Former EU and IMF Official spells out forgotten lessons of Eurocrisis

28 February 2014


On Wednesday 26 February, Max Watson, Wolfson College Fellow and Director of the Political Economy of Financial Markets programme at St Anthony’s College, drew on his thirty years of experience at the European Union and International Monetary Fund to outline the key lessons from the previous decades of crisis management that were forgotten in the handling of the Eurozone crisis.


Speaking at an FLJS lecture at Wolfson College entitled Can We Save Countries from Economic Crises? Some lessons from IMF and EU experience over three decades, he drew on examples of economic crises in South East Europe, Asia, and Central and Latin America to identify the successful strategies for tackling crises, and reached an optimistic view of the role of international institutions in bringing about positive change in the future.


On the Eurocrisis, Mr Watson argued that the severe depth and duration of the crisis can largely be attributed to the fact that five key lessons from the previous decades of crisis management had been forgotten:


  1. Firstly, that a large amount of money must, at the early stages of the crisis, be made available to tackle the problem in order to convince markets that the systematic problems will be effectively dealt with
  2. Some degree of austerity is necessary, but if the private sector is falling apart, as it did as a result of the banks’ deleveraging, too much austerity is harmful
  3. A targeted response is crucial – only so many reforms can be effectively implemented at any one time
  4. Creditors must speak with a single voice to secure urgent budgeting reforms (as was the case in Latin America)
  5. Debt rescheduling should be implemented swiftly to ensure that banks are not allowed to escape without being held to account.


The lecture was framed as a response to the acclaimed book Why Nations Fail by economists James A. Robinson and Daron Acemoğlu, which analyses the factors that cause nations to be rich or poor, and argues that so-called extractive institutions are responsible for the lack of development and relative poverty of certain nations.  


In response, Mr Watson sought to question the intractability of these institutional problems, choosing instead to explore exactly how external actors might improve the economic prospects of countries by targeting such extractive institutions.


Drawing on examples from South East Europe in the first decade of Transition, Mr Watson showed that the most effective way to tackle economic crises was by tackling vested interests, which was successfully achieved in Croatia, where hyperinflation was brought under control and growth stimulated, but which Romania was unable to achieve, where the vested interests proved too diffuse to strip out of the economy.


Besides tackling the internal causes of inflation and stagnant growth, another key lesson for policymakers is the effectiveness of external incentives, such as membership of the World Trade Organization, which, despite some resentment in Asian countries to the number and scope of the conditions applied to WTO membership, can be successful if managed appropriately.


Civil society, he found, is another fruitful ground for stimulating economic growth, and international bodies such as the EU can have a role to play in encouraging the emergence of NGOs and a free media, which often proves more effective than top-down interventions such as loans to governments whose economies are failing.


Mr Watson ended with an endorsement of the work of the European Stability Mechanism, and, despite the failures to apply the lessons of previous decades in the handling of the Eurocrisis, expressed cautious optimism on the ability of policymakers to positively intervene in future economic crises.


David Vines, Professor of Economics and Fellow of Balliol College, Oxford, gave a response to the lecture by emphasizing the need for countries facing economic instability to avoid transferring risk onto tax payers, and instead, to adopt an outward looking strategy of growth promotion by focusing on increased competitiveness in the global market.


He identified the very nature of the monetary union in Europe as responsible for the length of the adjustment phase following the crisis, and argued that, in cases of extended adjustment such as this, increased lending should be the focus of policymaking efforts as opposed to harsh austerity measures.


A transcript and podcast of the event can be downloaded from the links at the top right of the page.