Can the Euro be re­paired?

Financial Mirror (Cyprus) - - FRONT PAGE -

When Wolf­gang Schäu­ble, Ger­many’s fi­nance min­is­ter, re­cently tabled the op­tion of a Greek exit from the euro, he wanted to sig­nal that no mem­ber could ab­stain from the mon­e­tary union’s strict dis­ci­plines. In fact, his ini­tia­tive trig­gered a much broader dis­cus­sion of the prin­ci­ples un­der­pin­ning the euro, its gov­er­nance, and the very ra­tio­nale for its ex­is­tence.

Only a fort­night be­fore Schäu­ble’s pro­posal, Europe’s lead­ers had barely paid at­ten­tion to a re­port on the euro’s fu­ture pre­pared by Euro­pean Com­mis­sion Pres­i­dent Jean-Claude Juncker and his col­leagues from the other Euro­pean Union in­sti­tu­tions. But the new dis­pute over Greece has con­vinced many pol­i­cy­mak­ers of the ne­ces­sity to re­turn to the draw­ing board. Mean­while, cit­i­zens won­der why they share this cur­rency, whether it makes sense, and if agree­ment can be reached on its fu­ture.

For cur­ren­cies, as for coun­tries, found­ing myths mat­ter. The con­ven­tional wis­dom is that the euro was the po­lit­i­cal price Ger­many paid for French ac­qui­es­cence to its re­uni­fi­ca­tion. In fact, Ger­man re­uni­fi­ca­tion only pro­vided the fi­nal im­pe­tus for a pro­ject con­ceived in the 1980s to re­solve a long­stand­ing dilemma. Euro­pean gov­ern­ments were both strongly averse to float­ing ex­change rates, which they as­sumed would be in­com­pat­i­ble with a sin­gle mar­ket, and un­will­ing to per­pet­u­ate a Bun­des­bankdom­i­nated mon­e­tary regime. A truly Euro­pean cur­rency built on Ger­man prin­ci­ples ap­peared to be the best way for­ward.

In ret­ro­spect, Ger­man re­uni­fi­ca­tion was more a curse than a bless­ing. When ex­change rates were locked in 1999, Ger­many’s was over­val­ued, and its econ­omy was strug­gling; France’s was un­der­val­ued, and its econ­omy was boom­ing. Dur­ing the en­su­ing decade, im­bal­ances slowly grew be­tween a resur­gent Ger­many and coun­tries where low in­ter­est rates had trig­gered credit booms. And when the global fi­nan­cial cri­sis erupted in 2008, con­di­tions were ripe for a per­fect storm.

No one can say how Europe would have evolved with­out the euro. Would the fixedex­change-rate sys­tem have en­dured or col­lapsed? Would the Deutschemark have been over­val­ued? Would states have rein­tro­duced trade bar­ri­ers, end­ing the sin­gle mar­ket? Would a real-es­tate bub­ble have de­vel­oped in Spain? Would gov­ern­ments have re­formed more or less?

Es­tab­lish­ing a coun­ter­fac­tual base­line against which the euro’s im­pact could be as­sessed is im­pos­si­ble. But that is no ex­cuse for com­pla­cency. Over the last 15 years, the eu­ro­zone’s eco­nomic per­for­mance has been dis­ap­point­ing, and its pol­icy sys­tem must an­swer for this.

What re­ally mat­ters is whether a com­mon Euro­pean cur­rency still makes sense for the fu­ture. This ques­tion is of­ten evaded, be­cause the cost of ex­it­ing is deemed too high to con­sider it (and could be higher still if the break-up takes place in a cri­sis and sharp­ens re­cip­ro­cal ac­ri­mony among par­tic­i­pat­ing coun­tries). More­over, pulling the plug on the euro could un­leash the dark forces of na­tion­al­ism and pro­tec­tion­ism. But, as Ox­ford’s Kevin O’Rourke re­cently ar­gued, this is hardly a suf­fi­cient ar­gu­ment. It is the log­i­cal equiv­a­lent of ad­vis­ing a cou­ple to re­main mar­ried be­cause di­vorce is too ex­pen­sive.

