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May 2013

The EuroFuture Project

Paper Series
Better to Suffer Inside the Eurozone
For the South, Europe is Still the Solution
by Andrs Ortega

Summary: For Southern Europe, integration into an ever-deepening European Union has historically gone hand-inhand with democratization and economic modernization. While the euro crisis and the policies of austerity, seen as imposed prescriptions, are undermining the pro-European stance of Southern European societies, in spite of all of the associated shortcomings and suffering, there is still a high level of support for the euro and the permanence of the Economic and Monetary Union (EMU) among Southern Europeans. A euro exit would have tremendous costs for these countries and their societies, particularly for the middle classes. People, governments, and businesses across Southern Europe have concluded that even if it is cold inside the eurozone, it might be freezing outside.

1744 R Street NW Washington, DC 20009 T 1 202 683 2650 F 1 202 265 1662 E info@gmfus.org

Introduction For Southern Europe, integration into an ever-deepening European Union has historically gone hand-in-hand with democratization and economic modernization. Spain is the problem, and Europe the solution, the Spanish philosopher Jos Ortega y Gasset famously wrote in 1910, a dictum that could have been be applied to Italy (and Germany) after World War II and to Greece, Portugal, and Spain with the end of the dictatorships in the 1970s. But is it still applicable to the region today? The euro crisis and the policies of austerity, seen as imposed prescriptions, are undermining the pro-European stance of Southern European societies. But, in spite of all of the associated shortcomings and suffering, there is still a high level of support for the euro and the permanence of the Economic and Monetary Union (EMU) among Southern Europeans. A euro exit would have tremendous costs for these countries and their societies, particularly for the middle classes. People, governments, and businesses across Southern Europe have concluded that even if it is cold inside the eurozone, it might be freezing outside.

Divergence Machine For the Southern European countries, and especially for Spain, the story until 2008 was one of success, characterized by a convergence in terms of real GDP per capita with the core countries of the EU, in part due to transfers through European cohesion funds. Underneath the surface, however, there was a growing divergence in terms of productivity, competitiveness, and current account balances, due to a number of factors. Although not as visible during the boom years, integration into the EMU did not produce real convergence, but rather resulted in a divergence between North and South, core and peripheral economies. At first glance, the euro appeared to be a great leveler when in fact the divergence resulting from the single currency proved to be unsustainable. Low interest rates that came with the introduction of the euro were initially perceived as a bonus, but they became a curse as they fuelled housing bubbles in Spain and other countries. They also led to the private accumulation of debt during the boom, resulting in negative consequences for public finances following the bust and the resulting bank bail outs. While Spain and Greece thrived during those first years of the euro

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and Cyprus flourished as an offshore financial center, the same could not be said of Portugal, which did not experience significant growth, nor of Italy, which remained mired in seemingly permanent economic difficulties. This supposed convergence machine has now brutally stopped in the Southern part of the EU and has moved into reverse in Greece, Portugal, and Spain, with little chance of short-term improvement. Italy, meanwhile, has been falling behind since the early 1990s,1 according to a Bruegel report by Zsolt Darwas and Jean Pisani-Ferry. Darwas and Pisani-Ferry note that peripheral countries real exchange rates diverged by between 20 to 40 percent compared to that of Germany,2 and current account positions in deficit countries reached 10 percent of GDP in 2008.3 The introduction of austerity policies was perceived to be imposed from Berlin, Brussels, and the markets. These policies, combined with the 2010 banking crisis, the bail-outs for Greece in 2010 and Portugal in 2011, and the assistance to Spains financial sector in 2012, further exacerbated the situation. The convergence in living standards came to a sudden, even brutal, end without a sign of recovery on the horizon. In addition, while the difference in interest rates charged on sovereign debt was very low at the start of the EMU, by 2013, Germany was at times financing itself at negative interest rates, while Spain and Italy each faced interest rates of over 5 percent.4 Significantly, Greece and Portugal did not even have access to the markets. The problems of these countries led to another kind of divergence, one that is more political in nature and that has a bearing on the future of the European project: a divide not only between creditor and debtor countries, but between decision-makers and decision-takers5 in the EU, and in particular in the eurozone, that could impinge
1 Z. Darvas and J. Pisani-Ferry, Europes Growth Emergency, Bruegel, October 21, 2011, http://www.bruegel.org/fileadmin/bruegel_files/Events/Event_materials/110927_Papers/3Darvas_Pisani-Ferry.pdf, p. 2. 2 Ibid, p. 19. 3 Ibid, p. 12. 4 Country Risk Premium: Spain, http://countryeconomy.com/risk-premium/spain. 5 I. Molina, After bottoming out: A new European policy for Spain, Real Instituto Elcano, April 29, 2013, http://www.realinstitutoelcano.org/wps/portal/rielcano_eng/ Content?WCM_GLOBAL_CONTEXT=/elcano/elcano_in/zonas_in/europe/ari8-2013-molina-politica-europea-spain/?utm_source=newsletter158&utm_medium=email&utm_ campaign=may2013.

