The story that Europe is telling about the global financial
crisis is untrue: The crisis is not simply the fault of the United
States. European policies, on both the national and the EU levels,
contributed to the buildup of systemic risk that led to the crisis.
These policies reduced European competitiveness, led to high levels
of leverage at European banks, helped to create property bubbles
across Europe, and--through both the Euro and the broader policy of
European integration--introduced moral hazard into European
The basic fallacies of European policies are their emphasis on
top-down control and their advocacy of a one-size-fits-all model.
The policies the EU is advancing for the G-20 summit repeat these
errors on a larger scale. Instead of blaming the U.S., Europe
should address its lack of competitiveness and growing entitlements
burden. Doubling down on centralized control will result in lower
growth and a less stable world economy at a time when Europe needs
to promote a sustained recovery.
The European Myth
Europe is telling a story about the origins of the global
financial crisis. The story is simple: It is America's fault. The
BBC reports that the European resistance to stimulus spending
derives from its reluctance to go deeper into debt "to rescue the
US economy, which they argue was the country that caused the crisis
in the first place." The Economist concluded in October
that the European approach to the crisis was based in part on the
"flawed" assumption that the financial system is chiefly suffering
from "transatlantic contagion."
The first signs of the current global financial crisis did
appear in the U.S. But the collapse of the U.S. real estate market,
though important, was merely the first stone in an avalanche. As
the Economist pointed out, the view that only the U.S. is to
blame "fails to take account of ... slowing [European] economies
... the slumping housing markets in countries such as Spain and
Ireland ... [and] European banks' dependence on wholesale
The origins of the global financial crash, not surprisingly, are
global. Some factors affected some countries more than others, but
no country has cause to claim that it was damaged solely by the
actions of others. Yet it is those actions that must now face
scrutiny. If there is a common theme in the crisis, it can be found
in the interaction between politics and economics that created
perverse and ultimately dangerous incentives.
The European Reality
In spite of the desire of the EU to pretend otherwise, the
European states are very different. Thus, at the national level,
the problems these states must confront are not identical.
Nevertheless, four features that are present in more than one
European state deserve to be highlighted:
- A loss of competitiveness. European states such as
Ireland and Italy have lost competitiveness. In these states,
public expenditure has grown faster than private sector pay and
productivity. In Ireland, for instance, public spending doubled
between 1997 and 2003. This caused inflation to rise two-and-a-half
times faster than in the Euro zone as a whole. The loss of
competitiveness was the result of government policies that placed
excessive burdens on productive employment.
- The level of leverage in European banks. Leverage is the
ratio of a bank's total liabilities to shareholder equity. Higher
leverage means the bank is doing more business on a relatively
narrower base. Leverage can be excessive, but it is not evil--on
the contrary, it is necessary for the functioning of the banking
system. There is wide debate on the best way to measure leverage.
But it is clear that many European banks were more highly leveraged
than their American counterparts. A survey by the Centre for
European Policy Studies found that the average leverage ratio of
Europe's twelve largest banks as of September 2008 was 35 to 1,
compared to less than 20 to 1 in the U.S. The survey described
Europe's ratios as "a disaster in waiting." Higher levels of
leverage do make more credit available and thus reduce its cost.
This was appealing in Europe, because cheaper credit fueled growth
in its generally sluggish economies.
- The European property bubbles. But this rapid expansion
of credit in Europe played an important role in the creation of
European real estate bubbles. The IMF has pointed out that, in the
run-up to the crisis, "credit aggregates grew extremely fast in the
United Kingdom, Spain, Iceland, and several Eastern European
countries. As in the U.S., these credit expansions fueled real
estate booms. House prices rose rapidly in most of the Eastern and
Western European countries now caught in the financial turmoil." The
bubbles in Europe were as unsustainable as those in the U.S.
- The moral hazards of the Euro and the EU. These factors
speak to the same underlying cause. The years after the Cold War
saw high global growth and benign conditions that "fed the build up
of systemic risk." As the IMF puts it, "[l]ow interest rates,
together with increasing and excessive optimism about the future,
pushed up asset prices ... [in] a broad range of ... advanced
countries and emerging markets." The result was a search for yield
and the creation of ever-riskier assets.
In Europe, the creation of the Euro was both consequence and
cause of that excessive optimism. The case for the currency was
always fundamentally political: that it would weld Europe closer
together. But the Euro zone is not an optimal currency area. The
Euro represents the triumph of politics over economics. It is a
one-size-fits-all model for a continent where, in fact, one size
does not fit all.
Moreover, the Euro was, in essence, a seal of approval on
countries such as Spain, Portugal, and Greece. This encouraged
investors to regard these markets as less risky than they in fact
were. The admission of many of the now-troubled Eastern European
states into the EU also created moral hazard in the market by
encouraging investors to treat these states as if they ranked with
the established economies of the West. This approach did not accord
The False European Solutions
In short, a series of policies--some national, some
European--created a framework that encouraged risky decisions by
investors and weakened the national foundations on which the
resulting bubbles grew. The irony is that Europe is now proposing
to double down on these failed policies in response to the
Europe's call for a global regulator with a mandate to ensure
the stability and balance of the world economy would be a
tremendous step toward forcing its slow growth model on the rest of
the world. Its campaign against "tax havens" is another part of
this effort to force other nations to adopt Europe's own
anti-growth, anti-competitive tax regime.
These policies are a return to the concept of one size fits all
and to the belief that politicians and unelected bureaucrats on the
global level can effectively manage the world's economy. Europeans
should ask why, if this model works so well, it failed to stop the
build-up of systemic risk in Europe. The campaign to blame the U.S.
is a form of denial: By refusing to look in the mirror, Europe
seeks to avoid facing the unpleasant reality of failure.
This reality includes the fact that the European states are not
all alike. Nothing underlines this more effectively that the fact
that Germany, having been one of the cheerleaders of European
integration, is now reluctant to bear a disproportionate share of
the Europe-wide costs of stabilizing that system. From the national
point of view, this reluctance makes sense. But it is a sign of the
incoherence of European integration that its leading advocate is
not willing to pay the bills for the policies it claims to
The True Solutions
It is legitimate to discuss measures that should be taken in
immediate response to the crisis. But neither these measures nor
the crisis itself should divert Europe from addressing its
underlying problems. These begin with its lack of competitiveness
and the entitlements burden that, as in the U.S., poses what will
in the long term be an unbearable burden. Instead of turning--as it and
its trading partners are now doing--to protectionism, Europe needs
to move away from the faith in centralized control and the ability
of governments to manipulate markets that has brought turmoil to
the U.S. and Europe alike.
Ted R. Bromund, Ph.D., is Senior Research
Fellow in the Margaret Thatcher Center for Freedom, a division of
the Kathryn and Shelby Cullom Davis Institute for International
Studies, and Daniella Markheim is Jay Van Andel Senior Trade
Policy Analyst in the Center for International Trade and Economics
at The Heritage Foundation.