Campa (2012; p. 195) starts by pointing out that the euro area is in crisis because of three unique characteristics; “the uneven distribution of the debt burden across the euro area; (doubts over) the ability to finance that debt burden in the short run; and the concerns on future growth as a mechanism to dilute the debt burden in the future” (Campa, 2012; p. 183).
In relation to these three characteristics, Campa asks three questions, two of which are of short-run nature. One of these is how to resolve the debt crisis (mainly in Greece); the other is whether basically solvent Spain and Italy will be able to avert a debt crisis.
The third and longer-term question is how to make the euro area uniformly competitive and growing. This question is actually one that the European Union (EU) has been asking almost since its inception, whose urgency intensified because of the crisis. To resolve this third question, many member states must undergo painful reforms. Without them, Europe cannot enjoy sustainable prosperity; no matter how the short-run questions are answered. This question is therefore very much relevant to Asian readers; what kind of mechanism will Asian countries employ in order to push forward necessary but domestically unpopular reforms? It is easy to criticize Europe for having introduced a single currency without a single fiscal authority. But if Europe's way is the wrong way, what is the alternative?
This question is directly related to one important reason why the euro was introduced in the first place. The euro meant “hiring a conservative central banker”, more fiscal prudence, and cost/price transparency. Thus, the euro was expected to make it easier for member states to implement unpopular reforms, by taking away the easy policy choices, and by revealing rigidities which were hampering growth. It was hoped that members would converge toward more flexibility and better economic health. But this convergence failed to materialize, asymmetries remained, and naturally the euro got in trouble. Fixing or doing away with the exchange rate does not work well under asymmetries.
As shown in Campa's paper, over the last 2 years, Europe has been conducting a large number of reforms. As most of these measures intrude upon vested interests and/or sovereignty, they cannot be successfully implemented without governance overhaul at the member state as well as the EU level.
Slower growth can result from fiscal tightening in the short run, but it also results from low productivity, low labor participation, and a lack of innovation. Europe needs to tackle these problems originally addressed by the Lisbon Agenda mentioned in Campa (2012). Lisbon's problem was that it did not involve sanctions (see Kaji, 2007). The new Macroeconomic Imbalance Procedure does, and we will see how effective this is.
As Campa (2012) points out, committing to Europe's fiscal rules did not put members in a sounder position to confront the crises, and violating the rules was not a good predictor of problems ahead, either. This should tell us that even after the euro area countries manage to put their finances in order, they expect all to be well. Deficit and debt reduction is important, especially when disorderly default is to be avoided. However, a low deficit, low debt, high unemployment country is not a happy one. What is important is sustainable growth.
This reminds us of the 1997–1998 Asian financial crisis. All countries involved had pre-crisis fiscal balances that can only be called exemplary by today's standards. Countries stabilized their exchange rates against the US dollar, which encouraged foreign borrowing. The “currency mismatch” (borrowing in dollars, lending in local currencies) and “term mismatch” (borrowing short, lending long) meant that once capital withdrawal began, these countries rapidly lost their ability to pay back the sums they owed. Needless to say, the post-crisis depreciation of their currencies made this even more difficult. But depreciation helps exports, if the country produces attractive goods and services. So Japan, for instance, would be better off with a floating exchange rate and a strong export sector, when the Japanese government bond (JGB) crisis hits.
The question is how to get the voters on board, and how to convince the markets that the voters are convinced.1 This is true for all countries from Germany to Greece, and also for countries in Asia. Japan needs to convince its voters that government spending will not increase growth without deregulation, and convince the markets that voters are indeed prepared to accept the painful changes needed for growth to avert a wholesale JGB meltdown.