Preparing for the green exit

Underpinning
European integration is the belief that unity between nations should
bring shared prosperity instead of social, political, and economic
turmoil. But today’s debt crisis has exposed a fundamental weakness in
the eurozone’s architecture: insufficient integration. This adds another
layer of complexity, compared to the United States or Japan, to the
economic challenges that the European Union faces. To paraphrase Leo
Tolstoy, the European family is unhappy in its own way.  

The
European Monetary Union acted as a powerful catalyst for European
integration, rapidly bringing together 17 diverse economies in a single
monetary union – but without fiscal solidarity, a way to enforce fiscal
discipline, or an established lender of last resort. This facilitated
massive capital inflows and unsustainable borrowing in the peripheral
countries – most notably Greece, but also Portugal, Spain, and Italy –
shrouding, and thereby accelerating, their increasing loss of
competitiveness. When the global financial crisis hit, the house of
cards collapsed.  

Now, troubled countries do not have the
option of reducing their debt burdens and increasing external
competitiveness by devaluing their currencies. Integration is thus
incomplete, with eurozone countries having abrogated monetary
sovereignty, while rejecting the stabilising mechanisms of shared fiscal
and economic policy.  

With the single currency on the
precipice, the necessity of greater fiscal and economic co-ordination is
clear. But such a move would require profound treaty changes, and thus
will take time. Still, more can be done to smooth the fiscal and
economic adjustments taking place in the eurozone’s troubled periphery.  

Austerity risks

The current focus on
austerity and structural reform carries severe social and economic
risks, in part because disenchanted electorates are fertile ground for
extremist parties. Indeed, in Greece’s recent elections, after five
years of recession and 20% unemployment, extremist parties from both
ends of the political spectrum made substantial electoral gains.
Likewise, in the first round of France’s presidential elections last
month, extremist parties from the right and left won more than 30% of
the vote.  

Europe needs a new plan to ensure sustainable and
shared prosperity, based in part on rebalancing growth and
competitiveness within the eurozone. Although Germany’s recent
indication that it may consider wage increases for its workers is an
encouraging start, a consumption-based recovery is clearly not
sustainable.  

Peripheral countries must undertake structural
reforms, while recognising that such changes will not bear fruit
overnight, and that internal economic rebalancing will be painful. In
order to facilitate this economic rebalancing and ameliorate its social
consequences, they also need targeted public investments, co-financed at
the European level.  

The green sector provides a key
opportunity for European investment, owing to its scale and long-term
growth potential. After all, real resource prices have reached record
levels and, on average, the oil intensity of GDP in Spain, Greece, and
Portugal is 60% higher than the European average.

Investing in
the green sector would contribute to Europe’s long-term productivity,
while providing productive cross-border capital flows to complement
structural rebalancing within peripheral countries. 

Europe’s
leaders should therefore agree on a large-scale recapitalisation of the
European Investment Bank. During the crisis, the EIB has played a
pivotal role in financing large-scale infrastructure projects, but it is
now curtailing its lending – and private banks cannot pick up the
slack. Options for raising new capital include requesting a €10 billion
contribution from member states, using the €12bn left over from the
European Financial Stability Mechanism, or reallocating the tens of
billions of unallocated funds from the EU budget.  

Project bonds

Furthermore,
the European Commission’s proposal that the EIB support privately
financed infrastructure projects through guarantees for corporate bonds,
called ‘project bonds’, must be accelerated and expanded. But there is
not yet much demand for such bonds in Europe, and the initiative’s
development will take time.  

Therefore, eurozone members,
possibly through the EIB, should guarantee ‘green covered bonds’,
securitised by revenue from existing green-sector assets, such as
renewable energy. This would allow banks to refinance green-sector
investments, thus freeing up bank capital for further lending. Banks’
experience and the diversity of products offered in the sector mean that
freeing up their balance-sheet capacities could swiftly inject funds
into the real economy.    

Thus far, Europe’s response to the
debt crisis has been impeded by a false juxtaposition of austerity and
stimulus. Productive investments in areas such as infrastructure and
knowledge, can not only stimulate growth and employment in the short
term, but also are a necessary condition for long-term prosperity.  

Solvent
countries currently can borrow at near-zero interest rates, so the time
is right to invest in long-term productive assets in the peripheral
countries, thus helping to facilitate the structural reforms that Europe
needs to claw its way out of crisis and into a sustainable, prosperous
future.  

This is a European crisis, so all of Europe must share
the burden of adjustment. That means coming together to provide the
resources needed to restore competitiveness, revive growth, and prepare
to face the challenges of tomorrow.