A Panorama of the European Crisis

03/02/2011 by

As Europe awaits with bated breath tomorrow’s ‘Comprehensive Solution’ to the European crisis, my good friends and colleagues Riccardo Bellofiore and Joseph Halevi kindly offered the following thoughts on the subject.

There is no such a thing as the Euro crisis independently from the global features of the political economy of the European Union. Today Europe is in the grip of two intertwined crises: one stemming from its exposure to the financial and economic crisis which originated in 2007 in the United States, the other arising from an institutionally engineered stance regarding the state of the public finances of the countries deemed to have an excessive deficit or debt relatively to GDP. The two crises connect via the export oriented bias inherent in the outlook of the developed countries of the Eurozone and of Northern Europe. Since Europe as a whole has been mired in stagnation for at least two decades, net exports are seen as a panacea. Each country, but Britain, Spain, Portugal and Greece who exhibit permanent external deficits,  depending on its export muscle power, aims at a beggar thy neighbor policy and at an extra European trade surplus. In this context, over the last 20 years the exporting countries of the European Union grew  more exposed  to, and dependent on, the United States. The transformation of the United States into a globally importing economy was due to what we have called  a form of privatized financial Keynesianism, following the policies developed by the US Federal Reserve under Alan Greenspan. These enabled the dynamics of effective demand to remain higher than in Europe or Japan, despite falling real weekly earnings in the US,  thanks to asset price inflation leading to easy credit and high personal debt. Now, the European Union has an overall deficit with China and East Asia, although such a deficit impacts differently on Italy and France compared to Germany and Scandinavia. Thus outside the infra-European balances, North America has provided  the most profitable area for net export demand. The export oriented countries like Germany, Scandinavia and Italy, along with France – which aims at being a net exporter but achieves that status only periodically and for short lapses of time – want to keep looking at their neighbors’ markets as external markets, and impose macroeconomic rules preventing any form of coordination which would cancel out the beggar thy neighbor approach. At the same time  France, Germany and the Benelux, in the years between the end of  Bretton Wood in 1971 and the formation of the euro in 1999, rejected infra-European exchange rates variations which, when they occurred, led to competitive devaluations. It is clear that, if infra-European exchange rate variations are eliminated by means of a single currency, the euro, the beggar thy neighbor game falls then on competitive wage deflation and on the budgetary policies of each single country. Within this framework the stronger countries, like Germany and some of its economic allies, wish to keep all the option open for an extra-European export route.

The first type of crisis: from the subprime bubble to the contraction of export demand.

Today Europe  is therefore in the grip of two kind of crises. The collapse of the so-called subprime bubble in the United States, that instantly spread to the British, Swiss, French and German financial systems. In the latter case the banks most seriously affected where the state owned landesbanken whose institutional task is to facilitate the financing of the many small and medium size firms that make up the vast networks of Germany’s industry. Yet given the two decade long stagnation in domestic investment, the landesbanken, spurred also by regulatory changes introduced by the Commission of the European Union,  ended up behaving as pure financial institutions seeking higher future returns in packages of structured portfolios tied, via London houses,  to the US subprime markets.  The US financial crisis cascaded onto the Eurozone countries mostly through the twin impact of the ensuing contraction of credit and of export demand . The drying up of credit affected the domestic economy of every single European country, but it had an immediate and devastating effect on the Spanish economy whose quite substantial dynamics had been based on a prolonged real estate boom and bubble. In the space of few months unemployment shot up from 11% to around 20%. As Spain has always been a major net importer, among the OECD countries the 2nd after the United States, the collapse of its economy dealt a severe, although unacknowledged, blow to the infra-European exports and, thus, to infra-European domestic demand.

