The political Economy of the Eurozone and the Case of Cyprus
The European Union is facing its most serious economic crisis since the creation of the Common Market in the 1950s. The current deep and persistent Eurozone crisis threatens the main pillars of the foundations of the Economic and Monetary Union (EMU). Even before the crisis several economists had put forward the view that the EMU also required a fiscal union and a minimum level of political integration for its smooth functioning. It is essential to understand the broader context of the crisis and how to take the debate on the future of Europe forward.
The economic policies pursued so far to address the excessive fiscal deficits and high public debts in several countries of the Eurozone have, not surprisingly, been procyclical. As demonstrated by the Greek experience, a draconian fiscal austerity policy cannot be effective in resolving the debt crisis and the restructuring of the economy.
Cyprus, which was once referred to as a model case for its economic record, now faces serious structural problems. Following the initial agreement on a memorandum of understanding it is expected that Cyprus will soon formally sign an economic adjustment program with the Troika. The challenge for Cyprus is to avoid the Greek predicament and to move out of the crisis relatively quickly.
But one must first understand the context and this is defined by two key parameters: (a) the overall philosophy of the Troika and the associated economic adjustment program for Cyprus and (b) the depth of the economic problems of this country and the appropriate way to address them.
To begin with it should be understood that Cyprus economic problems are basically of an endogenous nature. Undoubtedly, the exposure of the banking system to the Greek economy was the biggest problem. But the relevant decisions were taken in Nicosia in a climate of complacency, inadequate, even reckless, supervisory control as well as an element of greed.
On the fiscal side there were very deep structural problems which led to a situation where the state was consistently spending well above its means. This severely affected the labour market as it created several distortions and negative side effects. By the same token there have been long standing and serious problems with the Social Security Fund and related schemes.
Not surprisingly the Troika would like to see serious cuts in the public payroll, the social transfers and generally in public spending. At the same time there are provisions for tax increases. The program extends to 2016; that is the next four years. The Troika initially wanted to see a balanced budget in a three year period. The government asked and secured an extension. It would of course have been better if the program for fiscal rationalization extended to at least five years. The adjustment process would have been smoother and easier for the economy to deal with. Indeed, the more strict a fiscal package is especially during a recession the higher the risk for the recession to turn into a depression. The Greek predicament is a case in point.
But the major challenge is the process of the recapitalization of the Banks. If the required amount is debited on the state the great danger is that the public debt may turn out not to be viable. The new government that will be formed after the February 2013 Presidential elections will have the opportunity to reassess several aspects of the stabilization program given that economic developments at various levels are characterized by dynamic processes. With the implementation of the stabilization program as well as with new initiatives we may look forward to overcoming the recession. At the same time the EU must reassess it own economic strategy and formulate a new approach that will pave the way for economic stability and growth.