Yesterday I wrote about the tools a country has available if it faces a combination of sluggish GDP growth, excessive borrowing/weak banks and non-competitive industry (processes are outmoded and costs are too high). Greece is the poster child among EU countries …but Italy is the major EU economy that this description calls to mind. France is riding a compartment or two away.
What can an EU country whose economy is structurally out of balance do?
Well, external adjustment–meaning currency depreciation–is out, since it’s part of the euro.
That leaves internal adjustment, which can take three forms:
–tariff or other regulatory barriers. Yes, the EU can, and does, erect barriers to protect local industries against imports. But most EU countries trade more with each other than the outside world. So, say, Italy can’t bar imports from super-competitive Germany or lower-cost eastern Europe.
–slowing the borrowing, which is intended to maintain the current (unsustainable) lifestyle, by raising interest rates in a way that will cause a recession. This is the German “austerity” solution, which few, if any, other countries (nor any politicians concerned about being reelected) will willingly adopt. The EU experience after the 2008-09 recession shows austerity doesn’t work particularly well, either.
–that leaves structural reform.
This gets me to why I started writing about this. Paul Krugman recently reviewed a book I haven’t read, The End of Alchemy, by the former head of the Bank of England, Mervyn King. In the review, found in the New York Review of Books, Krugman says of King:
“He argues that Europe’s imbalances in production costs and hence in trade are too large to be resolved without either abandoning the euro or moving to full political union, and that given the lack of will for the latter, the former it must eventually be.”
What grabbed me is the “imbalances in production costs” part. In other words, despite almost two decades of having the euro, plus all the time before its debut when companies knew it was coming, inefficient EU countries have done very little to bring their production costs down. In addition, the reason Mr. King gives for this is “the lack of will.” In other words, the forces of the status quo, aimed at preserving local fiefdoms (both political and industrial), are so strong that no progress can–or will–be made.
Sounds a lot like Japan, with a twenty-year lag.
Tomorrow: investment consequences, if the King/Krugman analysis is correct.