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Guidance counseling

12 August 2016 By Neil Unmack

The euro is flawed and and Germany is to blame. That is the main contention of Joseph Stiglitz’s new book. Even a Europhile would have to admit there’s something to the bleak analysis of too little solidarity and too much austerity in “The Euro: How a Common Currency Threatens the Future of Europe”. While diagnosing a bad marriage is easy enough, working out how to fix or dissolve it is what no-one – including Stiglitz – has really managed.

Where many Europeans see a crowning achievement in political integration, the former World Bank chief economist sees a daft idea. A common currency hasn’t cemented European peace or extended its influence, and nor has it solved any serious problems. Instead, it wed countries with vastly different economic and social backgrounds together and deprived them of a critical economic tool: exchange rate flexibility.

The one thing worse than a bad idea, meanwhile, is a badly executed one. With fixed exchange rates and no ability to devalue, countries should have had extra help to cope with tough times, Stiglitz argues, yet the pain of adjustment was left with individual countries. This “fatal decision” was exacerbated by the ideology of Germany, which as the union’s largest member insisted on a central bank that prioritised fighting inflation over promoting growth, and fiscal rules that limited governments’ ability to support their economies. Belief in the efficiency of free markets left countries exposed to chaotic capital flows and bad investment decisions.

Greek bailouts get plenty of airtime. Stiglitz sees as “wrong, destructive and almost unbelievably narrow-minded” the decision to push through neo-liberal reforms and simultaneously bring down deficits by increasing taxes and cutting spending. Liberalisations helped foreign companies, not Greek citizens, while privatisations robbed them of profit, he argues.

Yet even aside from Greece, Stiglitz argues the zone has achieved the opposite of its intention: poorer economic growth, underinvestment and political fragmentation. Output per working-age person has risen just 0.6 percent since 2007, compared with 3.9 percent for other European countries. He estimates the present value of all future lost output at an implausibly high 200 trillion euros.

In reality neither European institutions nor Germany are quite as rigid as Stiglitz paints them. However barbaric the Greek bailout, the European Commission has allowed governments to increase deficits, or at least slow their reduction, and the European Central Bank been allowed to print money. Both have received Germany’s grudging acceptance.

So to the real question: how to fix this wretched union. Stiglitz argues that completing the euro zone would be the best option. Some of his proposals are non-starters or not very relevant – like fighting excess corporate pay – but the most critical ones are spot on: common social security funds, a proper banking union with deposit insurance, fiscal rules that promote investment, debt restructuring. He doubts this can be achieved in time.

That leaves divorce. Stiglitz doesn’t seem terribly interested in thinking about who or what would trigger a breakup, other than to say that a crisis is “more likely than not” in the “not too distant future”. Well, perhaps. But even after five years of recession, Greeks clung to the euro. One novel idea of returning to free-floating currencies but with rationed exports and imports to keep deficits and exchange rates in check is appealing, but not sketched out in enough detail to reassure anyone thinking of taking the leap.

The euro’s existential dilemma thus remains disappointingly unsolved. Making a true political union requires steps that few governments can endorse, such as transfer of fiscal sovereignty. Breaking the currency zone up looks harder still: Germany is very unlikely to leave, and governments in weak countries know the probable trauma will cost them their jobs. Italy, which owns more of its debt than foreigners and has a vibrant export sector, or a northern country with little debt, like Finland, could be the exception.

What Stiglitz also underestimates is how flexible Eurocrats have proven before when it comes to ensuring their survival. They have transgressed taboos from bailouts to default, and most recently quantitative easing. The UK decision to leave the European Union could tie the region up for decades, and discourage others from rocking the boat. Divorce and counseling have their place, but in any bad marriage there’s always a third option: simply keep up the facade for just a little bit longer.


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