I thank the Chairman for his invitation to address the joint committee. It is a privilege and an honour to be asked to speak to members. The European Union is the most successful mechanism that has ever been devised to boost co-operation between states. The most ambitious part of that mechanism has been the creation of the euro more than ten years ago. The question is whether the euro is now a strain on that mechanism and could actually do damage to it. For the first time in the history of European integration there is a question as to whether there could be a significant reversal in the process of integration, in other words, whether the euro can survive. These are unprecedented times and disaster is certainly not inevitable but at the same time nothing can be ruled out. It is very difficult to predict the future given how uncertain and unprecedented things are. On that basis I will give five reasons to be hopeful and four reasons to be very concerned. I will finish by looking at a worse case and a best case scenario.
I will begin by looking at the reasons for hope. First, the real economy in the world suffered a massive shock owing to the failure of the financial system but there are real signs all over the world that the non-finance economy is recovering. It is a fragile recovery and is subject to multiple risks but there are signs everywhere of the durability of producers, services providers and labour markets. If the recovery in the real economy can continue, it will make the process of dealing with the euro crisis much easier. Second, the package agreed 15 days ago is enormous, big enough to allow the next three weakest countries, Portugal, Ireland and Spain to obtain the same kind of bailout obtained by Greece. This is a significant and unprecedented package of measures agreed by the leaders of the euro area. It affords the weaker countries breathing space that gives them a chance to get out of the situation. Third, the argument that extreme fiscal tightening leads to a downward cycle that is inevitably self-defeating has been challenged by some of the evidence to date from Ireland and Latvia which suggests that it is not inevitable and that it can work. Over the past year both Ireland and Latvia have introduced measures that previously would have been considered inconceivable in terms of the contractionary effect on their economies. Both of the economies are now showing signs of bottoming out and returning to growth in spite of the fiscal contraction. That offers hope to those countries which are embarking on that very painful process. Fourth, the political effect of the crisis across Europe has been much less than most people who think about political dynamics would have considered. In my organisation, at the beginning of the crisis in late 2008, we thought a great deal about depression-era scenarios of the centre ground collapsing and a move to the extremes of the populist right and the extreme left. That has not happened in Europe. Political stability has been remarkable given the extent of the economic shock, the greatest shock in living memory since the first half of the 20th century.
The fifth reason is Germany, which is a key player. It has not covered itself in glory in dealing with this crisis but, given its size, its importance and its relative fiscal solidity, it is essential Germany remains behind the measures being taken. The opposition to this among the German public is extremely deep and there are many historical reasons for that. Despite that, the five parties in the Bundestag understand this is absolutely necessary and fully support it even though individuals oppose it. They also understand the costs of not doing it would be considerably greater than the cost of doing it. It is difficult to conceive of one or more of the parties in Germany peeling away from this consensus and taking considerable electoral advantage by opposing the bailout. These are five reasons to hope the course embarked upon can lead Europe out the other side without the crisis deepening substantially.
There are four reasons to be concerned. The first is the extreme fragility of the financial system. The collapse of the financial system in 2008 was like a large building being struck by an earthquake. Governments have buttressed the structures through various support measures to prevent the collapse. All those buttresses are still in place and without them we would go straight back to meltdown. Even with the supports, the mispricing of risk by the financial system in a range of asset classes, including sovereign debt, is causing other problems repeatedly and that will not go away. The financial system still poses a threat to the real economy and its recovery.
The second reason to be concerned is that, despite its resilience and its return to growth, the real economy faces other risks. These are not only related to finance but to the extent to which the recovery has been driven by intervention — fiscal and monetary — and how this will be withdrawn. There are other problems in other areas of the world. China is contributing to an enormous degree to global demand and could be at risk of a bubble. A significant crisis in one of the major poles of growth will have knock-on effects for the rest of the world.
The third reason for concern is the capacity of European governments to agree to the redesign of the euro. The "no bailout" package position has been abandoned. It was the foundation upon which the project was built and that has been removed. Now we need a new foundation. From the time monetary union was suggested, many people argued that one cannot have currency union without a fiscal union. I am not sure that is the case, it may be. At a minimum there must be more intrusive mechanisms to ensure the kind of fiscal crises we have had are not repeated. At a minimum this requires a much more intrusive role in the fiscal budgeting policies of member states on the completely equal basis that all countries must face the same scrutiny. There are several ways this could be achieved but, given what we saw from 11 February until two weeks ago in an extraordinary period of indecision and dithering before a proportionate package was put in place, there is concern that Europeans will not be able to agree to the very minimum needed to replace the foundation taken out of the euro structure.
The fourth reason, which is more long-term, is the legitimacy of the European Union. Members of this committee will be familiar with the Eurobarometer polls that ask questions about public opinion and how Europeans feel about the European Union. The legitimacy of a crucial part of European governance is much lower than at a national level. For countries where public opinion is hostile to a bailout, this will have a major impact on the legitimacy of the European Union and support for it. Over the longer term, one must wonder if an entity with limited legitimacy can be a successful political entity.
With those reasons for hope and real concern, I will finish by looking at a worst case scenario and a best case scenario. The worst case scenario is the collapse of the euro, the disintegration of the project with many enormously negative consequences, including some that are unforeseeable. The best case scenario is an extended period of austerity, particularly for weaker countries, which weakens support for the EU in those countries. More positively, that kind of crisis can lead to a range of reforms in the structure of the euro to put the entity on a firmer footing. In weaker countries the crisis being suffered may trigger the kind of reforms — such as labour market reform in Spain and public sector reform in Greece — that are so difficult to push in normal times. I thank the committee members for their attention.