The contraction of exports, which in turn cascaded on domestic production, arose from the chain connecting the largest European exporters to each other and to the world. Europe is anything but a single entity, within it there are institutional and structural hierarchies.  On the structural side we have a group of countries with systemic external deficits and countries with systemic surpluses. At the core we have Germany which runs persistent external surpluses. Tied to Germany we have both Eurozone, non Eurozone and non European Union net exporters: The Benelux countries, with Holland being, in per capita terms an even bigger net exporter than Germany,  Austria and Finland belong to the Eurozone. The Czech Republic, a significant repository for German outsourcing in the mechanical, appliances  and automobile industries, is shaping up as belonging to this group although it is not part of the eurozone. Except for Holland , which has a large net surplus with Germany, and in a tiny measure also the Czech Republic, all these countries exhibit a hefty deficit with Germany but an overall net external position. The same thing can be said about Sweden and Denmark which do not belong to the Eurozone. Denmark’s currency is however tied to the euro whereas the Swedish one is not. Switzerland, which is not member of the European Union either, is so enmeshed  with Germany that some of its industrial areas are fully integrated with that country.  Together Austria and Switzerland with a total population of 16 million, i.e. less than Holland’s,  are by far the largest importers of German production. In 2009 despite the crisis the two alpine nations imported from Germany more than France did, a country of 62 million people and the largest single importer from Germany.  For all practical purposes, the Benelux, Switzerland, Austria, the Czech Republic and Scandinavia form within Europe a bloc with Germany because they are linked to it by a dense network of input-output relations. We can therefore see that the bloc of German strictly productive economic power in Europe goes beyond the countries of the eurozone.  A main feature of this bloc is its dynamic relations with China: the sectors and companies that feed their overall net balance of trade position are also net exporters to China. Hence their  deficits with China do not, as yet, affect their global surpluses, but rather reflect a shift of imports away from other countries: essentially, away from North America and from some Southern European countries, Italy and France included.  Yet Italy has a split dimension. Its mechanical and high tech industries, located mostly and the areas from Milan eastward and in the Emilia Romagna region, have been  incorporated into the German bloc as areas of subcontracting activities. Within this framework small, pocket Italian multinationals have been born. A the same time in standardized consumption goods sectors Italy is subjected to a shift away towards China of the imports of the German bloc.

While the credit squeeze, due to the vanishing of asset values tied to evanescent derivatives, fell more or less equally on all the European countries, the cascading effect of the reduction in import demand must be analyzed consistently with the scenario outlined above.  There was a direct fall in exports due the onset of the recession in the United States with all the negative implications regarding the input-output network of the German bloc, including the relevant parts of Italy. This structural and engineering determined contagion mutated, through the cut in investment (output of capital goods industries), into a fall in domestic demand.  Furthermore when, around October 2008, it became evident that the US crisis was real and not just limited to liquidity problems within the financial sector, the future prices of oil and raw materials began to fall steeply, drastically reversing a rising trend dating from 2004. The steepness in the fall of commodity prices was determined by negative expectations regarding China’s growth.  From the last quarter of 2008 to the second of 2009 these were fully confirmed with China’s firms  laying off, without further ado, above 25 million workers. Brazil, a major seller of raw materials to the People’s Republic descended into a deflationary spiral.  As a consequence the German bloc received several blows since it is a supplier of technologies to China and of capital goods to the mining sectors in the countries supplying  raw materials to China. Hence the actual deflation of raw material prices and the massive retrenchments in China strengthened pessimistic expectations thrusting the German bloc into full reverse. It is not by chance however that the very same bloc responded rather quickly as soon as the counter cyclical measures launched  by Beijing began to take effect rekindling also a food, energy and raw materials investment boom in Brazil and other Latin American countries.

The moral of the story is that in Europe there exists a collection of countries tied together structurally, having an extra European outreach characterized by a global export orientated productive capacity  not inferior to that of Japan.  Although for the German bloc , and for Germany in particular, the rest of Europe, still represents the largest market and the largest zone for obtaining net surpluses, the most dynamic  areas for export growth are seen to be in China, Latin America, thanks to China, and in India. Around the German bloc move, in a satellite fashion, the majority of the Eastern European countries belonging to the European Union but not to the Eurozone. It is noteworthy that for Poland, by far the most important of these so that it can be taken as an example, Germany is the largest source of imports, not so much the rest of Europe. Poland’s non German imports originate overwhelmingly from Russia (energy) and China. Indeed Poland’s deficits with Germany, Russia, and China define the overall negative external position of the country’s economy.  Instead non-German Europe is the area where Poland minimizes its tendency towards large trade deficits. The Polish configuration is a proof that the extension to the East of the European Union has been a German affair from the start.  It has not opened up new spaces of net effective demand for the rest of the EU in any significant way while it did so for China, a fact  which is no bother to Germany.

