Euroland lesson for a stand-alone nation-state

WHILE Australia has been busy with its budget and resources tax debate, Euroland has come to the brink of financial meltdown in an event that captures a bigger story, the crisis of governance in the West.

Ten days ago Europe's leaders launched the biggest rescue package in the continent's history, a E750 billion ($1060bn) bailout designed not just to salvage Greece but to stabilise the euro. This emergency derives from a crisis where Euroland has been living beyond its means with debt and deficit levels revealing a failure of governing institutions and leaders.

In an interview with Spiegel online published last weekend, European Central Bank president Jean-Claude Trichet said: "It is clear that since September 2008 we have been facing the most difficult situation since World War II, perhaps even since World War I. We have experienced and are experiencing truly dramatic times."

Trichet compared Europe's situation with that of September 2008 following the Lehman Brothers' bankruptcy when the world stared into the financial abyss. His message is obvious: the crisis has evolved to a new flashpoint. The issue is sovereign risk and whether national governments will fail to meet their financial obligations.

"Now we see the signature of some governments put into question," Trichet said. "This is a problem for almost all industrial countries. In the G7, the major economies have a yearly deficit of about 10 per cent of gross domestic product. In the euro area as a whole it averages 7 per cent of GDP. In this situation with extremely elevated deficits across the globe the markets have signed out a weak link, Greece.

"There is always a danger of contagion, like the contagion we saw among the private institutions in 2008. And it can occur quickly. Sometimes it is a question of half days."

This Euroland perspective is defined by euro shock, broken hopes for the European project, punitive economic measures looming in much of Europe and the demand to re-assess domestic and European governance.

Anybody who thinks these events are irrelevant to Australia is a fool. There are two messages: that markets will smash weak nations and that rich world governments face a constant war against almost unlimited financial demands on the state by citizens and lobby groups that morph into vote-buying election techniques that, through time, constitute a sovereign risk.

This is what has happened in Europe. Greece's GDP is set to shrink by 7 per cent in two years; the next dominoes at risk are Portugal and Spain, the latter having a budget deficit of 11.5 per cent of GDP and unemployment at 19 per cent, with Prime Minister Jose Zapatero announcing a 5 per cent pay cut for public servants; the coming British crisis is irresistible now the campaign fantasies are terminated, with the European Commission predicting Britain's budget deficit heading to 12 per cent of GDP, the highest in Europe and proof of the failure of New Labour; and in Germany opinion has turned hostile to bailing out countries such as Greece, evidence of failing European solidarity.

The E750bn bailout is not a solution. It is a stabilisation mechanism to prevent defaults. The solution, bitter and slow, lies in economic reform, better productivity and restoration of fiscal balances. The dilemma is whether the bailout promotes such reform or, by rewarding bad policy only encourages more bad policy.

Europe has reached another crossroads: monetary union without genuine economic union (let alone political union) does not work. It is stranded in a half-way house. Centre for European Reform chief economist Simon Tilford says: "Unfortunately, the eurozone fulfils few, if any, of the criteria for a successful currency union. The participating economies can hardly be described as fully integrated." Labour mobility is virtually non-existent. There are vast trade imbalances between members, no fiscal integration and no devaluation option for nations in trouble. In the near term Europe faces a new austerity; in the medium term its choice is deeper integration or growing disintegration.

The project of a united, strong Europe is back in the melting pot. It is no cause for celebration. It is also false to think the crisis of contemporary governance is a Europe phenomenon. It is, rather, a North Atlantic story. The origins of the 2008 global financial crisis lay in America's financial system, poor prudential supervision and defects in US governance. The most recent analysis from the US Congressional Budget Office on President Obama's 2011-year requests projects a budget deficit of 10.3 per cent of GDP with public debt growing to $20.3 trillion or 90 per cent of GDP by 2020. Sadly, there is no US strategy to return to surplus. The idea is not on the agenda.

For Australia, this leads to vital conclusions. The world is a highly dangerous and unpredictable place. The structural economic adjustments required in Europe and the US are huge. The strains imposed on their democratic societies will be immense. If the eurozone needs to be stabilised just imagine the consequences of equivalent blunders for Australia.

Our strategic situation needs to be appreciated. Australia, unlike Spain, Italy or Greece, is completely responsible for its own fate. No longer does it enjoy the protection of a great empire. It belongs to no regional or monetary union. It has nowhere to run and nowhere to hide. It is a stand-alone nation state that will succeed or fall on its own efforts to negotiate the globalised world. Its destiny lies in disproving the assumption that underpins Euroland, that nation states are weak and self-serving and need a grand union to guarantee safety in numbers.

The truth is if Australia were delivering the same economic results as much of Europe or the US, markets would take their vengeance and our situation would be untenable. It is this recognition, born in the crises of the 1980s, that has driven public policy under the governments of Bob Hawke, Paul Keating, John Howard and now Kevin Rudd. This is why Howard and Peter Costello eliminated public debt. It is why Rudd and Wayne Swan have brought down a budget that predicts a surplus in three years after public debt peaks at only 6 per cent of GDP, results most other First World nations only dream about. Swan was right in his budget speech to raise the spectre of Greece. The medium-term fiscal rules set by the Rudd government are critical as a signal to unforgiving financial markets.

Australian strategy must lie in policy that aspires to first-best global practice, whether the issue is fiscal, monetary or the resources tax. The defining test for our governance is to avoid the deadly malaise that grips much of the North Atlantic democratic zone.