After ECB Liquidity Injections And Fiscal Reform Agreement, Europe Is Looking Much Better – But Systemic Economic Weakness For Greece, Italy And Spain Remains Unchanged

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By Paolo von Schirach

March 3, 2012

WASHINGTON – A European summit without the pressure of another imminent crisis. Now, this is news. The EU leaders just met and they congratulated one another for being there, alive and standing. Indeed, it seems that the liquidity/solvency crisis has been finally stabilized. After untold pain and various twists, there is a deal for Greece. Italian Prime Minister Mario Monti had enough political authority to squeeze some more revenue from the Italians. Higher taxes, combined with more spending cuts, improved the outlook for Italian public spending. And so the “spread” between the interest rate on Italian and German bonds mercifully narrowed down to more acceptable levels.

ECB liquidity injection

But the real magic has been the injection of massive amounts of liquidity into the European banking system engineered by Mario Draghi, the new president of the European Central Bank, ECB. Flooded with the equivalent of about $ 1.3 trillion, even the most rickety European banks now look good. (Remember that these are the same banks that had passed with flying colors various stress tests. Some tests, really).

And finally, now 25 EU members (out of 27) are formally committed to higher standards of fiscal frugality. Even though the agreement they just signed needs to be ratified and then implemented, this step should be interpreted as a good sign.

Brighter outlook?

All in all, therefore, a better picture. No immediate liquidity shortages. No fear of default. And, going forward, improved fiscal policies. But does it mean that all is well? Not really.

While there is no denying that the EU avoided a disaster, Southern Europe is still structurally weak, fiscally and economically. Italy and Greece still have a massive national debt well in excess of 100% of GDP. Spain has far less debt but it is stuck with a very weak economy and very high unemployment. Youth unemployment across Mediterranean countries is still sky high.

Systemic problems in Southern Europe

Unfortunately, the hard issues in Southern Europe are still the same: the welfare state is too expensive, public administration is still bloated and inefficient, there is too much corruption and the broader environment does not invite investments and new enterprise. Hence no growth. On top of that, there are dreadful demographic trends. No babies. Extremely low fertility rates mean a shrinking pool of active workers carrying the burden of a growing senior population. This is bad for financing the welfare state and bad for economic growth. Add to that immigration flows from North Africa that bring into these economies unskilled and difficult to integrate workers who do not help improve productivity.

Stagnating economies

And these large, systemic problems are reflected in stagnating economies that barely grow or do not grow at all. Changing all this may be possible; but it is going to be extremely difficult. It is a matter of changing national psychology and established pattern of behavior. I just do not see Greece transforming itself into a vital society propelled by enthusiastic, risk taking entrepreneurs.

Stop gap measures help, but…

So, this welcome calm is due mostly to the massive liquidity injection provided by the ECB, and to new confidence coming in the wake of the acceptance of the fiscal policy commitments. However, the point is that while more cash helps this is only temporary relief. Good fiscal policies, in turn, while absolutely necessary, are not sufficient. Unless they go together with welfare reform and measures that will ignite economic growth, they will not transform Southern Europe.

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