The problems in Spain cannot be denied any longer. In fact, the crisis that hit the Eurozone is something that cannot be hidden.

Since the credit crisis that began in the U.S. a few years ago, countries and their banks have fallen like trees, showing black holes that had been hiding for years, as well as very bad practices that did nothing but make what was already a big problem worse.

Now that the complete rescue is about to come to Spain– the first one was only for the banks, although it counts as government debt– many authors and writers of Spanish newspapers question the competence of the European Central Bank (ECB), and wonder what prevents the ECB from saving us from total disaster by buying public debt of states that are worse off. In these writers’ speeches they explain that the ECB should act as the International Monetary Fund (IMF), and provide financial resources to those who need it.

Are they wrong asking for this? Absolutely. The answer to the question of why the ECB does not act as the IMF is this one: because they are not the same. Despite the fact that, apparently, both agencies have similarities, the truth is the objectives for which they were created are completely different in each one, and the way they respond is not the same. That is why it is advisable to make a couple of clarifications on the differences between the two entities, in order to understand why the ECB is not a “European IMF.” It was not intended to be one.

The IMF was created in a completely different context, when the consequences of the Great Depression could be still felt. Its creation reflected the attempt of several countries to avoid repeating the disastrous measures that weakened economic activity during those years.

Meanwhile, the ECB, successor to the European Monetary Institute, was created in 1998, but it did not make full use of its powers until the entry of the euro in 1999. The creation, established in the Maastricht Treaty, responded first to the oversight of the transition of member countries from their national currencies to the euro and, second,  the need for the existence of a bank for this currency.

With these completely different contexts it is logical that the objectives of both entities are not the same. Thus, the main function of the IMF is to oversee the smooth running of international economic policy, and to encourage it, acting as a fund where countries can ask for help when they need temporary financing.

However, the main objective of the ECB is to maintain the price stability in the euro area by maintaining the inflation at low levels, leaving other objectives subordinates to this first and foremost. Broadly speaking, it seems that we can define the IMF as a fund that lends money to countries who need it, and the ECB as that one who ensures the proper functioning of the Eurozone. So, the role of the first one is active, while the second one’s role is rather passive.

Now the big question is: if the euro is not working properly and there is a risk of its disappearance, can the ECB not protect it through the purchase of public debt? The answer is, again, no. Why? Because of the statutes which regulate it.

Since it was created, the ECB defined itself as completely independent from the member countries of the Eurozone– which has been questioned in recent years, especially by the suspect origin of the last directors of the ECB– and the measures should not respond to the national interests of any country. In the same way, the European institutions and national governments are required to respect this independence, and this means that there is no mechanism by which a member state may compel the ECB to act in one way or another.

This is the main reason why the ECB cannot rescue any Eurozone country. Besides this, there is another powerful reason that we forget sometimes: the conditions for being a member of the Eurozone are strict. It is not enough to wish to adopt the currency, there are steps to follow before completing the transition.

The ECB is responsible for safeguarding the proper functioning of the euro because it assumes that other institutions– created for that purpose– have been responsible for verifying that the candidates have the specific requirements for entry. If someone has not, whose fault is it then?

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New York, U.S.A. — Amid continued economic, financial, and political turmoil, several E.U. countries are seeing improvement in a crucial measure of competitiveness. According to a new Executive Action Report from The Conference Board, the cost of labor per unit of output has fallen significantly in a number of the hardest-hit economies, led by Ireland and Eastern Europe.

For the Euro Area, controlling unit labor cost (ULC) — defined as nominal labor compensation per unit of real output —may be key to redressing the competitive unbalance between core and periphery that has haunted a continent and fueled four years of recurring crisis.

“A drop in unit labor cost is an important sign of the beginning of adjustments in Europe’s most trouble economies,” said Bart van Ark, The Conference Board Chief Economist and co-author of the report. “For now it is mainly the reduction in wages which leads the adjustments, but once productivity begins to increase as well, it could be the key to a more sustainable recovery.”

Since states within the Euro Area cannot devalue their currencies or dictate interest rates, boosting ULC and, thus, competitiveness relative to other members of the zone can only come about through real changes in worker efficiency,” he adds.

There are early signs that the rebalancing through unit labor cost adjustments is under way. While France, Germany, Austria, and other relatively strong continental economies have pursued social welfare policies to limit unemployment during the downturn — thereby reducing productivity and increasing unit labor costs — countries with more flexible labor markets in the “Anglo-Saxon” model have been able to make faster adjustments.

Ireland lowered its ULC by 5.3 percent between 2008 and 2011, a success only rivaled by less mature Eastern European countries such as Hungary, Latvia, and Lithuania, which still retain their own currencies. Elsewhere outside the Euro Area, ULC in the U.K. has fallen by 3.6 percent — the sharpest decline of any large economy.

