What Should we Learn from Europe's Mistakes?

The European Union project that was once seen as a great hope for the continent to re-energize itself has increasingly obviously run into an existential crisis.

The more than 50 years of shared history of peace and stability, along with a desire to avoid a relapse to old-fashioned beggar-thy-neighbor policies, is likely to galvanize the necessary political will to preserve the Union, as well as the Euro.

However, it is clear that the crisis will take years to fully overcome and understandable questions are now being asked about what went wrong and how this can be avoided going forward.

The lessons of the European crisis are of great importance for the Gulf, not only in their own right as indications of what responsible policy making entails but also because the GCC not only resembles Europe as an economic community but also hopes to replicate its successful integration. A number of key messages from the European experience merit close attention.

Clear rules are essential. This is one area where the track record of the Gulf countries is far superior to that of Europe. Chastened by the painful experience of low oil prices in the 1980s and 1990s, the Gulf countries have embraced a highly technocratic and strategically anchored approach to policymaking.

This has helped the region to get through the crisis with relatively minimal disruptions. The most vulnerable economies – Dubai and Kuwait – owe their problems to insufficient regulation and supervision of the real estate and non-banking financial sectors, which resulted in excessive leverage and a property bubble.

In both cases, the authorities have been forced to focus their efforts on fundamental regulatory reform. Perhaps the most important thing going forward is to ensure that the rules underpinning policy making are subject to an ongoing review and revised where appropriate. The purpose of regulation is to foster, not inhibit, growth, while ensuring its sustainability.

Transparency keeps you honest. Proper economic statistics area needed to understand ongoing trends and to identify risks in a timely manner. The key challenge for the Gulf countries is not only to improve the quality, coverage, and timeliness of statistics but to harmonize them across the region.

The experience of the global economic downturn has highlighted the vulnerabilities created by a lack of understanding, in turn caused by a lack of accurate data. While the Greek problems were obvious enough to most observers, their impact was amplified by inaccurate statistics. The crisis was significantly accelerated by periodic revelations of misreporting. Among other things, the ultimate correction of these misperceptions led to repeated downgrades of Greek government debt, thereby further fueling market anxiety.

Economic integration should be about concrete economic benefits. One of the vulnerabilities of European Union project has been a disproportionate focus on the political dimension of integration.

While this has been an understandable concern from the perspective of ensuring timely and efficient decision-making in what is now a community of 27 nations, it has also alienated the project from ordinary citizens. The European Union remains above all an economic undertaking.

One of the most encouraging aspects of integration in the Gulf region has been the recent focus on economic and technical issues. This is ultimately likely to be the main way of generating concrete benefits for the local population and businesses. The more obvious and tangible the results of integration, the greater the popularity of the project in the eyes of citizens and policymakers alike.

A single currency without credible rules risks becoming an economic straightjacket. In many ways, the Euro has been an impressive success that has exceeded expectations. It has created large, deep financial markets, fostered corporate consolidation, and driven regulatory harmonization.

It was in part this success that sowed the seeds for the current crisis. By reducing the traditional risk premiums associated with some of the Mediterranean issuers, the Euro enabled them to raise debt capital more cheaply and effectively than used to be the case.

Essentially, they became ‘free-riders,’ benefiting at the expense of their more disciplined neighbors. Nonetheless, the single currency rules out many conventional adjustment mechanisms in this situation and, in the absence of sufficient flexibility on the part of individual members, risks becoming a burden in the same way as the inter-war Gold Standard.

Under the circumstances, competitiveness, when lost, must be regained through increased productivity and lower costs. Gulf countries have a particular advantage in this regard because of the long-standing Dollar pegs outside of Kuwait, but the revaluation debate nonetheless became vocal in 2007-2008.

Rules must be monitored and effectively enforced. The principal shortcoming in Europe was not a lack of rules but there incomplete implementation and ineffective enforcement. Under the European Growth and Stability Pact, Greece should never have run up the deficits it did. Yet there was no credible mechanism preventing it from doing so. A key challenge for the GCC economies, as they prepare for the single currency, is to make sure that economic imbalances are detected before they become too great and that there are collective enforcement mechanisms to force countries to embark on corrective action in a timely manner.

Risk management matters. Formal risk management mechanisms always create risks of moral hazard but also help boost credibility. The existence of the International Monetary Fund, because of the strict conditionality of loans, has created a reasonably effective last-resort mechanism, one that governments are reluctant to tap unless they have to. The European Union was ill prepared for the crisis and the current debate on a European Monetary Fund is one that the Gulf countries should pay close attention to.

Mistakes are expensive. Europe is paying a heavy price for its failure to enforce rules. The countries facing years of austerity will pay a heavy economic price, and it is still too soon to tell whether these costs will prove politically acceptable. Moreover, bail-out packages are expensive in their own right, but also because of the risks of moral hazard and the political costs they entail.

In Europe, the support from the Union is even threatening the credibility of the European Central Bank, once seen as an heir to the German Bundesbank which was known for its rigorous rules. Now it has had to enter the markets as a buyer of Greek bonds to assuage investor fears.

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