It follows therefore that the German bloc, regardless of the fact that it contains several non Eurozone countries, operates in a rather coherent neomercantilist fashion. It is an oligopolistic  price setter at the world and especially at the European level. It is not particularly interested in the cohesion of the European Union beyond what it deems necessary to avoid a splintering of the European market.  The Eastern European periphery is tied to Germany and its bloc in such a way that it is both an area of industrial outsourcing and of trade surpluses for Germany.  Therefore, the German focused industrial network of the Eastern European periphery does not jeopardize Germany’s objective of maintaining and expanding overall net external surpluses. The crucial preoccupation of Germany is to guarantee the minimally required cohesion of the EU market on the Southern and Western fronts.  France, Italy, Spain, Portugal, and Greece, all within the Eurozone, and the United Kingdom, within the European Union but outside the Eurozone, absorbed even in 2009, the worse crisis year for Germany, over 28% of German total exports, as per United Nations trade statistics (comtrade). More importantly, while in 2009 Germany realized a net world surplus of 211 of whatever units (billion, trillion, etc) of US dollars, with the Western and Southern European countries alone the German surplus was 110 units of dollars. In other words, as a market for the net realization of the profits of its industry France, Italy, Spain, Portugal, Greece and the United Kingdom generated a value which was equal to more than half of the German world total.  These countries represent therefore the real hard core of the German space of net effective demand in Europe and beyond. Looking at them more closely we notice that four of them, the United Kingdom, Spain, Portugal and Greece, have absolutely no chance of jeopardizing competitively the German position. In Britain industry has become ancillary to services and to the financial sectors. It has ceased long ago from being a dynamic factor. It is just a set of data in British GDP. Spain simply does not have the capital goods industry necessary to sustain growth and even to maintain a static economy without relying on industrial imports from Germany. This is even truer for Portugal and Greece. The only two countries in Europe that could challenge Germany’s export oriented drive are France and Italy.

For Germany and the neomercantilist German bloc net exports are vital exactly in the sense understood by Rosa Luxemburg and formulated in an effective demand framework by Michal Kalecki. Net exports are a means to transform output surpluses into capitalist profits, without being constrained by domestic investment demand. The stronger industrially is a country, the more  compelling becomes this need. Ever since the end of the fixed exchange rates regime of Bretton Woods in 1971 up to the early 1990s, Germany’s policies have been directed towards preventing undesired, from the point of view of its leading industries, infra-European currency devaluations.  Bonn aimed at establishing some kind of stable exchange rate regime always with the option of modifying  the rules of game as it happened with the scuttling of the European Monetary System in 1992-93. The creation of the European Monetary Union with the euro as its single currency in 1999 was not wanted by Germany whose capital city was by now located again in Berlin. Yet the euro brought about precisely the end to currency devaluations that were so much feared by Germany, as it learned from the tough experience with Italy’s sharp devaluations in the 1970s and 1990s. And, indeed, the rise and rise of German infra-European surplus, despite overall European stagnation, occurred after 2000-2001. At the same time however, the formation of the single currency eliminated the option of altering the position of the country if conditions were not suitable.

The second type of crisis and its roots

In this new historical and political context the degrees of freedom were sought, through a tug of war with France which always entailed an accommodation between Berlin and Paris relatively to the interests of the other EU countries, in two elements which characterize the opaque institutional set up of the Eurozone and of the European Union as a whole. The first element consists in that the single currency transferred onto wages in relation to productivity, the adjustments that would have otherwise fallen onto the exchange rates. Given the very low growth rates of Europe as a whole and the persistence of mass unemployment, wage deflation, and not even so much in relation to productivity, became the guiding agreed upon principle on which to gain cost advantages. Wage deflation found the wholehearted support of the whole of the Eurozone business leaders. And it was implemented, with Germany being the most successful of the lot. The above is the genuine class basis of the attachment to the euro as a single currency. It has given rise to a race to the bottom from which German business emerged victorious in export terms since, given the vast array of German industrial sectors, they could combine industrial wage deflation with industrial restructuring involving also the outsourcing of basic production lines to the newly acquired industrial periphery of Eastern Europe. Yet class unity over wage deflation is also the concrete which is cementing European business from Portugal to Finland. On everything else the Eurozone is failing because the cementing factor is actually undoing the effective demand basis of the European Union. The second lever,in action till this very day, to obtain freedom to maneuver resides in the way in which the so called Maastricht criteria, enshrined in the Dublin Stability Pact of 1996, are used by the two major powers of the European Union: France and Germany.

