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Thursday, 03 May 2012

The Eurozone: A challenge and a chance for Europe and the global community

  Christopher Wood
His Excellency, Dr Horst Freitag, Ambassador of Germany His Excellency, Dr Horst Freitag, Ambassador of Germany

The on-going economic crisis facing the Eurozone does not only have potential ramifications for the single currency and the future trajectory of the European Union itself, but also for the rest of the world. Recent decisions by the eurozone members have increased international confidence in the ability of the Union to weather the storm.

To share some insights on recent events and developments, SAIIA invited His Excellency, Dr Horst Freitag, Ambassador of Germany to the Republic of South Africa, to address a Speaker's Meeting at Jan Smuts House on Tuesday 24 April 2012. Ambassador Freitag engaged a large and widely representative audience on the subject of "The Eurozone: A challenge and a chance for Europe and the global community."

Ambassador Freitag opened his lecture by outlining three main themes:

• the nature of the crisis,

• what the Euro's zones response to the crises tried to achieve, and

• what opportunities the crisis created for Europe and Africa.

Download Ambassador Horst Freitag speech [English.pdf]

He detailed the historic successes of the Euro, including its success in managing interest rates and inflation, and the rise of the Euro to the status of a global reserve currency. As such, the Ambassador classified the current crises not as a crisis of the Euro, but rather a crisis of confidence, stemming from a sovereign debt crisis, sparked by increased scrutiny of government debt following the broader financial crisis of 2007.

Dr Freitag then identified three major structural causes of the crisis. The first was a problem of basic macroeconomic imbalances, specifically a combination of high government debt and low productivity. The second was a lack of financial regulation, which allowed for risky practices in the financial sector. And the third and most emphasized was the flaws in the institutional architecture of the Eurozone. The biggest structural flaw identified says the Ambassador, was that the Eurozone's currency union was not accompanied by a fiscal union, and that the safeguards put in place by the Stability and Growth pact were not enforced. Although the creation of the Eurozone was a historic achievement and a great political victory, the structures and the way they were used created a situation under which membership of the Eurozone gave countries access to lots of cheap debt, which could be excessively accumulated without consequence. When the financial crisis hit and this debt was brought under scrutiny, these fundamental imbalances laid the foundation for the current Eurozone crisis.

A two-track response was employed to deal with the crisis:: using emergency loans to stem the immediate crisis, and attaching conditions to those loans to correct the structural roots of the crisis. Two bodies came into play, namely, the European Financial Stability Fund (EFSF), and the recently created European Stability Mechanism (ESM). The Ambassador responded to questions of whether these institutions created enough of a firewall to address the crisis, with three replies. Firstly, he argued that "like the tower of Babel, an ever increasing wall of money will never reach heaven", and as such there were limits on how large these funds should reasonably be. Secondly, he stressed that these measures are not meant to resolve the crisis, but just to buy time until appropriate structural reforms can be implemented. Finally, and most importantly, he stressed the incredibly large capacity of the current institutions, with the ESM alone wielding a $500 billion lending capacity.

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Ambassador Freitag with students from Pertoria High School for Girls (left) and Florida Park High School (right). Both schools will be representing Germany in Youth@SAIIA's Model United Nations Programme to be held in September this year.

Nevertheless, the ambassador once again stressed that structural reforms were most important to addressing the crisis, and that it was these reforms that created the opportunity for a better Europe, and thus a stronger trade partner for Africa. The ambassador highlighted two major structural reforms. The first is the Euro Plus Pact, which most importantly created an automatic punishment mechanism, with countries that infringe on the pact or do not take appropriate steps to correct economic imbalances forced to forego 0.3% of their GDP in penalties. This automatic mechanism not only corrects one of the fundamental flaws in the Stability and Growth pact, but is also unprecedented in international law. Complementing the mechanism put in place in the Euro Plus pact was the second major reform, the Fiscal Stability Treaty, which aims to facilitate greater fiscal coordination between countries, and to set stricter limits on structural deficits.

Overall, the Ambassador stressed that for all the challenges currently facing the Euro area, the creation of the Eurozone remains an historic achievement, and one that poses the only viable future source of global influence for European countries. A strong Europe is thus in every European country's self-interest. With structural reforms of the EU and greater regulation and transparency in the financial sector, the ambassador is confident that a stronger Eurozone, and a stronger partner for Africa, will emerge from the crisis.

Christopher Wood is a KAS-SAIIA Scholar and is currently completing his Master's degree in Development Studies at Wits University.