daunting task, to say the least. Yet without growth the debt burden will linger on, as Vicky Pryce, senior managing director of economics at FTI Consulting, has said. The fiscal austerity to which Europeans have been adhering so zealously is only one side of the coin and does not solve the structural problems that affect the Mediterranean countries. One need only to look at the ominous slashing of growth forecasts in the United Kingdom, which has embarked on an audacious deficit reduction programme, to see how austerity can tighten the tap of an economy reducing it to a mere trickle. Christopher Smallwood, writing for Lombard Street Research, claims that the Club Med will restore competitiveness by falling wages and mass layoffs, both of which are likely to have extremely painful repercussions. External financing may mitigate the shock but will also have the corollary effect of slowing down the adjustment process. Furthermore, Martin Wolf points out that if external deficits are to fall in Greece and its neighbours, then surpluses must fall in other countries, notably Germany. Yet discussion on this aspect has been conspicuously absent. The quagmire in which the euro zone finds itself then, is only the beginning of a very long and tortuous process to address the fundamental imbalances within it which were disastrously overlooked in its inception.

A two-tier job market

With the world economy sputtering forward at a snail’s pace and Europe mired in its sovereign debt-crisis, the issue of youth unemployment has acquired a new prominence on the front pages. This is not a novelty, however, and youth unemployment has been festering in southern Europe for around a decade. As the Economist points out, Mediterranean countries (in particular Italy, Greece and Spain) share a similar plight: that of a two-tier job market characterised by an older generation of insiders with permanent contracts and a younger cohort of outsiders who are either unemployed or fumbling along on short-term contracts.

This is largely due to an excessively rigid job market in which it is too costly to fire workers and payroll taxes are overly cumbersome. The upshot of this system is that firms are loth to hire full-time workers and only offer short-term contracts which offer no protection to the worker, as the New York Times reports. Temporary contracts had been introduced to render the labour market more flexible, yet they are now the bane of southern Europe’s youth. The example of Francesca Esposito, who despite her excellent credentials had to work as an unpaid trainee lawyer for Italy’s social security administration, is but the tip of the iceberg.

Couple a job market in a straitjacket with an economic crisis and sluggish growth across much of the Western world, and you end up with entrenched youth unemployment. The Economist makes the point that the young are often the first to suffer when the economy hits a standstill because they are less skilled and easier to fire. However, this was usually redressed in the subsequent upturn as the young had better prospects of re-entering the job market. Not so this time around. In the words of the Economist, the "rigging of the labour market in favour of incumbents and against the young makes what new jobs there are inaccessible”.

This is why southern Europeans often live at home until their thirties, a phenomenon which is too easily attributed to men being “mammoni”. It is not necessarily a choice for the more than 7m Italians aged between 18 and 35 to live at home. On the contrary, when faced with endless temporary contracts which pay little and provide no security, young people feel they cannot take on the obligation of a rental contract, let alone a mortgage. This is a vicious circle for the stay-at-homes were more likely to be unemployed than those who had moved out.

Faced with such a bleak and inaccessible job market, scores of young people choose to emigrate. Italy is in the paradoxical position of being the only net exporter of graduates among rich European countries. The brain drain phenomenon is more commonly associated with developing countries which have not yet developed a satisfactory education system, or a skilled job market. In fact Italy is not exporting blue-collar workers, but a well-educated elite. Sadly, I count myself as one of the many young Italians who opted to study abroad for better job prospects afterwards.

There is no panacea to youth unemployment and what works in one country cannot be used as a blueprint for job creation. It has been plastered on every newspaper that one of the main priorities should be fostering growth. If the economy continues to plod along weakly as it has done so far, then new jobs will not be forthcoming. Italy in particular has had a decade of lethargic growth and the political class has done precious little to alleviate the problem (it is not a coincidence that politicians can count themselves as belonging to the “insiders”).  As bond markets have put politicians under increasing pressure, these have rushed to hash out draconian austerity measures that will strangle what little growth there is. This is not to say that the balance sheets ought to be left to gather dust in a corner, but there is no hope for a country to balance its budget if it does not grow.

Yet even with a re-kindled growth, the young will not be able to benefit from it if structural reforms are not implemented across much of southern Europe. These include an overhaul of the pension systems, deregulation of the labour markets and eliminating red tape so that businesses will be more willing to invest in the region. The latest austerity budget passed by Italy showed that its politicians would be more adept at haggling over prices in a fruit market than being put in charge of solving the myriad of problems that afflict it.

Entrenched youth unemployment marks the deviation from a trend in the developed world which has been taken for granted for decades, namely that the younger generation was almost guaranteed a better quality of life than their parents through hard work. Not only does the sense of betrayal felt by many of today’s young engender a deep sense of malaise and resentment, but this “lost generation” is brewing and bound to reach boiling point at some stage. It is a veritable hollowing out of society encouraged by the two-tier labour market. As the older middle class approaches retirement age, there is no new generation to fill the gap; it has been left behind on the slow speed train.