So does the euro still make sense? It was ex­pected to de­liver three eco­nomic ben­e­fits. Mon­e­tary union, it was as­sumed, would foster eco­nomic in­te­gra­tion, bol­ster­ing Europe’s long-term growth. In­stead, in­traeu­ro­zone trade and in­vest­ment have in­creased only mod­estly, and growth po­ten­tial has ac­tu­ally weak­ened. This is partly be­cause na­tional gov­ern­ments, rather than build­ing on cur­rency uni­fi­ca­tion to turn the eu­ro­zone into an eco­nomic pow­er­house, tried to hang onto their re­main­ing power. This was per­haps log­i­cal po­lit­i­cally, but it made no eco­nomic sense: Europe’s huge do­mes­tic mar­ket is one of its main as­sets, and op­por­tu­ni­ties to strengthen it should not be squan­dered.

Sec­ond, it was hoped that the euro would be­come a ma­jor in­ter­na­tional cur­rency (par­tic­u­larly given how few coun­tries are equipped with the nec­es­sary le­gal, mar­ket, and pol­icy in­sti­tu­tions). And, ac­cord­ing to re­cent ECB sta­tis­tics, this hope has been largely ful­filled. With in­ter­na­tional use of the euro be­hind only the US dol­lar, this achieve­ment can help Europe to con­tinue shap­ing the global eco­nomic or­der, rather than slid­ing into ir­rel­e­vance.

Third, it was (some­what naively) be­lieved that the in­sti­tu­tions un­der­pin­ning the euro would im­prove the over­all qual­ity of eco­nomic pol­icy, as though Europe-wide poli­cies would au­to­mat­i­cally be bet­ter than na­tional ones. The acid test came in the af­ter­math of the 2008 global fi­nan­cial cri­sis: be­cause it over­es­ti­mated the fis­cal di­men­sion of the cri­sis and un­der­es­ti­mated its fi­nan­cial di­men­sion, the eu­ro­zone per­formed worse than the United States and the United King­dom.

If the euro is to cre­ate pros­per­ity, fur­ther re­forms of the pol­icy sys­tem are there­fore needed. But an agenda can be de­signed and im­ple­mented only if there is a broad con­sen­sus on the na­ture of the prob­lem. And, as the on­go­ing dis­pute over Greece il­lus­trates, agree­ment re­mains elu­sive: Par­tic­i­pat­ing coun­tries have de­vel­oped con­tra­dic­tory analy­ses of the causes of the debt cri­sis, from which they de­rive con­tra­dic­tory pre­scrip­tions.

Richard Cooper of Har­vard Univer­sity once ob­served that in the early days of in­ter­na­tional public health co­op­er­a­tion, the fight against global dis­eases was ham­pered by coun­tries’ ad­her­ence to dif­fer­ent mod­els of con­ta­gion. They all fa­vored joint ac­tion, but they could not agree on a plan, be­cause they dis­agreed on how epi­demics crossed borders.

That is the prob­lem the eu­ro­zone faces to­day. For­tu­nately, it is not un­solv­able, as sig­nif­i­cant re­forms like the cre­ation of the Euro­pean Sta­bil­ity Mech­a­nism and the launch of bank­ing union show. Dis­agree­ments also did not pre­vent the ECB from act­ing boldly, which il­lus­trates that the gov­er­nance of in­sti­tu­tions does mat­ter. But the fact that re­forms and ac­tions were un­der­taken only lately, and un­der the pres­sure of acute cri­sis, is a sober­ing re­minder of the dif­fi­culty of reach­ing con­sen­sus.

Europe can­not af­ford to pro­cras­ti­nate and pre­tend. Ei­ther the eu­ro­zone’s mem­bers find agree­ment on an agenda of gov­er­nance and po­lit­i­cal re­forms that will turn the cur­rency union into an en­gine of pros­per­ity, or they will stum­ble re­peat­edly from dis­pute to cri­sis, un­til cit­i­zens lose pa­tience or mar­kets lose trust.

Clar­ity is a pre­req­ui­site of se­ri­ous dis­cus­sion and am­bi­tious re­form. Each of the ma­jor par­tic­i­pants now has an obli­ga­tion to de­fine what it re­gards as in­dis­pens­able, what it con­sid­ers un­ac­cept­able, and what it is ready to give in ex­change for what it wants.

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