In the most troubled European economies of Greece, Portugal, and Italy, a tradition of rigid labor markets kept unit labor costs rising through the early years of the crisis. Continued weakness and deepening austerity measures, however, have recently pushed them towards turning points suggesting a strong reduction in costs and faster efficiency gains compared to the Euro Area’s northern core.

In Greece, ULC rose by 4.4 percent overall between 2008 and 2011, but fell by more than 5 percent from 2010 to 2011. With its large contingent of flexible part-time workers, Spain is further along; Spanish ULC fell 4.4 percent between 2008 and 2011. Across the Euro Area, unit labor costs in manufacturing have fallen by 3.9 percent in the past two years, after rising at the outset of the crisis.

Because of the rapid shifts in unit labor cost in recent years, the German manufacturing sector has become less competitive in terms of cost per unit of output relative to the manufacturing in many other European economies — again, led by Ireland, Eastern Europe, and the United Kingdom. Dramatic reductions in workforce and compensation have propelled British firms ahead of formerly more cost-competitive French, German, and Italian rivals. Meanwhile, Ireland is now Europe’s most efficient manufacturing economy by far, ahead of even low-wage off-shoring destinations like Poland.

In contrast to manufacturing, the service sector — which is more labor-intensive with output largely composed of non-tradables — remains a weak performer across Europe. Only Spain and the United Kingdom have managed to substantially lower unit labor costs in the services sector. With output falling faster than workforce or wages can be cut, Germany, France, Greece, and Ireland all saw significant ULC increases in services. The remarkable 41.5 percent decline in Irish ULC for manufacturing was largely offset by a 26.4 percent ULC increase in services.

Given the significant private and public sacrifices needed to bring down unit labor costs against an over-strong currency, an exit from the Euro Area altogether has become a tempting option for the most troubled economies. To test the consequences of a Euro Area exit, The Conference Board modeled the impact that regaining a national currency — and independent monetary policy — would have on unit labor costs in a country like Greece compared with alternative scenarios.

“The huge devaluation following an exit from the Euro Area would certainly boost competitiveness in the first year or two,” said Bert Colijn, labor market economist for The Conference Board Europe and co-author of the report. “But these effects would quickly evaporate, as the subsequent recovery in labor compensation in the medium- to long-term outpaces GDP growth. Hollowing out labor costs can only do so much. Lasting competitiveness gains must ultimately come from the productivity side of the unit cost labor equation.”

“For this reason, we found that neither a troubled economy nor the Euro Area as a whole is likely to benefit in the long run from a unilateral exit, or a wider breakup, or the status quo of muddling through,” says Colijn. “Ultimately, the best outcome for competitiveness is achieved with greater fiscal integration, including a banking union and Eurobonds, that will encourage the sort of investment needed for productivity, innovation, and competitiveness that is substantive and sustainable.”

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From the year 2007 to 2011, the global economic system as a whole learned some of its toughest lessons and faced the hardest of times since the great depression of the 1930s. All of this started with irregularities in the US housing market and following credit crunch; then came the demise of Lehman and the chaos in the financial markets which triggered the global downfall in the growth rate, literally acting as fuel for a global recession.

This crisis was transported through various channels across the globe, creating a situation very close to the great depression where the pace of growth actually faded dramatically, where trade stumbled, financial markets dried out, and of course global unemployment bloomed.

A conceptual analysis of the empirical evidence from the period between 2007 to 2011 presents two broad cases of distinction. In the first case we were struggling to put the US economy back on track with the help of financial bailouts to corporations and financial institutions. In the second case we found that international institutions are providing a series of bailouts, creating a firewall against default by some countries in the Eurozone.

Death by Debt

Rapid, large scale accumulation of public debt poses a repugnant and most grievous threat to a national economy because it paralyses the eligibility of a country to secure any assistance in the future by the international community. It is nothing but financial death for a nation because it kills the natural basis of the financial system. The banking industry may collapse, lowering the value of domestic currency, causing irreparable damage to banks invested in the sovereign debt of the defaulting nation and worsening the potential global credit crunch.

Today economies, markets, and institutions are so interconnected and interwoven that any event or activity that can trigger a potential negative extreme, will have a direct and strong impact on other economies. For example, a drastic increase in public spending in China will probably increase demand for natural resources in Australia — and many more sophisticated illustrations can be easily found.

Bailouts and Future

How far can we really rely on bailouts? It all depends on how much we are prepared to mend the gaps between revenues and expenditure in government finances. In simple words, bailouts provided to any country does not mean that fiscal disparities are eliminated. In fact, bailouts often only act as the respirator of an ailing economy at its death bed.

In the case of the Eurozone debt, with the complications and assistance extended by the International Monetary Fund (IMF), it is a matter of diplomatic dynamics and not a real resolution that can be relied upon in the future.

IMF and other global economic and financial intuitions should draft a policy recommendation that virtually limits any reliance or mere assurance of a bailout by other nations in the future.

Image Courtesy of    DoraBakoyannis

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