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Recovering, Restructuring, and Rebalancing. Oh My!
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Recovering, Restructuring, and Rebalancing. Oh My!

Let’s Learn from the Latest Sovereign Debt Crisis

The crisis in Greece underscores the many ways the global economy needs to be restructured, writes Sabina Dewan.

A machine counts euro bank notes at a bank in Dresden, Germany. As the euro falls in value it increases the competitiveness of European exports relative to ours. (AP/Matthias Rietschel)
A machine counts euro bank notes at a bank in Dresden, Germany. As the euro falls in value it increases the competitiveness of European exports relative to ours. (AP/Matthias Rietschel)

In yet another example of how small our world really is, the crisis emanating from a little country like Greece is rocking the global economic system. Fear that a Greek default on its sovereign debt could upset a fragile global economic recovery is fueling panic. All of this turmoil once again underscores the need to restructure the global economy—and this time for real.

But what does "restructuring the global economy" mean? And how can it be done? The global economy is a patchwork of imbalances in need of equilibrium. In a nutshell, restructuring the global economy requires the following:

  • The euro zone needs to reassess its strict monetary policy and its criteria for entry into the European monetary union.
  • The global engine of economic growth ought to be driven by domestic demand rather than export-oriented growth in Europe as well as in the emerging economies of Asia and Latin America.
  • American consumers cannot remain the engine of global economic growth because Americans needs to save more while citizens in other countries need to save less.
  • Efforts to help developing nations achieve stronger, sustainable economic growth so they can enter the ranks of emerging economies over time must start with building stronger government and social institutions that create the conditions for a wider sharing of the benefits of growth and greater domestic prosperity.

Let’s look at each of these points in turn. 

The euro zone’s monetary policies 

The 16 members of the European Union now using the euro as their currency range from powerful export-oriented economies such as Germany ($3.6 trillion in exports in 2008; $3.3 trillion in 2007) to the Mediterranean islands of Cyprus ($24.9 billion in 2008; $21.4 billion in 2007) and Malta ($7.4 billion in 2007). While the euro zone countries are subject to a tight monetary policy that is the responsibility of the European Central Bank, they do not have a strictly common fiscal policy.

There are certain convergence criteria for government finances to maintain some evenness across the 16 euro zone nations, but the experience with Greece has called these criteria into question. Currently, criteria for membership include having government deficits that do not exceed 3 percent of gross domestic product, and gross government debt that must not exceed 60 percent of GDP. Inflation rates should not be higher than 1.5 percentage points more than the average of the three member states of the European Union that have the lowest inflation over the previous year.

Joining the euro zone meant that smaller and less wealthy countries such as Greece would be able to borrow, draw enough capital, and spread risk to join the ranks of the wealthy European nations. In theory, the euro zone could be seen as a good model for balance and price stability, but in order to be part of the club and meet the eligibility criteria, Greece cooked their books. And what’s worse is that until recently, nobody noticed.

In 2009 Greece faced a real budget deficit of approximately 14 percent of its GDP, and its debt stood at approximately 120 percent of GDP. It does not have the option of devaluing its currency to bolster its exports or to decrease the value of its debt. Meanwhile export-oriented economies such as Germany benefit from a falling euro, but are having to bailout Greece to help manage the euro zone’s and the Greek economy’s fiscal imbalances.

Alarm that the situation in Greece could lead to a run on the debt of other euro zone countries such as Spain, Portugal, and Ireland, which are not in as bad shape as Greece, sparked the European Union’s $1 trillion rescue package. And talk of restructuring Greece’s debt is prompting European banks to consider tightening their lending while skittish investors are contributing to wild fluctuations in global markets.

This Greek tragedy inevitably calls on Brussels to reassess its strict monetary policy and its criteria for entry into the club. 

Domestic demand driving economic growth 

As the euro falls in value, it increases the competitiveness of European exports relative to ours. And as contagion shocks our economy American consumers could retrench, with consumer spending declining sharply (just as it did during the first wave of the recent economic crisis). Such a development would reverberate across Asia and Latin America, where exporting to the United States drives much of their economic growth.

The economic crisis has made apparent that it is no longer sustainable for American consumers to spend beyond their means. And our nation’s large trade deficit ($706 billion in 2008, $420 billion in 2009) is indicative of our domestic savings imbalances.

Bringing these import and export factors into balance means improving upon our domestic weaknesses but also encouraging citizens through appropriate government policies in emerging countries to become consumers of their own products as well as consumers of ours. This means shifting from a model of export-oriented growth to one that is driven by domestic consumption. This will inevitably be difficult since the export-oriented model of growth arguably has an enviable track record for spurring economic growth and development. But as the first wave of the economic contagion highlighted, the current way of doing things is unsustainable.

An initial step to bring this disequilibrium into better balance would be to encourage governments in emerging economies to create the social safety nets and worker protection institutions needed so that a greater number of people can partake in a growing economic pie and move into the ranks of the middle class with the capability to consume. One step by China exemplifies what needs to be done. Beijing’s $124 billion health care reform plan announced in 2009 is partly intended to improve household financial security that will help promote consumer spending. 

Helping the world’s newly developing economies 

Finally, restructuring and rebalancing the global economy necessitates assistance to developing countries to help them move up along the economic development trajectory more swiftly. But this must be done by enhancing the capacity of these countries to develop, implement, and maintain their own government and social institutions that help drive a sustainable development process and take ownership of them.

The United States acted quickly and effectively to provide humanitarian aid in the aftermath of the Haitian earthquake. But as President Barack Obama noted, the United States together with the international community “can ensure that assistance not simply delivers relief for the short term, but builds up Haiti’s capacity to deliver basic services and provide for the Haitian people over the long term.”

There is a lot to be done. Each of these brief recommendations requires a whole host of policy measures to be implemented at regional and national levels. And who should assume responsibility for overseeing the rebalancing the global economy? At this juncture, our best bet is the leaders of the Group of 20 developed and rapidly developing nations. The United States can and should play a major role in strengthening this institution and helping it evolve as an ongoing forum for global governance, but other developed and developing nations, particularly China, India, and Brazil must also step up to the plate.

At the upcoming G-20 meetings in June 2010 and then in November 2010, the G-20 leaders should take stock of the measures that the countries are taking to rebalance their respective economies to help rebuild a more harmonious, balanced, and stable economic system. There is now a system in place to address these interconnected global issues. It’s time for the participants to engage on these issues seriously and swiftly.

See also:

Sabina Dewan is Associate Director of International Economic Policy at the Center for American Progress. To read more of our analysis and and policy recommendations in this arena go to the Global Economy page of our website.

The positions of American Progress, and our policy experts, are independent, and the findings and conclusions presented are those of American Progress alone. A full list of supporters is available here. American Progress would like to acknowledge the many generous supporters who make our work possible.

Authors

Sabina Dewan

Senior Fellow

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