PRIME Minister Manmohan Singh has called upon countries of the world to help bail out the European countries from the ongoing crisis. India, Russia, Brazil and China have agreed to provide funds to the IMF for this purpose. India has agreed to provide more money than the total spending by Centre and State Governments on health services of 1.2 billion people in a year. This policy is entirely disastrous because problems of Europe are structural and cannot be solved by money infusions.
The dominant view is that the main problem of Europe is the disconnect between monetary and fiscal policies. Monetary policies such as interest rates and liquidity in the money market of all members of the Eurozone is determined by the European Central Bank (ECB). However, every member country is free to determine its own fiscal policies such as tax rates and unemployment compensation. Problem is that the two policies are often working in opposite directions. For example, the ECB has followed a tight monetary policy in order to control inflation. However, countries like Greece have adopted an easy fiscal policy. They have increased expenditures on salaries of government employees and welfare programmes such as unemployment compensation and health benefits. The loose fiscal policy requires the government to borrow large amounts from the markets. This is not possible in a tight monetary policy framework.
The Greek Government has had to consequently borrow at high rates of interest. The interest burden has mounted and the Greek government has become insolvent. It is unable to repay its debts leading to an imminent default. Greece could have simply printed its currency and financed these expenditures had it been a master of its own monetary policy. Indeed, that would have led to devaluation of its currency but that would not lead to a crisis. The lenders would have lost value of their loans quietly and borne the same without demur. Greece has lost the option of devaluation and that can be held to be responsible for the present crisis. In other words, the crisis can be attributed to the disjoint between fiscal and monetary policies. European countries have accordingly committed to work towards a fiscal union. G-20 have decided to provide bailout though the International Monetary Fund with this understanding.
I do not think attaining a fiscal union will be easy. It is like ceding sovereignty to a European Parliament. The national governments will lose control over policies like tax rates, welfare programmes and defense expenditures. Political difficulties aside, the question is whether even such a fiscal union will pull Europe out of the economic mess.
Indeed the specific problem of weak countries such as Greece will be somewhat managed. The Greek Government will not be able to spend as much money as it wants on salaries of government employees and welfare programmes. Consequently it will not have to borrow huge amounts to finance these expenditures. But that will not solve the basic problem of competitiveness.
The real problem of all high-wage developed countries including those of Europe, United States and Japan is lack of competitiveness with emerging low-wage economies like those of India and China. The American crisis of 2008 had its roots in the pressure on jobs of American workers exerted by low-priced goods made in China and low-priced services provided from India. Till the nineties only low-priced goods were being imported from China. But the internet revolution changed the game. It has become possible to outsource services such as call centers, translation and legal research to service providers in India. Consequently American workers started losing their jobs in this hitherto protected sector. The workers were not able to repay their housing loans. Banks had to foreclose their properties and sell them at a huge loss. Losses were incurred by the banks and they pulled the entire economy down along with them.
Europe is not able to compete with China and India any more than the United States. The wages in Europe are more or less equal to those prevailing in the United States. Welfare benefits are more sumptuous. This puts an additional burden on the government budgets. This loss of competitiveness is leading to lesser tax revenues forcing the governments to borrow more to meet their welfare obligations which, in turn, is manifesting in the form of debt crisis. The interest burden is mounting and governments are unable to raise loans leading to a possible default.
The question before us is this: Will a fiscal union make Europe more competitive and pull it out of the crisis? Say a patient is suffering from chronic malnutrition and is admitted to the hospital. The physician and radiologist put him on separate regimens leading to some troubles. Coordination between the two doctors will certainly make the treatment more effective. But the basic problem of chronic malnutrition will not be solved because the hospital has no arrangement to provide wholesome food for long periods of time. Similarly coordination between monetary and fiscal policies will help Europe manage its immediate problems but not solve the problem of loss of competitiveness which is rooted in high wages. It is in this perspective that we must read American Congressman Tom Coburn’s statement: “We’re throwing good money after bad down a hole that I think is not a solvable problem… Europe is going to default eventually, so why would you socialise their profligate spending.” Coburn is planning to bring a legislation directing the US government to veto an expanded role for the IMF in Europe.
We must assess the assistance to be provided to Europe by India in this background. The money will be used to strengthen European Banks and to provide assistance to troubled countries like Greece till they straighten up their fiscal mess. Problem is that this does not solve the basic problem of loss of competitiveness. Stronger banks maybe, able to hold their own in the face of defaults by lenders. But default will take place anyways because companies are unable to face global competition. Greece may cut its welfare expenditures. But that still does not lower the wages. Thus the G-20 package may create some resilience in the financial superstructure but the underlying economic woes will not be reduced one bit.
Russian Prime Minister Putin has said that Russia has agreed to provide the assistance so that it has a voice in determining how the money is spent. This reasoning is acceptable. Manmohan Singh must, therefore, apply his mind to suggest how to use the money. It seems to me pressure should be put on the European countries to reduce wages. Then alone giving of assistance by India will be justified.