on the support for democracy as national governments and parliaments lose relevance. In other words, there is an increasing tension between those who lend money (less and less so as the case of Cyprus has shown) and make decisions, and those who receive bailout funds and obey the formers instructions. The only positive convergence brought on by the crisis and the internal devaluation (mainly in salaries) that became inevitable in the monetary union could be observed in Spain in the important realm of labor unit costs, which dropped by 5.1 percent from the end of 2007 to the end of 2012, while growing by 3.1 percent on average in the euro area during the same period of time.6 The reduction in labor unit cost has also created confidence that has lead to increased direct investments in Spain. It has allowed the country to improve its current account balance.

There is an increasing tension between those who lend money and make decisions, and those who receive bailout funds and obey the formers instructions.
More Europe, Fewer Europeans There is also an observable divergence in public opinion. The Southern European societies, in particular Portugal, Spain, and Greece, are the most demoralized in the EU. The lack of confidence in politics and democracy a general trend in the EU as a whole is growing at an alarming pace in the region. Thus, in Spain, the latest Eurobarometer (the regular opinion poll conducted by the European Commission) from autumn 2012 shows that 91 percent of Spaniards do not trust political parties (compared to 84 percent in 2011; EU average 80 percent), and 86 percent do not trust government.7 The support for the main institutions has been diminishing very quickly. The same trend is
6 J. Diaz, Los costes laborales espaoles, los que ms bajan de la UE, Expansin.com, February 28, 2013, http://www.expansion.com/2013/02/28/economia/1362074175. html. 7 Key Indicator Results for Spain, Eurobarometer Autumn 2012, http://ec.europa.eu/ public_opinion/archives/eb/eb78/eb78_fact_es_en.pdf, p. 2.

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present all over Europe, but is more acute in the Southern region.8 The support in Italy for Beppe Grillo and his Five-Star Movement, not a party in the traditional sense, which placed third in the recent Italian elections, has been interpreted as a vote against the euro. However, this interpretation is too simplistic, even though Grillo himself has asked for a referendum on the single currency in his country. According to a poll published by Il Corriere della Sera, 69 percent of Italians think a referendum on Italys euro membership would be a negative thing.9 If the referendum were to take place, 74 percent of Italians would vote to stay in the euro including 73 percent of Five-Star Movement voters with only 16 percent in favor of leaving the euro.10 In spite of the loss of confidence in the EU, Italians want more, not less, Europe. But that also means that more integration has to go hand-in-hand with more solidarity.

