Outside View: Europe’s sterile debate: Austerity vs. stimulus

COLLEGE PARK, Md., May 22 (UPI) -- The European summit this week will feature a standoff between German Chancellor Angela Merkel advocating austerity and French President Francois Hollande promoting stimulus to boost growth.

Neither position is without merit but neither by itself will solve what ails Greece and other failing Club Med states. Sadly, none of the leaders involved, including the insurgent left most likely to win the next Greek elections, appear willing to accept that a successful strategy to put Europe back on track will require abandoning the euro and returning to national currencies.

After the single currency was introduced in 1999, productivity growth was slower and prices rose faster in southern Europe than in Germany and other northern states owing to both cultural and immutable geographic conditions. Consequently, the north enjoyed growing trade surpluses at the expense of deficits in the south.

Trade deficits can instigate high unemployment and curb tax revenues and to support employment and social programs on a par with their northern neighbors, the Greek, Italian and Portuguese governments borrowed too much.

In Spain, northern Europeans purchasing second homes and vacationing in its sunny climate instigated a rush of foreign funds into its banks to build dwellings and hotels. Spain actually had budget surpluses prior to the 2008 global financial crisis and its trade deficits were financed by bank borrowing from foreign sources and questionable loans to homeowners -- the American model of excess.

Trade deficits permitted all the Club Med states to consume more than their uncompetitive economies produced by borrowing, in one form or another, but none used the opportunity to boost productivity and regain competitiveness.

When the U.S. banking crisis thrust the global economy into the Great Recession, investors became increasingly aware that Portugal, Italy, Greece and Spain were pursuing flawed economic models and would never be able to pay what they owe. Borrowing rates skyrocketed pushing governments in all four countries and Spanish banks to the brink of collapse.

To get these economies growing again, all must, as Merkel prescribes, spend less on social programs. Europeans like Americans are living longer and must work beyond current retirement ages or national finances simply can't work and they must rid themselves of the notion their government owes them a living.

These economies must become more competitive too -- exporting more, importing less, running trade surpluses to earn euro to service debt. This requires lower wages and prices for what they make, as valued in euros.

Lacking national currencies, austerity through high unemployment must force down wages. For southern Europe that would require at least five, perhaps 10, years of unemployment of at least 25 percent -- that is simply not politically feasible.

Iceland had a banking crisis similar to Spain in 2008, but has its own currency. It let the krona decline against the euro fall by more than 50 percent, dramatically slashing wages as compared to the rest of Europe. Its government gave continuing support to the unemployed and assisted troubled homeowners more aggressively than the U.S. and other European governments.

The combination made Iceland a competitive and attractive location for investment and supported the domestic economy as the private sector restructured.

Without the most substantial elements of the fiscal reforms prescribed by Merkel, southern Europe cannot become solvent and eventually independent of German aid but neither can it be without abandoning the euro and some reasonable continuing assistance for the unemployed, homeowners and other private debtors.

Germany, Finland and others need to support this course for their own good -- their private sectors are quite dependent on southern Europe for customers.

Without abandoning the euro, southern Europe will collapse and it will take Germany and the other northern economies down with them.

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(Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist.)

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(United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.)