Hans-Werner Sinn, the president of the respected Ifo think-tank, says France could put the future of the single currency at risk and warns that the Ukrainian crisis threatens to trigger a "triple-dip depression" in parts of the bloc.
By Szu Ping Chan, 4-10-2014
The eurozone is doomed to a decade or more of economic stagnation and civil unrest that could destroy the single currency if countries such as France do not implement vital reforms, according to one of Europe’s most influential economists.
Hans-Werner Sinn, the president of Germany’s Ifo Institute for Economic Research think-tank, said policymakers would continue to misuse capital to finance the higher living standards unlocked by joining the euro, while dragging their heels on reform.
“My prediction is not that the euro will fall apart, but that it leads to a stagnation and animosity even more than we see today among the people of Europe,” he said. “You see this very strongly in southern Europe, where people face this mass unemployment, in France, where Marine le Pen in the polls has the strongest party and with Syriza in Greece which is presenting radical decisions and has the most support in the polls.”
In an interview with the Telegraph, Mr Sinn also warned that while the Ukrainian crisis would hit German growth, the pain for its neighbours, many of which rely on Europe's largest economy, would be more severe.
"Germany is obviously affected by the Russian crisis. More than 40pc of German companies have eastern European connections and this will have repercussions on the rest of the eurozone also, because they have their own problems and when Germany, which is one of their main customers, has difficulties, they will also be affected.
"There is now a risk of a triple-dip recession in some southern European countries, if not a triple-dip depression."
He warned that if French policymakers failed to implement the vital supply side reforms needed to stimulate growth, it could be the final nail in the coffin for the euro. Mr Sinn said it was vital that France shrank its bloated public sector, which currently represents 55pc of gross domestic product (GDP), by at least 10 percentage points.
“If France continues this way and doesn’t want to scale down and go through austerity, but rather seek Keynesian solutions, then they will threaten the stability of the eurosystem. Of course borrowing at the moment gives us some Keynesian demand stimulus, which for a year or two may help, but it just postpones the necessary reforms and it exacerbates the situation in the long run.
"It is as if you are sick, need surgery and take drugs to numb the pain."
Mr Sinn highlighted that many workers who had left France’s uncompetitive manufacturing sector now worked for the state.
"French industry has been dying for decades now. The share of manufacturing in GDP is only 9pc, less than half of what the German share is. The people who were set free from manufacturing, or their children, have by and large been absorbed by the government sector, which has now a quarter of the workforce, twice that of Germany.
"Hiding the unemployed in government offices is not a healthy solution."
Mr Sinn recognised the task facing France. “It’s very difficult and I wonder if the current socialist government will be able do it, but sometimes it takes Nixon to go to China. In Germany we saw that only the Social Democrats under Chancellor Schröder at the time were able to carry out market-orientated reforms."
Mr Sinn, who presents a bleak picture of the 18-nation bloc in his latest book, the Euro trap, suggests countries should adopt a “breathable euro”, where struggling nations could temporarily leave the single currency, write-off some of their debts, devalue, and then re-enter.
"Greece would have done better had they exited the eurozone in 2010, but not permanently," he said. "The proposal is that the exit is only temporary and that the country stays legally part of the eurozone. It devalues its currency, carries out reforms and returns when it has recovered. I see this status of being outside the euro as a sort of hospital stage.
"The realignment of relative prices that Greece and perhaps other countries need cannot really be achieved within the euro because it would either mean astronomical inflation in the core or deflation in Southern Europe of an order of magnitude which requires so much austerity that society may fall apart.
"The whole point of structural reforms is that you become competitive. What makes you competitive? You have to have prices which for a given type of product are not higher than elsewhere. The southern countries all inflated incredibly under the credit bubble that the euro brought them. This extra inflation now has to be undone.
“No dream of any politician can overcome this fundamental problem of having the wrong wages and prices,” he said.
He also said Germany should accept higher inflation in order to offset some of the pain in southern Europe.
"Germany could and should accept some inflation, but some deflation in southern Europe is also indispensable. Which southern European states are willing to live with that I do not know," he said.
"According to Goldman Sachs a German inflation of 70pc would be needed to make southern Europe competitive without price cuts there. That is 5.5pc annual inflation for ten years in Germany or an average inflation of 3.6pc for the eurozone. That is simply too much and not compatible with the mandate of the ECB."
Mr Sinn advocates a "United States of Europe" in his book, and says that ultimately, the eurozone will have no choice but to integrate further.
However, he warned that achieving a common European state with equal living standards would be difficult. "I find it very unlikely given the difficulties we see today and I see growing animosity towards the European project. This is a big pity but I insist that Europe in the end has no alternative but to unite."
Hans-Werner Sinn: read the full interview
*The Euro Trap; On Bursting bubbles, Budgets and Beliefs, is published by Oxford University Press. Mr Sinn will be in London next week to launch his new book.
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He also said Germany should accept higher inflation in order to offset some of the pain in southern Europe.
"Germany could and should accept some inflation, but some deflation in southern Europe is also indispensable. Which southern European states are willing to live with that I do not know," he said.
"According to Goldman Sachs a German inflation of 70pc would be needed to make southern Europe competitive without price cuts there. That is 5.5pc annual inflation for ten years in Germany or an average inflation of 3.6pc for the eurozone. That is simply too much and not compatible with the mandate of the ECB."
Mr Sinn advocates a "United States of Europe" in his book, and says that ultimately, the eurozone will have no choice but to integrate further.
However, he warned that achieving a common European state with equal living standards would be difficult. "I find it very unlikely given the difficulties we see today and I see growing animosity towards the European project. This is a big pity but I insist that Europe in the end has no alternative but to unite."