Furthermore, Spanish mistrust in the EU has grown to 72 percent, 10 points more than a year earlier.11 But it is significant that 67 percent12 support the idea of staying in the euro. Such seemingly contradictory positions partially stem from the fact that citizens mistrust their own national institutions even more than the EU. This phenomenon also explains why those countries were among the most proEuropean in the EU before the crisis. Now, however, there appears to be a growing negative consensus on Europe in these societies. There is room to recover public trust in Europe if the EU manages to successfully overcome the crisis, and to avoid repeating what happened in Cyprus in early 2013. Paradoxically, for those countries that have suffered the most from the euro crisis, the euro might serve as the framework for recovery of their faith in Europe. The support for the euro is strong, as the latest report from the Pew Research Survey shows,13 but it is the overall trust in the EU that is slipping. If these countries see that the EMU progresses towards a real banking, fiscal, and economic union, and the EU does more to fight unemployment, especially youth unemployment, then Europe will be seen again as part of the solution to their national problems. Yet, for the moment, there is a clear deterioration of support toward the EU throughout the peripheral countries. Two out of three Spaniards expressed high confidence in the EU in 2007. This result is in stark contrast to the finding from the fall of 2012, when 72 percent expressed a mistrust of the Union.14 Only 20 percent of Spanish citizens trusted the EU (although it should be noted that only 11 percent trusted their national government).15 In general, trust in national government is lower in the Southern countries (Italy, 17 percent; Spain, 11 percent; Greece, 7 percent; Portugal, 22 percent; and Cyprus, 6 percent),

In spite of the loss of confidence in the EU, Italians want more, not less, Europe.
The Italian vote in February 2013 was clearly directed against the policies of austerity and against excessive sacrifices, despite the fact that both the Partito Democrata and Silvio Berlusconis People of Freedom party supported austerity measures in the previous Parliament. But it is clear that Grillo voters were signaling their dissatisfaction with austerity, as were the voters for Syriza in Greece, and for Izquierda Unida in Spain. However, it is also important to note that Greece is the only country so far that has seen a simultaneous rise of extremist political parties, on the far left as well as the far right.

11 Key Indicator Results for Spain, Eurobarometer Autumn 2012, http://ec.europa.eu/ public_opinion/archives/eb/eb78/eb78_fact_es_en.pdf, pg. 2. 12 According to the most recent Pew Research Global Attitudes Project poll, when asked whether they wanted to keep the euro as their currency, 67 percent in Spain agreed, http://www.pewglobal.org/2013/05/13/the-new-sick-man-of-europe-the-europeanunion/

8 Ibid. 9 G. Jones, Italians say no to referendum on euro membership poll, Reuters, March 10, 2013, http://uk.reuters.com/article/2013/03/10/uk-italy-euro-poll-idUKBRE9290BR20130310 10 Ibid.

13 http://www.pewglobal.org/2013/05/13/the-new-sick-man-of-europe-the-europeanunion/ 14 Key Indicator Results for Spain, Eurobarometer Autumn 2012, http://ec.europa.eu/ public_opinion/archives/eb/eb78/eb78_fact_es_en.pdf, p. 2. 15 Ibid.

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compared to an EU average of 27 percent.16 Similarly, trust in the EU (Italy, 31 percent; Spain, 20 percent; Greece, 18 percent; Portugal, 34 percent; and Cyprus, 38 percent) is often lower than the EU average at 33 percent.17 These results illustrate the link between national and European politics in the Southern countries. While the figures do not necessarily mean that most Southern Europeans reject the idea of more Europe, the deterioration in trust for both the national and European frameworks may present problems for the democratic well-being of these countries.