It is worth reminding the reader that the criteria entail, for no good reason since no theorem exists showing why should a particular debt or deficit level be taken as a limit, a 60% ceiling on the stock of public debt relatively to GDP and a 3% limit to the budget deficit, also in relation to GDP. In practice there is no mechanism to enforce those criteria, as proven by the behavior of Britain which is a signatory to the Dublin Pact.  However France and Germany made the Eurozone countries, to which, among the traditional capitalist countries of the European Union, neither Britain nor Denmark and Sweden belong, accept the view that the Frankfurt based European Central Bank is the lawful enforcer of the criteria in the name of price stability.  Shortly after  the European Monetary Union came into being those criteria started to unravel because the export and employment prospects of Germany and France worsened as a consequence of the US recession of 2000-2001. By the end of 2002 Paris and Berlin agreed not to respect those criteria thereby allowing their public deficits to expand. The ECB obliged. Austria and Holland, two countries of the German bloc,  actually voiced their protest arguing that they have put their population through social and economic sacrifices for nothing. But they were told to shut up and put up with the Franco-German decision. This episode is relevant in the light of what was to come few years later.

In 2005 the criteria were amended and stretched out in a rather convoluted way in order to meet the new objectives of France and Germany. But by 2007 Germany’s net exports were booming and both the Bundestag (parliament) and the Berlin government raised the need to reenter within the Maastricht criteria, thereby catching France off guard. However  when the financial crisis in the United States turned onto the real economy causing a sharp decline of Germany’s net exports, Berlin quickly relaxed its fiscal policies both for automatic reasons and in order to save the banks and help the restructuring of firms.  Thus  from 2008 to 2010 Germany has been among the Eurozone countries with the highest rate of growth of its public deficit, rising from near zero percent of GDP to about 5%. At the beginning of the Fall of 2009 a new twist occurred in the German stance stimulated by a faster than expected rise in exports especially towards Asia and Latin America.  Business leaders and the Berlin government became convinced that Germany can escape the recession and the European crisis by intensifying its world export capacity tying it increasingly to China’s growth. Sweden and Finland are already on that route quite effectively, not in terms of lower unemployment but certainly in terms of profitable outlets. Given the interindustry relations within the German bloc, the acceleration of the extra-European trade path by Germany entails a similar process for Austria, Switzerland and North East Italy. Against such background the German government, also prompted by an ideologically conservative vote of the Bundestag to attain a structural balanced budget by 2016, reversed to an absolutely tight fiscal policy throughout the Eurozone and especially towards the most exposed countries. These are the roots of the so-called fiscal crisis of Greece, Spain, Ireland and Portugal, on which much has been written.

