Labor Productivity per Hour Worked (EU-15 = 100) 

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... a matter of fact, the main differences between European forms of capitalism concern the financial systems and the labor markets, which remained national competences. As far as the financial system is concerned, such variables as the capitalization and liquidity of stock markets and the ratio between risk and debt capital are much higher in the USA and UK than in continental European markets such as Germany, France and Italy. In the latter, banks are more important in financing firms than in the former countries, have a universal nature, and their monitoring of and control over firms is stronger (Dietl 1998; Rajan 2010), in spite of significant changes in the last two decades. In such a way they are often able to detect early risky situations in firms and push them to rescue, thus avoiding default. Although capital re-allocation is slowed down, the rapid contagion by financial crises can also be hindered. In this kind of economic system, though, the risk of private gain from control, entrenched management, and side dealings between banks and firms may be a relatively serious problem and may slow down post-crisis recovery. 6 As a matter of fact, European progress towards truly unified financial markets and taxation has been bumpy to say the least: the most important European instrument so far has been periodical cross-controls by national authorities with some support by the European Union on so-called fiscal paradises within the Union and the control that taxpayers pay taxes in the country where they reside. As to the labor markets, entry and exit flexibility are usually higher in such countries as the USA, UK, and Ireland, and seniority relations and firm specific investments are more important in continental Europe. Due to these features, European labor markets are usually less reactive to financial shocks, thus hindering the contagion of the real economy, although at the price of slower labor re-allocation, youth and long-term structural unemployment. The institutional architecture of the EZ is intended to create opportunities for European countries and increase systemic resilience through an enlarged market and greater financial discipline. However, it also introduced new elements of vulnerability, in particular through the decoupling between fiscal and monetary policies and the asymmetry of mobility and flexibility between financial and labour markets. The common currency exacerbated both outcomes. The institutional asymmetry has to be seen in conjunction with the inherited and new structural imbalances, i.e. the imbalances which derive from the economic history of the member countries, in particular productivity differentials and the relation between public and private finance. Given the institutional architecture, these imbalances have prepared the scene for problematic and asymmetric adaptation to the global crisis. To work properly as it was designed the EZ should have complied with a number of requirements. Among the most important are: a) European integration and globalization should have been compatible: this aim was largely implemented; b) a common monetary policy should have accompanied monetary integration: a goal that was implemented successfully, the ECB having kept inflation around 2%; c) common criteria for fiscal policies should have been identified and enforced upon member countries: the Stabilization and Growth Pact (SGP) has been repeatedly broken by some of its members, even though the EZ16 as a whole exceeded the limit of 3% target only once; d) resources should have flown from strong to weak countries for supporting microeconomic convergence: this was a major failure of the integration process, also because the EU concentrated on macroeconomic issues; and e) domestic microeconomic adaptation and transformation should have been pursued with the support of national governments: another major failure. Overall, and in spite of important successes, the integration process was asymmetric to the disadvantage of the microeconomic side as compared to the macroeconomic one, thus generating an unbalanced integration. This asymmetry is the most critical element of EZ vulnerability, particularly in the long run. There is an interrelation among the above successes and failures that contributes to explain the external and internal vulnerability of the EZ in front of the international crisis. The monetary integration has strengthened the European monetary system, limiting the aggregate vulnerability to exogenous shocks of Member States. Smaller states with limited capacity to manage their currency could rely on the credibility of the Euro and the common monetary policy, while financially weaker economies gained reputation by giving discipline and credibility to their budgets anchored to European shared rules. The monetary integration and the introduction of a common currency thus led to enlargement of markets, easier and smother internal flow of resources, elimination of exchange rate risk and uncertainty, and reduction of transaction costs. Since monetary integration increased the domestic effect of asymmetric shocks, due to the lack of the monetary lever, national sovereignty of fiscal policy was conceived as the main institutional device for national adaptation along with EU budget transfers. The entire system was conceived to strengthen national and European resilience to external shocks. This process of integration and the EZ creation, together with globalization, exposed productivity differentials and made their sustainability hard, at least in the long run. Indeed, traditional coping mechanisms (in particular, the depreciation of the national currency) disappeared. In order to overcome these differentials, policy-makers promoted pro-market policies in favour of profits since the Seventies, thus causing growing distributive disparities which obtained additional peculiar drivers within the EZ. They were intended to provide incentives to investment for fostering productivity convergence. Growing employment and income should have resulted through trickle-down mechanisms, thus boosting demand and production. However, this standpoint disregarded important effects, thus meeting with unforeseen events. Indeed, increasing inequalities have reduced the importance of domestic markets, particularly of domestically produced commodities consumed by the middle-income population and have hampered opportunities for people in general and potential entrepreneurs in particular (e.g. through the polarization of savings that dried up an important source of diffused, small-scale investment). This resulted in segmentation of the economy, the society, and finally the EZ. This outcome had particularly disadvantageous effects in laggard countries. Segmentation within countries in turn depressed demand, production, and savings and fostered public and private debt. Since segmentation was primarily to the disadvantage of the middle class, a politically and economically sensitive domain, policies tried to foster the trickle-down mechanisms by supporting the middle-class consumption through different channels (easy credit, particularly for consumers and housing) Such policies increased the countries’ and economies’ vulnerability. Vulnerability, together with non-convergent fiscal rules at the European level, created the conditions for microeconomic failures hampering macroeconomic convergence and stability. In this frame the crisis has indeed magnified the gap between the vulnerable peripheral EZ member countries and a more resilient core, made up of economies with high private savings, low public debt and strong current account surplus, low disparities, high productivity and low unemployment. These economies, whose prototype is Germany, are competitive internationally and internally and capable of affording microeconomic reforms which further increase their competitiveness. They can thus implement and sustain financial constraints. On the other hand, EZ periphery is undergoing a remarkably severe downturn, which is urgently calling at the time of writing for resolute intervention spanning from ‘internal devaluation’, mainly through wage adjustments (Baldwin and Gros 2010), to credible fiscal action and structural reforms (Draghi 2010), to sovereign default (Rodrik 2010) and debt restructuring (Eichengreen 2011). At a general level of analysis, peripheral economies suffer from low or negative savings, low productivity (Figure 3) and activity rates (mostly to the disadvantage of women), high disparities (Figure 4) and unemployment (with remarkably elevated youth unemployment), rapidly rising ratios of debt to gross domestic product, high fiscal and current account deficits and elevated interest rates. The specifics differ among Greece, which meets all the aforementioned features, Portugal, which has low public and high private debt, Spain, which has low savings and low public debt, Ireland, experiencing a bank and financial system crisis hampering financial stability, and Italy, which has elevated private savings but suffers from high public debt (Table 8). All of them have been unable to comply with structural and microeconomic reforms and to implement and sustain financial constraints, and are consequently uncompetitive both externally and ...