2013 reflect the discrepancy between the economies of eurozone countries: the average unemployment rate was 11.9 percent in the EU, compared to 26.4 percent in Greece, 26.2 percent in Spain, and 17.6 percent in Portugal. Italy, Ireland, and Cyprus, however, had lower unemployment rates for the same period (11.7 percent, 14.7 percent, and 14.7 percent, respectively). In all countries, many of the jobless had exhausted their entitlements. In terms of wealth, the deterioration of the region has been egregious. According to Eurostat numbers, Spanish GDP per capita (in Purchasing Power Standard) was above the EU index average of 100 in 2007 at 105. However, in 2011, this figure had dropped to 98. Similarly, Italys GDP per capita in 2007 was at 105, while in 2011, it was at 100. Portugal came down from 79 in 2007 to 77 in 2011.18 And Cyprus GDP per capita for this period remained the same, although the recent bail-out will likely result in a loss of wealth. However, although Spain, for instance, has gone back a decade in terms of GDP per inhabitant, it is still more than twice as wealthy as it was in 1982. By the end of 2013, the number of people who qualify as absolutely poor in Italy will exceed 4 million, or 6 percent of the population, compared with 3.9 percent in 2006, according to the Trade Confederation Confcommercio. In Spain, 3 million people now fall into this category. Similar data on the rise of poverty as well as the loss of wealth can be found for the other countries of the region. All economic variables have been in decline since 2008. And these trends have solidified despite the policy of social cohesion toward poorer countries and regions, which has been in place in the EU since 1986. Without the social cohesion policy, the Southern countries would be in an even worse position. In addition to poverty, there has also been an increase in income inequality in the countries of the region, which in and of itself represents a failure of public policy. In this category, Spain has backslid to where it was 30 years ago.19 This trend is observable almost everywhere in the EU but more acutely in the Southern countries, where the decline of the middle classes and the increasing sense of dclassement (declassing, or fall to a lower class) could have corro18 Eurostat, GDP per capita in PPS, December 1, 2012, http://epp.eurostat. ec.europa.eu/tgm/table.do?tab=table&plugin=1&language=en&pcode=tec00114 19 Jos Saturnino Martnez Garca, Estructura social y desigualdad en Espaa, (Madrid: Ctedra, 2013), p. 627.

The deterioration in trust for both the national and European frameworks may present problems for the democratic wellbeing of these countries.
The Erosion of the Social Fabric The crisis and the ensuing response also brought a new divergence in terms of living conditions, wealth, and GPD per capita, as the Southern countries started to fall behind instead of closing the gap as in the previous two decades. The harsh medicine that was administered managed to increase convergence in terms of competitiveness, but it was based on so-called internal devaluation, i.e. a reduction in salaries and prices in certain sectors. In addition, the brain drain that occurred as young professional people left their countries to work in Germany or elsewhere further created a moral divide between northern and southern Europe. This emigration was very different in nature from the outflows in the 1950s and 1960s, when the people leaving these countries were often from the working class and not highly skilled workers. With the exception of Ireland, the peripheral eurozone countries have suffered the most from the crisis and the austerity measures. The unemployment figures for January
16 Public Opinion in the European Union, Eurobarometer Autumn 2012, http:// ec.europa.eu/public_opinion/archives/eb/eb78/eb78_publ_en.pdf, p. 37. 17 Key Indicator Results for Spain, Eurobarometer Autumn 2012, http://ec.europa.eu/ public_opinion/archives/eb/eb78/eb78_fact_es_en.pdf, p. 2.

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sive political and societal implications. In the European public consciousness, there is a return to the concept of social class (though not in a Marxist sense). According to some polls, half of the Spaniards and the same could be said of Greeks or Portuguese feel they now find themselves in a lower social class because of the crisis.20 Impoverishment has had several negative socio-economic implications, including increased inequality, mass unemployment, brain drain, the creation of a lost generation, and the fall of the middle classes. The destruction of the social fabric in the countries of the region could have dramatic consequences in terms of social and political instability.

