In 2010, the 2008 global financial crisis morphed into the “eurocrisis.” It has not abated. The 19 countries of Europe that share the euro currency—the eurozone—have been rocked by economic stagnation and debt crises. Some countries have been in depression for years while the governing powers of the eurozone have careened from emergency to emergency, most notably in Greece.
Hailed by its architects as a lever that would bring Europe together and promote prosperity, the euro has done the opposite. The crises have revealed the shortcomings of the euro. Europe’s stagnation and bleak outlook are a direct result of the fundamental challenges in having a diverse group of countries share a common currency—the euro was flawed at birth, with economic integration outpacing political integration. The current structure promotes divergence rather than convergence. The question then is: Can the euro be saved?
The European Central Bank’s misguided inflation-only mandate and eurozone policies, especially toward the crisis countries, have further exposed the zone’s flawed design, There are few possible ways forward: fundamental reforms in the structure of the eurozone and the policies imposed on the member countries; a well-managed end to the single-currency euro experiment; or a bold, new system dubbed the “flexible euro.”
This Newsletter throws light on the major Economists consensus on what happened with the Euro and the way forward. Although a few economists still stand in support of the eurozone’s survival we are now moving towards the dangerous precipice where things are getting out of hand.
The euro is the currency of 19 countries, each with a different economic situation. Because the currency is not flexible, crisis-hit countries like Greece are unable to devalue their currency during hard times. Not only was the design of the euro flawed from the beginning, but the austerity policies enacted as a response to the euro crisis—generally higher taxes and lower government spending—made the situation worse by stunting growth. These policies were enacted due to neoliberal “market fundamentalism,” a belief that the market is always right and government has little to no role in shaping economic policy to solve the crisis, there should either be “more Europe” (greater economic integration between eurozone members) or “less Europe” (a partial unraveling of the euro project). Regardless of the solution chosen, the current path is extremely costly and unsustainable.
The euro was founded on three interrelated principles:
Uniting Europe economically and politically.
Increasing economic growth due to tighter integration.
Peace due to economic prosperity and political integration.
Given Europe’s tumultuous and bloody history during the first half of the 20th century, these interrelated goals were seen as vital by the founders of the eurozone. They had hoped that a united Europe would be more influential and powerful on the world stage, but, in reality, the EU only has true influence on a limited number of issues where there is a broad consensus among member states.
Economic integration can be achieved without a common currency. The United States and Canada, for example, have had a free trade deal since 1988 and have very co-dependent economies. Although the euro was a noble goal, an integrated economic system without agreement on how the economy should be managed is unsustainable. Economic integration that outpaces political integration is a major problem, and while the eurozone is economically integrated, it is quite divided politically. Moreover, the euro has created a “democratic deficit” in which democratically elected governments such as Greece have been forced to accept policies they oppose. Their economy and membership in the eurozone is held hostage by the powerful European Central Bank, which is not democratically elected and is heavily influenced by powerful countries like Germany.
The eurozone has performed poorly during the post-financial crisis period. Germany, held up by some as a model of European growth, has only grown by 6.8 percent since 2007, an extremely low growth rate by historical standards. Other countries, such as Spain, Italy, and Portugal, have seen GDP fall by levels that rival or exceed the contractions they experienced during the Great Depression.
Countries like Germany have blamed these problems on corruption, profligate spending, inefficient labor markets, and the like. Yet it was the euro’s lack of flexibility that made it impossible for countries to adapt to changing economic circumstances, and has therefore caused much of the eurozone’s financial pain. It is important to note that while the economic problems are the most visible, other indirect effects, such as a spike in suicides, reveals the truly devastating cost of the failure of the eurozone.
Many people have looked to the United States and argued that if it can have a single currency, so can Europe. However, the United States is much more united in terms of culture, language, and legal regulations, making the US model inapplicable for Europe.
Because the euro makes a country-specific devaluation of currency impossible, many believed that internal devaluation—lower prices of labor, goods, or services—on a country-specific basis would fill in the gap.
While internal devaluation has occurred, it has not been an adequate substitute for the exchange rate mechanism. Perniciously, internal devaluation results in lower GDP and hurts workers who have to settle for lower wages Furthermore, Europeans tended to emphasize fiscal deficits instead of trade deficits. In the 1990s, many believed that trade deficits were caused by excessive government spending, but now we know they are caused by the private sector.
Moreover, eurozone countries are limited to a fiscal deficit of 3 percent of GDP, which means they are not able to spend their way out of a crisis. Currencies that are fixed and inflexible—as is the euro—are prone to crisis because they lack a proper exchange rate mechanism. The euro has created a peculiar situation in which a country borrowing in its own currency exposes itself to the risk of being unable to repay its debts. If, for example, the United States is in debt, it can always print the money that it owes. Greece, on the other hand, cannot freely print euros, and is thus stuck with crushing levels of debt. While it was believed the euro would create convergence among economies in Europe, it has, in reality, pushed them apart.
