Providing more bailouts for struggling members is no way to run a successful business – whatever the political agenda
Imagine for a moment that you are one of those straight-talking celebrity executives signed up by TV to turn round an ailing business. Imagine also that this is not a restaurant, a retailer or a small manufacturing business but the 17-nation eurozone. What would your analysis be?
The first thing you would want is the latest trading statement of the business, which does not make pleasant reading. Created more than a decade ago, Euro PLC has continued trading but growth in turnover has been slow and market share has been lost to more dynamic companies operating out of East Asia and the Pacific Rim. More recently, there has been a series of acute financial crises in some of the smaller enterprises that make up the conglomerate.
Your first thought as chief executive is to wonder why the previous management bought these businesses in the first place. But then you remember that the Greek, Portuguese and Spanish divisions were acquired during a period of aggressive expansion in which it was assumed that there would be positive synergies from a diversified portfolio of businesses.
There were, you recall now, those who favoured a core-business strategy based operated out of the German head office and that the acquisitions of Greece, Portugal, Spain, Italy and Belgium were rushed through without the normal due diligence.
Those peripheral businesses are now proving a real headache. They are taking up far more management time than they should, and are a drain on the financial resources of the group. Large amounts of capital have been channelled into Greece, Ireland and Portugal in an attempt to keep them as going concerns, but the shareholders have started to get mutinous. In the City, financial analysts have started to speculate on which bit of the business will require help next.
So what do you do? There are really only two choices. The first is to carry on with the current lame-duck strategy, providing bailouts to the struggling parts of the business empire in the hope that they will one day wash their face. You can insist the financial help comes at a price, with onerous conditions designed to ensure an improvement in efficiency, which is markedly lower at the Portuguese, Italian and Greek plants than it is in Germany or Holland. The workers in the struggling divisions can be disciplined: they can be forced to work longer hours for less money; their pension rights can be made less generous; their fringe benefits removed. They can be told to shape up or else.
If you were the chief executive of our imaginary Euro PLC, the second option would be to cut your losses and shut down the loss-making bits of the company. Instead of a strategy built around mergers and acquisitions, there would be a core-business strategy. Potential buyers would be sought for the struggling divisions; management buyouts encouraged. While paying lip service to your predecessor's go-for-growth approach, your message to the markets would be that it was time for the business to become smaller, leaner and more profitable.
None of this will happen, naturally. For a start, the rationale for the eurozone was always as much political as economic. The people running it have a different mindset to the boss of a multinational corporation. What's more, they would bridle at the suggestion that monetary union is failing. Instead, they would argue that the past decade or so has been a great success; the single currency is still there; it has expanded its membership and has established itself as a rival to the dollar. While acknowledging that there are problems in some countries on the periphery of monetary union, there is no sense in Brussels or Frankfurt that these are the result of design flaws in "the project". Rather, they are problems that are specific to the individual countries concerned, and as such they can be solved with the correct supply-side policies rather than by defaults, let alone the splintering of monetary union into a two-speed Europe.
The longer the sovereign debt crisis goes on, the more tenuous this argument looks. True, monetary union was never just about economics, but it should have been. Bending the entry requirements to allow countries in for political reasons was a mistake. It was an even bigger error to assume that it was possible to lump together diverse economies and expect them to thrive as one seamless unit. The vision was that the eurozone would emerge as BMW. Instead, it has turned out to be British Leyland.
Does this mean the single currency is at imminent risk of breaking up? Certainly not, although it is worth noting that there would have been few takers in 1975 of British Leyland going to the wall, or in 1985 of the Soviet Union collapsing within five years. A vast amount of political capital has been invested in monetary union, and there would also be a cost to the weaker countries were they to default or, as a last resort, decide to abandon the euro altogether.
But there have been two interesting developments recently. The first is that the European Central Bank has started to adopt its own "core business" strategy by raising interest rates. Higher borrowing costs make life more difficult for countries like Greece, Portugal and Spain, both through raising the cost of financing their debts and by slowing their growth. The ECB has decided policy should be run on the basis of what is good for Germany – which has a population of 80m and is growing strongly – rather than Ireland, which has had three years of economic depression and has the population of Berlin.
The second development is that the financial markets are doing the debt sums for countries on the periphery and coming up with some worrying answers. Put simply, a country's national debt will rise if the interest rates it is paying to borrow are higher than the increase in nominal national output. If interest rates are higher than nominal GDP, the only way to prevent the debt level rising is to run a surplus on its primary budget, which excludes interest payments.
The weak countries have ceded control over interest rates to the ECB and cannot tweak their macro-economic policies to generate the higher inflation that would boost nominal national output. They therefore have to boost their real growth rates, or impose even more stringent austerity in order to run a primary budget surplus.
The first option looks impossible for economic reasons; the second looks challenging politically. Financial markets are starting to send a clear message: the debt dynamics of certain eurozone countries are unsustainable. And the lesson from Britain on Black Wednesday in 1992 is that if a strategy is unsustainable, it is not sustained. Whatever policymakers might say or think.