could also affect support for democracy and the EU more broadly. The idea of a welfare state is well-ingrained in the vision that Spanish, Portuguese, and Greek citizens have of their democracies and of their ideal of the European model, which they were only able to truly develop with the advent of democracy in the late 1970s and early 1980s. The development of democracy went hand-in-hand with the development of welfare systems, in particular universal public education, pensions, and health care. For at least two generations, citizens in Southern European countries have seen the welfare system expand, including the introduction of unemployment benefits. Now, however, they are receiving increasingly fewer benefits. Significantly, the Southern European countries also share a negative characteristic that is very closely related to the funding of the welfare system: seriously flawed tax systems. Greece lacked a proper tax system, especially a revenue system, until the bail-out in 2010. In Spain, the so-called black economy is estimated to represent about 25 percent of total GDP, and the lost taxes could amount to as much as 30 percent of total tax revenue. A Southern European Identity Does not Exist If there has been a divorce between North and South in the EU, there has also been a divorce within the South. Many of the national politicians who advocate for more solidarity within the EU do not wish to be associated with other peripheral countries that have experienced financial problems. These leaders emphasize that their countries are financially and socially stable by proclaiming, We are not Greece, we are not Portugal. This lack of regional solidarity was evident in Spains satisfaction that the spread of its 10-year bonds over German bonds was lower than Italys, a country that has avoided any kind of bail-out. Michael Pettis argues that the problems of the deficitarians cannot be solved until Germany changes its policies, which is unlikely to happen any time soon.21 Therefore, the Southern European countries should unite in order to ensure that the whole of the eurozone shares the costs of adjustment. Those countries particularly Italy, Spain, and Portugal share similar interests and visions for the EUs future. The
21 Michael Pettis, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead (Princeton, NJ: Princeton University Press, 2013).

The destruction of the social fabric in the countries of the region could have dramatic consequences in terms of social and political instability.
However, in Southern Europe, the family features prominently as a social cushion. It is the only institution that has been reinforced by the crisis. Adult sons and daughters have moved back in with their parents due to lack of funds. Senior citizens who had been living in old age residences have also moved into the family home in order to contribute their pensions to the family finances. However, people aged 45-60 who previously sustained their families with well-paid, jobs are now at a higher risk of losing their employment under the new, more flexible labor laws. This could undermine the viability of a three-income family in which one member earns an adequate salary, a second member receives state assistance, and a third member is a part-time employee. The social crisis is happening at a time when the European welfare state is undergoing a deep change due to austerity and political choices. As a result, these factors
20 La mitad de los espaoles baja de clase social por culpa de la crisis, La Cadena Sur, May 11, 2012, http://www.cadenaser.com/espana/articulo/mitad-espanoles-bajaclase-social-culpa-crisis/csrcsrpor/20121105csrcsrnac_1/Tes.

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situation thus calls for a coalition within the eurozone of at least these three countries, ideally plus France (and President Franois Hollande is taking steps into this direction) with deep links to Greece and Cyprus, to defend common interests and positions. One good example of how such a coalition might work was the European Council summit in June 2012, during which the prime ministers of Spain and Italy and the president of France come together in advance in order to press German Chancellor Angela Merkel to move decisively toward the creation of a banking union. However, this strategy was unsuccessful in the March 2013 attempt to prevent the Eurogroup from accepting a solution for the bail-out of Cyprus that included a substantial haircut for higher deposits in banks. Mediterranean countries had tried to avoid this, without success, fearing it could become a precedent for themselves in case of further trouble. Democracy and the EU Another political change across Southern Europe resulting from the euro crisis is the declining dominance of the big traditional political parties. In Greece, the combined vote total for the two parties of government at 32 percent in the June 2012 elections was less than half their aggregate support in previous elections. In Spain, the Socialist Party and the Peoples Party combined for 84 percent of the votes in 2008, compared to 73 percent in the election of November 2011, and according to current polls now rate at between 57-63 percent. Elections in Catalonia have shown an atomization of the vote that could spread to the whole of Spain. In Italy, the technocratic government of Mario Monti failed to secure a significant number of votes, and the February elections resulted in major difficulties to form any kind of government. Similarly, technocracy failed at the ballot box in Greece. In Spain as well as in other countries throughout Europe, the discrediting of the traditional parties, the rise of anti-establishment movements, and the accelerating distance between voters and the ruling elite all conspire to create a major political crisis. The answer to who decides? is different in the deficitarian countries than in the austerian countries. The sense that the major economic decisions are made in Brussels or Berlin by, as this paper has described, decision-makers rather than decision-takers, is well entrenched among EU citizens.

