Eurozone needs structural expansion policy

Although being stimulated by all means, the eurozone economy has not shown any sign of recovery. On the contrary, manufacturing shrank for the first time in the past two years, while the latest Purchasing Managers Index, an indicator of the economic health of the manufacturing sector, also fell below 50, the lowest since 2009, and a sign of contraction.

Considering the situation, ratings agency Standard & Poor's has issued warnings about a possible second wave of recession.

The global economy is not faring much better. According to Martin Wolf, chief economics commentator at the Financial Times, we are entering "the second great contraction" the Great Depression of the 1930s being the first. If history repeats itself, a long recession means stocks collapse, consumption declines, unemployment rises and social turmoil is possible.

The excessively tight eurozone policies are partly responsible for this grim situation. To cut deficits, one European country after another has resorted to tightening measures such as cutting welfare spending, raising taxes and reducing staff. The European Central Bank (ECB) also joined in by raising benchmark interest rates in April and July.

The tightening policy by itself is not to blame, but it is being overdone and universally implemented, such as in some relatively rich countries like Germany and the Netherlands. This has hurt the long-term driving force of growth and thus the eurozone's economic prospects. Now, with willingness to consume and invest in decline, and investors fleeing to the US, the eurozone faces uncertain recovery.

Errors are inevitable in setting economic policies, but when a policy is proven ineffective in helping an economy out of a recession, it must be altered. That is the situation in the eurozone today. Most of the moves meant to cope with debt crisis rely on the economic recovery of Europe and the world, but the global economy is in deep recession and cannot recover in the short term.

Eurozone countries should shift from tightening to stimulus policies involving structural expansion, which would further promote the political sense of European integration. In other words, member states enjoying relatively better economic conditions, such as Germany, the Netherlands and Finland, must be united with their Greek and Portuguese brothers in their hour of difficulty.

With better economic foundations, these rich members of the euro club have more financial policy options. For example, Germany has already lowered its budget deficit to 3 percent, two years earlier than required by the Maastricht Treaty, which created the European Union. Because the eurozone needs them to counterbalance the tightening policies of poorer members like Greece and Portugal, Germany and other richer members should suspend their tightening plans and establish positive policies, like cutting taxes, to awaken the economy. Member states hit by the crisis, namely Greece, Ireland and Portugal, should continue cutting deficits and provide guarantees for assistance funds.

Another important cause for Europe's crisis is that the ECB hesitated to act as a lender of last resort. Its limited help in purchasing bonds from member states was even suspended once this year, which has hurt investors' confidence. Now is the time for the ECB to perform its role.

Numerous economic data and facts show that the eurozone needs much more than maintaining basic interest rates; it needs to lower them and provide further support for banks in member states in their efforts to increase reserves. That is because banks are more relied upon in Europe than in US, and a crisis among them would be fatal to the European continent and affect the whole world.

From Aug 1 to 22, stock prices for European banks fell by 22 percent. Indeed, the Royal Bank of Scotland and Socit Gnrale of France fell 45 and 39 percent, respectively. A crisis is inevitable if the trend continues, and the ECB must make effort to prevent this.

History teaches us that hesitation only makes a crisis worse. It is time for the eurozone to act with decisiveness and efficiency. Germany and other member states enjoying better economic foundations need to make larger contributions even sacrifices if necessary to propel reforms forward. That would require political wisdom and courage, and we hope the old, noble European spirit that has many times helped the continent cope with difficulties will once again come to the rescue.

The author has a PhD from China Institute of Contemporary International Relations.

(China Daily 09/29/2011 page8)