Many believed that the euro would foster convergence among economies; in reality the opposite was true—it created divergence. For example, even though Greek and German banks both do business in euros, money has flowed out of Greek banks toward German ones, as most believe German banks are more stable than their Greek counterparts. The weaker banks thus become less well-capitalized. If there was a common deposit insurance scheme across the eurozone, this problem would be eliminated, yet Germany opposes it, believing that it would essentially amount to rich countries bailing out poor countries. The German government argues that common standards and rules are necessary as a precondition to common deposit insurance. The common euro system has also led to a regulatory race to the bottom as countries compete to attract business by offering the least regulation. Since every eurozone country has the same access to the single market, but each country has separate regulations, this encourages individual countries to lower their standards in order to attract businesses that can base themselves in lightly regulated areas and sell products or financial services to areas with stricter regulations.
The free movement of labor also exacerbates the problem, as skilled high-earning individuals leave crisis-hit countries for other areas of the eurozone. Not only does this hurt the ability of indebted countries to pay back their debts, it increases the incentives for other workers to leave, as only the workers who remain are responsible for the increased taxes needed to supply government services and pay off the immense debt. Further causes of divergence include the austerity policies—such as higher taxes and lower government spending—adopted as a response to the crisis, the lack of investment in infrastructure and other areas by poorer countries, the lack of wealth of certain eurozone countries, and the differing rates of adopting technologies.
Although common Eurobonds—bonds jointly issued by all eurozone members—could solve some of the problems of divergence, they are adamantly opposed by a group of countries led by Germany. Further austerity and economic reforms imposed to alleviate the crisis may only make it worse.
European Central Bank
Although the European Central Bank has been fundamentally flawed since its inception, it has done some good, particularly in 2012, when the head of the institution, Mario Draghi, declared that the ECB would do “whatever it takes” to save the euro.
A key flaw of the ECB is its mandate to focus solely on taming inflation. By contrast, the American Federal Reserve addresses both unemployment and financial stability in addition to inflation. This singular focus on inflation has restricted the ECB from helping alleviate unemployment, which has, in turn, permanently lowered economic growth in Europe. Combating inflation instead of joblessness prioritizes creditors over debtors and employers over job seekers, which increases inequality. While it is often believed that the ECB is not and should not be a political institution, the reality is that the choices made by the ECB are political decisions. The decision not to bail out Greek banks was political in nature, just as was the decision to make the ECB independent. In reality, no institution is truly independent. The ECB is largely staffed by financial professionals with their own agendas, while other voices affected by ECB decisions—like labor—are absent.
In the modern era, many different theories of monetary policy have been ultimately discarded. Monetarism, the belief that the monetary supply should be increased at a fixed rate, was popular; however, it led to the US recession of the early 1980s and a lost decade in Latin America.
Inflation targeting, the belief that the central bank should focus solely on inflation, took the place of monetarism, yet it too has proven unworkable, as shown by the ECB’s failed inflation-only mandate, which resulted in higher unemployment.
Quantitative easing, essentially the printing of money as a form of economic stimulus, which had only a limited impact in the United States, fared even worse in Europe because other countries were already doing it, and emerging market countries had begun to protect themselves from competitive devaluations.
The Troika Policies Compounded the Flawed Eurozone Structure, Ensuring Depression (The Troika comprises of the European Commission, the European Central Bank and the International Monetary Fund)
The euro was built on shaky foundations, and the policies enacted to fix the euro crisis have only exacerbated the problem. Instead of focusing on growth in crisis-hit countries, the economically stronger countries forced austerity programs on the hard-hit countries, making it even more of a challenge for them to recover from crisis. For example, the Troika pressured Greece into adopting measures that make it almost impossible for cash-strapped Greeks to protect their houses from foreclosure. This policy won’t fix the economy; it will merely put families on the street.
Austerity is not only a flawed policy but an ideological attempt to minimize government and its role in the economy. Austerity primarily consists of increased taxes, reduced spending, and the privatization of certain sectors of the economy. Of course, reduced spending and higher taxes simply compound the economic malaise. Moreover, the system implemented in Greece, which includes paying taxes ahead of time, simply encourages more tax evasion and hurts small businesses.
Germany has consistently opposed a realistic debt restructuring for Greece, yet some believe that Greece should go ahead with or without German approval. Indeed, Argentina grew rapidly after its own restructuring. A more realistic proposal, with sensible structural reforms, some debt write-offs, and a lower primary surplus requirement, would have helped Greece much more than austerity.
Most academics agree that austerity is a flawed policy and that the austerity policies imposed on Greece have exacerbated its downturn.
In return for financial assistance during the crisis, the Troika demanded structural reforms to the economies of crisis-hit countries. These so-called reforms were often counterproductive, outright harmful, or simply a waste of time. For example, the Troika demanded Greece change its laws regarding uniform bread loaf size and what qualifies as fresh milk.
