A productive look at the eurozone

This is my latest Perspective column for Fund Strategy magazine.

It is so rare for an economist to give serious attention to the productive side of the economy it is welcome when it happens. This is particularly so when one of the UK’s most astute experts sets his mind to a key economic challenge of our time.

Although Nicholas Crafts is well respected in his field, he is little known to the general public. This lack of popular name recognition should not be taken negatively. On the contrary, many celebrity commentators and big name economists rarely say anything of interest.

Indeed, strictly speaking, Crafts is not even an economist. He is an economic historian. In many respects, this too is an advantage. Having an historical perspective is far preferable to relying on abstract economic models with little bearing on reality.

Crafts is a professor of economic history at the University of Warwick. Apart from an academic career stretching across several leading top-tier universities he has also acted as a consultant to the Treasury and several international organisations.

In a new paper for Chatham House, the UK’s leading foreign policy thinktank, Crafts has come up with a new approach to tackling the eurozone crisis. Given how much has been written on the subject, this alone is no easy task.

Craft’s approach also gets to what in many respects is the heart of the problem. His main goal is to work out how to tackle the relatively low productivity of the southern European member states. It is this imbalance between an unproductive southern Europe and a more productive northern Europe that in many ways is the nub of the problem. The financial bubbles that developed in several eurozone states can be partly understood as a consequence of combining relatively stronger and weaker economies in a currency union.

The accompanying table helps to illustrate the problem. In the run-up to the emergence of the crisis, the average productivity level of the southern European states was well below the European Union average. Yet for three out of four of them, their productivity growth was also below the EU average.

In other words, not only were their economies weaker to start with but the gap between them and the rest of the eurozone was widening. The exception was Greece, where productivity growth was rising more strongly than average, but in absolute terms it was still only just over half the European average.

Nor has this productivity gap narrowed since the advent of the crisis. On the contrary, it has almost certainly widened as a result of the severe economic squeeze on southern Europe.

Crafts’ solution is a new Marshall plan for the eurozone periphery. In his view, these countries should be offered aid but only on the strict condition of structural reform. They should be pressed to make their economies more efficient by improving education, reforming taxation, freeing labour markets and liberalising competition policy.

Such measures, he argues, would bolster their productivity and therefore help narrow the gap with northern Europe. It would also benefit the eurozone as a whole as it would mitigate the drive towards break-up.

Crafts’ model is the Marshall plan, officially known as the European Recovery Plan, launched by George C Marshall, the American Secretary of State, in 1948. The plan offered aid to help European economies to recover from the impact of war on condition of economic reform.

It came against the backdrop of the Cold War in which there were widespread fears that the Soviet Union could attempt to destabilise or even invade Western Europe. The US therefore had a clear strategic interest in backing the plan. It also included conditions such as the need to purchase US goods.

Crafts does not see his updated Marshall plan as an alternative to moves towards closer economic integration. For him, it is a complementary initiative.

The new paper is a welcome contribution to the debate as it takes the important step of focusing on a key question – how can relatively poor productivity be tackled? But there are weaknesses in his approach.

Most importantly, he downplays the importance of democracy in implementing structural reform. He does talk of the need for “genuine democracy at the EU level” as a long-term solution but fails to recognise this as an oxymoron. The EU and the eurozone are both inherently undemocratic institutions.

Take the eurozone as an example. It has been implemented as a top-down elite initiative without popular support. Indeed, when given the chance to vote, the public has often rejected such initiatives.

Democracy, rule by the people, should clearly be welcomed as an end in itself. But it is also an instrumental good. Popular input can help economies work better.

If politicians had listened to the public rather than followed technocratic advice, the eurozone, certainly in its present form, would probably not have been created. The economic problems facing southern Europe would therefore not be so severe.

Any future initiatives should also have public backing. Most likely, this will mean a break-up of the monetary bloc. Full fiscal union is only likely to come against the wishes of the region’s inhabitants.

There is also a more directly economic element missing from Crafts’ proposals. His focus is on the regulatory framework on the supply side but he otherwise seems to see the state’s role as limited.

Yet in this respect there is scope for the authorities to play a more activist policy in promoting growth. They should be prepared to allow antiquated or weak areas of the economy go bust while providing aid to individuals affected by the restructuring. There is also scope to help promote new areas of production and growth.

Despite these reservations, the Crafts paper is a positive addition to the debate about the future of the eurozone.

^* “Saving the Eurozone: Is a real Marshall plan the answer?” Briefing Paper, June 2012, Chatham House. Available with a related podcast.