The Euro cannot cope

On the basis of the above narrative any attempt to assign to the European Monetary Union a fully fledged institutional role is pure idealism. The EMU is not a German invention but rather a French one. Also the notion of tight fiscal rules comes from France as way to slowly, but surely, disenfranchise the population from the social acquisitions obtained since the end of the WW2.  The strategy of president Mitterrand was purely political. Internally the aim, successfully attained, was to achieve wage deflation as to kill or render ineffectual the labor movement. Mitterrand’s objectives towards France were no different from the declaration of Margaret Thatcher regarding the elimination of socialism from British politics. In France it meant weakening the Communist Party and the trade union CGT. At the European level the objectives were remarkably similar to those of the peace of Westphalia at the end if the 30 year war, which saw France emerging as the European hegemon. And, indeed, it is not at all by chance that from the Mitterrand circles the Maastricht Treaty has been defined as a direct successor to that of Westphalia. The European construction, as French officials call it, is nothing but a tug of war between two opposing strategies. One hand we have France, who wishes Europe to be the domain of its bureaucratic capitalist class, including the powerful military industrial complex. The economic element intervenes in that the construction of Europe – not a united Europe, French leaders never said that, but only la construction de l’Europe – must free France’s capital from (a) the weaknesses in the balance of payments, which were viewed as stemming from uncompetitive too high wage demands, and (b) from its second tier position relatively to German capital. Not for one moment have the French leaders thought that the European Central Bank had to be empowered in the same way as the Banque de France is. La construction européenne  means therefore exercising an institutional control within Europe in relation to Germany. On the other hand we have Germany, whose strategy is quite straightforward and dates back to Bismarck: to make sure that Europe is the safest area of realization for German production. It is therefore an institutional strategy of economic oligopolistic hegemony. Thus for Germany too the ECB must only reflect the light coming from the Bundesbank. It follows that both Paris and Berlin agree, for different reasons, that the ECB must of be purely a front institution of the Banque de France and of the Bundesbank when they strike a compromise usually after direct talks between the President of the Republic and the Chancellor.

Several commentators from the left, such as the association representing in Brussels the European Trade Unions, as well as from the centre-right, such as Ministers Juncker and Tremonti, respectively from Luxemburg and Italy, have proposed the creation of European bonds to address the issue of the sharing and weighting of European public debt. Whatever the technical merits of these proposals the fact remains that the whole system of treaties is based on ascribing to the individual countries the responsibilities of the debt and of the fiscal deficit. In common the European Union countries have only the disciplinary rules.  Several years ago the Committee headed by the former French President Valéry Giscard d’Estaing charged to draft the text of the European constitution went to great length to formulate an intractable text the essence of which is the following. Europe should be made into a common playing field for the oligopolistic corporations. Yet as to fiscal balances and social policies, the responsibility legally falls entirely on every single state and it is not shared by the others. Although the constitution has been rejected in the referenda held in France and Holland, the text has been largely embodied into the Lisbon treaty which acts as the final legal text of the European Union.

The road to a fiscal integration of Europe is thus barred by its very institutional set up. The transformation of even a tranche of national bonds into Eurobonds would be a legal and  constitutional nightmare unless the treaties are radically amended. A very long process in itself considering that the transition from the Nice Treaty of 2000 to the Lisbon Treaty of January 2010 took 10 years.  What remain are the systemic fallacies of composition which underpin the so-called European construction. These are (1) the psychopolitical denial, dictated by a microricardian view of class interests, that competitive wage deflation is even worse than competitive devaluations since it sinks the bulk of effective demand in the whole Eurozone, (2) the fact that budget austerity makes the fiscal position of the countries involved worse as it reduces income and tax revenues, (3) that the European economies together are too big to expect the rest of the world to lift them up by means of Bismarckian exports.  However it seems that there is very little awareness of these  issues even among the forces that should be more interested in wages, employment and social expenditure.


  1. Riccardo Bellofiore would like to thank the laboratoire UMR 5206 Triangle. Action, discours, pensée politique et économique in Lyon and the University of Lyon 2 for having hosted him while working at this paper.
  2. This paper ss an excerpt of the authors’ contribution to the forthcoming volume by  Ozlem Onaran, Torsten Niechoj, Engelbert Stockhammer, Achim Truger, and Till van Treeck (eds), Stabilising an unequal economy? Public debt, financial regulation, and income distribution, Metropolis Verlag, Marburg, Germany, 2011.
  3. Riccardo Bellofiore is Professor of Political Economy, ‘Hyman P. Minsky’ Department of Economics, University of Bergamo, Italy, and Research Associate in the History and Methodology of Economics Group at the Faculty of Economics and Econometrics, University of Amsterdam, The Netherlands. Joseph Halevi teaches at the University of Sydney in Australia and at the International University College in Turin, Italy.
  4. Joseph Halevi is Senior lecturer in Political Economy at the University of Sydney and Professor at the Turin International University College. He would like to thank UADPhilEcon, the University of Athens Doctoral Program in Economics for having hosted  him during January 2011 thereby  providing material and logistical support for completing the final revision of the paper.
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