More disconcerting, the Troika curtailed workers’ rights through labor reforms. It would be better, to adopt an industrial policy that steers crisis-hit economies toward productive industries instead of simply relying on the market to lead to economic growth. A focus on fighting inequality and distributing political and economic power equitably would also promote lasting growth.
Furthermore, reforms to the financial sector, including greater oversight to prevent financial crises in the first place, are crucial. Finally, committing to fight climate change is not only a moral and ecological imperative, it is also sound economically.
For example, Spain and Greece have the ability to produce wind and solar power that could be exported to other countries in Europe. Adopting an agenda that promotes growth, instead of the austerity measures that restrict it, could mean a healthier Europe.
Unfortunately, austerity has ruled European policy, resulting in higher unemployment and anemic growth.
A Way Forward? Creating a Eurozone That Works
To fix the eurozone’s economic problems, a way to go is either “more Europe” or “less Europe.”
To achieve “more Europe,” the following changes are necessary:
A banking union complete with common deposit insurance to prevent bank runs in weaker countries.
The “mutualization of debt,” such as through jointly issued Eurobonds, to help prevent divergence between the fortunes of weaker and stronger eurozone members.
A “common framework for stability” that includes a fund for common action, improved budget rules, automatic stimulus in the case of a downturn, better regulation of the economy, and other steps to ensure stability in the eurozone.
A “true convergence policy” that discourages surpluses and simultaneously increases wages in creditor countries like Germany. Changing the mandate of the ECB to focus on full employment and economic growth, not only on controlling inflation. Adopting further structural reforms, including an expedited bankruptcy process, corporate governance reforms, the promotion of investments in the environment, and financial reforms to ensure stability and long-term prosperity.
A “commitment to shared prosperity,” including limiting tax competition between member states and making redistribution a supranational, European-level responsibility. In addition to these reforms, further “crisis policy” reforms are necessary, including growth policies, ditching austerity, and restructuring the debts of crisis-hit states that are unable to move past crushing levels of debt.
Can There Be a Divorce which isn’t messy?
Although “more Europe” might solve the eurozone’s problems, these reforms may never be implemented for political reasons. If they are not, a “less Europe” strategy would involve several important steps.
Leaving the euro, a crisis-hit country such as Greece could convert to an e-payment system, eliminating paper currency and allowing the country to return to the drachma without a lag period. Moreover, this would result in improved ability to collect taxes. After a divorce, Greece would restore its ability to create credit. This would allow Greece to create a new, accountable system that prevents bankers and financial institutions from irresponsible actions, which would exploit investors, the poor, and national governments.
A trade token system (or Chits or Tokens), would require chits in proportion to exports, resulting in a trade balance or a trade surplus. Exporters would be granted one token for each euro worth of goods exported. Importers would need to pay one token for each euro worth of goods imported. This would create a market in tokens, but since the supply of imported goods could not outweigh the supply of exports, Greece would experience long-term stability.
Furthermore, debt restructuring of Greece would help set it on the path to prosperity. Alternatively, Germany and other northern European countries could leave the euro, minimizing many of the problems and contradictions inherent in the common currency.
Moving toward a system with a flexible euro is another workable strategy. Countries would change to an electronic system, allowing flexible euro exchange rates by country. To stabilize the relative exchange rates between eurozone countries, the following steps could be taken:Germany and other surplus countries could balance their trade through a chit system (as described in the previous Paragraph). The burdens of economic adjustment could be shared more efficiently by all members, instead of being primarily imposed on deficit countries. More investment in struggling countries, including infrastructure investment and a solidarity fund, would help close the productivity gap. Fundamentally, regulators need to improve oversight over economic matters and actively work toward a fairer system that eliminates negative externalities, i.e., the harmful effects experienced by disadvantaged people who have no voice in making these economic decisions. Although some want to return to a time when there were fewer regulations in the economy, this will only lead to financial crisis or disaster. Eventually, once sufficient harmonization and convergence has been achieved, this flexible euro strategy could allow Europe to have a true, successful single currency.
It is unlikely that any of the methods spoken about will be implemented. Instead, the pressure will build until one or more countries leave the eurozone. Usually, creditors want to make it possible for their debtors to pay back their loans. So why did Germany implement policies that actually made it harder for Greece to repay its debts? The root cause is a belief in discredited economics and blame-the-victim ideology. Fundamentally, arguments over austerity and the euro are a fight about power and ideology, which have been forced upon countries like Greece. Not only is this bad policy, it is undemocratic. Neoliberalism has failed in the United States, resulting in economic stagnation for most people and rising incomes only for those at the top. These same trends are playing out in Europe. Despite these headwinds, saving the European project is extremely important. Europe was the birthplace of the enlightenment, and it continues to be a strong voice in the fight for human rights and democratic values.
The euro can be saved, but it must be done in a way that creates prosperity for all.
(The article first appeared on https://thefinancialpandora.com/)