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What can the Eurozone learn from Eastern Europe's transformation?, London

29 Aug 2012

Open Europe hosted a lunchtime discussion entitled “What can the eurozone learn from Eastern Europe’s transformation?”, with a keynote speech from Professor Leszek Balcerowicz of the Warsaw School of Economics, formerly Governor of the Polish Central Bank, and also former Deputy Prime Minister and Finance Minister on two separate occasions.

To view Professor Balcerowicz's presentation click here.

Professor Balcerowicz identified two different types of crises affecting the eurozone’s weaker countries. The first, a ‘financial-fiscal crisis’, breaks out when excess cheap credit feeds economic bubbles, which eventually leads to worsening public debt and deficits, such as in Spain. The second, a ‘fiscal-financial crisis’, is caused by reckless government spending, which in turn has negative spill-over effects for the financial sector – primarily because national banks tend to buy the largest amounts of government debt. This was observed, among others, in Greece.

He stressed that, with the exception of Finland, “no country in the eurozone respects the Maastricht criteria” on limiting public debt and deficits. On the other hand, countries outside the eurozone are in a better fiscal position. In particular, he noted that Poland introduced a constitutional “debt brake” in 1997 – before even Germany adopted its Schuldenbremse.

Professor Balcerowicz used the example of Eastern European countries to show that it is possible to get out of recession through structural reforms, contrasting the policies adopted by the so-called BELL group (Bulgaria, Estonia, Latvia and Lithuania) with those of the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain). However, he argued that the current debate on how to solve the eurozone crisis was “hugely biased” in favour of bailouts, with their proponents adopting an apocalyptic rhetoric, while it was “very fashionable” to demonise internal devaluation.

Professor Balcerowicz argued that, “If you have a lot of money, then incentives to reform are weaker… many politicians prefer taking the easy money and putting off painful reforms.” In particular, he challenged the assertion that “structural reforms only pay off in the long run”, arguing that such reforms also generate short-term “confidence effects” on the markets. He also strongly warned against the ECB becoming the eurozone’s “lender of last resort”, adding that the consequences of ECB purchases of eurozone government bonds – moral hazard, inflation, loss of trust in the ECB, and so forth – make them an “even worse” option than bailouts. He also added that the models used by central banks to forecast the effects of quantitative easing policies often failed to take into account their potential negative side effects.

Professor Balcerowicz concluded that while there is nothing inevitable about a break-up of the eurozone, there was “no European solution to Italian or Spanish problems, but there are Italian solutions to Italian problems and Spanish solutions to Spanish problems.” He warned that “trying to rush the process more political integration [within the eurozone] will backfire.” Therefore, instead of dreaming of an “unrealistic” federal state, eurozone politicians should try to put in place the two conditions to make a monetary union function – fiscal discipline and flexible labour markets. Finally, he also criticised the effects of EU social and employment legislation on growth, and argued that while EU-financed infrastructure spending – given appropriate project selection – could be beneficial, the current system of involving all regions in all member states needed to be reformed.  

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