But the unfolding tragedy of a bankrupt Greece is only a symptom of an even more fundamental miscalculation: a wrong-headed conviction, widely held across Europe, that if austerity is failing, it is because there is not enough of it.
Already the half of the euro zone that is in recession threatens to bring down the other half. But, by holding dogmatically to a policy of ever more austerity despite all the evidence of stagnation, Europe now threatens the economic recovery of not just the euro area but also the wider world.
Understandably the biggest U.S. economic worry of 2012 is that of a recovery derailed in an election year by another sharp European shock.
But the current infection in Europe is potentially even more damaging in the longer term. Another downturn could condemn the continent to perhaps a decade of misery, with low growth, high unemployment and social unrest. It would destroy Europe’s pivotal position as the world’s second-largest engine of growth, and condemn the euro zone to permanent decline and marginalization from the wider world, severely damaging international trade and curtailing global growth for at least the rest of the decade.
Europe’s problems are not exclusively fiscal, as current policymakers argue, but stem also from a deep-seated and ongoing banking crisis and a long-term collapse in competitiveness. These problems are so profound that they are now reshaping the continent’s role in the world, yet its leaders seem to think them of secondary importance.
While many U.S. banks still have leverage ratios that are 10 times their capital, the banks of Germany have a leverage ratio 32 times their capital, and French banks are leveraged 26 times their capital. Europe’s banks have done only a fraction of what their U.S. counterparts did to rid themselves of toxic assets and to recapitalize, leaving them no choice now but to liquidate their assets.
A European banking model that is suffocating under such leveraging, financed by short-term borrowing, is fatally damaged and cannot survive without fundamental reform. That model also massively damages the prospects of economic recovery for a private sector that needs liquidity and investment to function efficiently.
Europe’s loss of global competitiveness, however, presents an even more profound problem.
A continent that was once responsible for 40 percent of the world’s output is now producing only 18 percent — and within a decade it will produce little more than 11 percent. This is an epic shift, yet one virtually unnoticed.
What Europe is experiencing may prove to be a permanent and irrevocable loss of prosperity.
The continent’s problems look increasingly as though they are part of a global transfer of economic power, where production, investment and demand shift from west to east. Historians will certainly point out in the years to come — although politicians today note it with ambivalence — that Europe is today selling just 7.5 percent of its exports to the countries that are responsible for 80 percent of the world’s growth — China, India, Brazil, South Africa, Turkey, Russia and South Korea. The historians will undoubtedly ask how the continent could ever assume its survival as an economic powerhouse with such a tiny footprint in the world’s newest and fastest-expanding markets.
Against this background, the obsession of Europe’s leaders with imposing a swift and deep austerity seems hopelessly superficial and short-sighted. The debt-to-national-income ratio is the internationally agreed standard for measuring fiscal health and, not surprisingly, as growth falters, debt ratios in Greece, Spain, Portugal and Italy are not falling but rising.
Yet the whole of Europe has signed up to German-led austerity that will ensure the levels of growth that could reverse this rise remain impossible to achieve. This low-growth Europe still has to find a way of securing several trillions in borrowings to fund their government deficits and bank liabilities. And yet, even now, after months of discussions, the question of who pays, or even who guarantees, the deficits can’t be convincingly answered.
With Europe unable to generate its own growth without outside support, a coordinated global growth plan — a modern and international equivalent of the Marshall Plan — is the only way to stem the continent’s decline and prevent a new European recession from pulling down the rest of the world. China should raise its consumer demand and import more, giving U.S. and European industry a boost in confidence. Europe and America should expand investment in infrastructure.
When the Group of 20 meets in Mexico in June, world leaders should focus on agreeing a coordinated global plan with Europe at its center. Helping Europe for the long term is the best way of helping America and Asia for the long term too.