Conclusion Although the EU as such is losing credibility, support for the euro remains strong in Southern Europe. It is still seen as part of the solution to the crisis, even if many leading economists and commentators insist on certain peripheral countries leaving the euro. What these analyses fail to grasp is the political importance of the single currency and the European project overall for these countries. A withdrawal from the euro would be perceived as a major political failure that could have deep consequences for their democratic stability. No responsible political leader would take that step. But the widespread belief of many citizens that Europe is still the solution is based on the fact that the EU continues to be the major factor for change and modernization in these countries. It is the European framework and external pressure that are driving these countries to adopt some of the structural reforms that have been delayed for too long. Not belonging to the euro would relax this reform pressure, as individual currencies could offer the possibility of successive devaluations to regain competitiveness.

The widespread belief of many citizens that Europe is still the solution is based on the fact that the EU continues to be the major factor for change and modernization in these countries.
By now, there has also been a realization in Europes north that a failure of the peripheral countries in the eurozone could have the potential to bring down the monetary union and even endanger the future of the EU. Accordingly, the visit of Angela Merkel to Athens after the summer of 2012 can be seen as an effort to quell speculation that Germany would drop Greece. Nonetheless, the crisis surely has marked a division between North and South in the EU and in the eurozone.

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Together, there is a belief among Northern countries (especially Finland, the Netherlands, and Germany) that they have done their homework by having enacted reforms a decade ago and that they share a vision that the countries of Southern Europe lack. On the other side, within Southern Europe, there is an increasing rejection of austerity. Or more specifically, a rejection of what is seen as excessive austerity. As Jean Pisani-Ferry writes, the economic and social situation in Southern Europe is bound to remain grim for several years,22 with the possibility of a true lost decade.23 Not surprisingly, he adds that the IMF foresees that the per capita GDP [in those counties] will be lower in 2017 than it was in 2007,24 which could have dire consequences for the functioning of democracy. Northern Europe may thus be asking for an excessive effort from the South that the political and social system might not be able to withstand. The EU has to help those countries help themselves, individually and collectively. Europe is still part of their solution.

About the Author

Andrs Ortega is a Spanish private consultant. He has twice been director of the Policy Unit at the Prime Ministers Office in Spain. He also has had an extensive career in journalism. He is a member of the European Council on Foreign Relations and a senior research fellow of the Real Instituto Elcano.

About The EuroFuture Project

The German Marshall Fund of the United States understands the twin crises in Europe and the United States to be a defining moment that will shape the transatlantic partnership and its interactions with the wider world for the long term. GMFs EuroFuture Project therefore aims to understand and explore the economic, governance, and geostrategic dimensions of the EuroCrisis from a transatlantic perspective. The Project addresses the impact, implications, and ripple effects of the crisis in Europe, for the United States, and the world. GMF does this through a combination of initiatives on both sides of the Atlantic, including large and small convening, regional seminars, study tours, paper series, polling, briefings, and media interviews. The Project also integrates its work on the EuroCrisis into several of GMFs existing programs. The Project is led by Thomas KleineBrockhoff, Senior Transatlantic Fellow and Senior Director for Strategy. The group of GMF experts involved in the project consists of several Transatlantic Fellows as well as program staff on both sides of the Atlantic.

22 Jean Pisani-Ferry, Is the Euro Crisis Really Over? Project Syndicate, February 1, 2013, http://www.project-syndicate.org/commentary/the-euro-crisis-and-europeanreform-by-jean-pisani-ferry. 23 Ibid. 24 Ibid.