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A New Crossroad: Reflections on the global economy (2)

(Beijing Review)

08:10, October 17, 2012

Getting back on track

The cause of the European sovereign debt crisis is largely due to the structural imbalance of euro zone member states. That is, each member state pursues an independent fiscal policy despite sharing a common currency.

A successful monetary union requires identifying differences in how the economies are structured among member states. Member states differ in terms of economic development, politics and culture. Before the crisis, the monetary policy of the euro zone was too relaxed in the southern states, leading to an excessive accumulation of debt in both the public and private sectors. In these countries, demand expanded excessively and labor costs increased while competitiveness declined, eventually leading to the European sovereign debt crisis.

Two solutions are needed to fundamentally solve the crisis. First, problematic countries must strengthen structural reforms in the labor market to enhance their competitiveness. Second, the euro zone must accelerate its integration process and establish a more uniform European fiscal union.

Although structural changes may take time, the market cannot wait. The huge pressure of the sovereign debt market and the continual decrease of bank deposits in periphery countries indicate that the euro zone cannot wait until reforms are complete. In creating policies to cope with the crisis, euro zone governments have been unable to catch up with market developments, creating more pressure on the ECB.

Another difficulty facing Europe is how to manage the economic and social consequences of austerity. The core of structural reforms is to improve the flexibility of the labor market, cut redundant staff and reduce salaries, welfare and public spending. Austerity will then bring in lower revenue and slow the pace of reducing fiscal deficits.

To break the vicious circle, the euro zone needs to not only relax its monetary policy, but also increase investment and maintain economic growth. Therefore it is of vital importance to attract investment from the private sector. In this respect, we have seen some signs of improvement.

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