Summary and Analysis of The Euro: How a Common Currency Threatens the Future of Europe - Joseph E. Stiglitz (2016)

PREFACE

The world has been bombarded with depressing news from Europe. Greece is in depression, with half of its youth unemployed. The extreme right has made large gains in France. In Catalonia, the region surrounding Barcelona, a majority of those elected to the regional parliament support independence from Spain. As this book goes to press, large parts of Europe face a lost decade, with GDP per capita lower than it was before the global financial crisis.

Even what Europe celebrates as a success signifies a failure: Spain’s unemployment rate has fallen from 26 percent in 2013 to 20 percent at the beginning of 2016. But nearly one out of two youth remain unemployed,¹ and the unemployment rate would be even higher if so many of its most talented young people had not left the country to look for jobs elsewhere.

What has happened? With advances in economic science, aren’t we supposed to understand better how to manage the economy? Indeed, Nobel Prize-winning economist Robert Lucas declared in his 2003 presidential address to the American Economic Association that the “central problem of depression prevention has been solved.”² And with all the improvements in markets, shouldn’t it be even easier to manage the economy? The mark of a well-functioning economy is rapid growth, the benefits of which are shared widely, with low unemployment. What has happened in Europe is the opposite.

There is a simple answer to this apparent puzzle: a fatal decision, in 1992, to adopt a single currency, without providing for the institutions that would make it work. Good currency arrangements cannot ensure prosperity, but flawed currency arrangements can lead to recessions and depressions. And among the kinds of currency arrangements that have long been associated with recessions and depressions are currency pegs, where the value of one country’s currency is fixed relative to another or relative to a commodity.

America’s depression at the end of the 19th century was linked to the gold standard, where every country pegged its currency’s value to gold and, therefore, implicitly to each other’s currencies: with no new large discoveries of gold, its scarcity was leading to the fall of prices of ordinary goods in terms of gold—to what we call today deflation.³ In effect, money was becoming more valuable. And this was impoverishing America’s farmers, who found it increasingly difficult to pay back their debts. The election of 1896 was fought on the issue of whether, in the words of Democratic candidate William Jennings Bryan, America would “crucify mankind upon a cross of gold.”⁴

So, too, the gold standard is widely blamed for its role in deepening and prolonging the Great Depression. Those countries that abandoned the gold standard early recovered more quickly.⁵

In spite of this history, Europe decided to tie itself together with a single currency—creating within Europe the same kind of rigidity that the gold standard had inflicted on the world. The gold standard failed, and, other than a few people known as “gold bugs,” no one wants to see it restored.

Europe need not be crucified on the cross of the euro—the euro can work. The key reforms that are needed are in the structure of the currency union itself, not in the economies of the individual countries. Whether there is enough political cohesion, enough solidarity, for these reforms to be adopted remains in question. In the absence of reform, an amicable divorce would be far preferable to the current approach of muddling through. I will show how the split-up can be best managed.

In 2015, the 28-member European Union was the second largest economy in the world—with an estimated 507.4 million citizens and a GDP of $16.2 trillion, slightly smaller than the United States.⁶ (Because exchange rates can vary a great deal, so can relative country sizes. In 2014, the EU was the largest economy.) Within the European Union, 19 countries share a common currency, the euro. The “experiment” of sharing a common currency is relatively recent—euros only began circulating in 2002, though Europe had committed itself to the idea a decade earlier, with the Maastricht Treaty,⁷ and three years earlier the countries of the eurozone had pegged their values relative to each other. In 2008 the region was pulled, along with the rest of the world, into recession. Today the United States has largely recovered—an anemic and belated recovery, but a recovery nonetheless—while Europe, and especially the eurozone, remains mired in stagnation.

This failure is important for the entire world, not just for those countries in what has come to be called the eurozone. Of course, it is especially dire for those living in the crisis countries, many of which remain in depression. In our globalized world, anything that leads to stagnation in such an important part of the global economy hurts everyone.

Sometimes, as the example of Alexis de Tocqueville’s Democracy in America so clearly illustrated, an outsider can give a more accurate and dispassionate analysis of culture and politics than those who are more directly entangled in ongoing events. The same is true, to some degree, in economics. I have been traveling to Europe since 1959—in recent decades, multiple times a year—and spent six years teaching and studying there. I have worked closely with many of the European governments (mostly in the center-left, though not infrequently with the center-right). As the 2008 global financial crisis and the euro crisis brewed and broke out, I interacted closely with several of the crisis countries (serving on an advisory council for Spain’s former prime minister José Luis Rodríguez Zapatero and as a long-term friend and adviser to Greece’s former prime minister George Papandreou). I saw firsthand what was happening within the crisis countries and the councils of the eurozone that were forging policies in response.

As an economist, the euro experiment has been fascinating.⁸ Economists don’t get to do laboratory experiments. We have to test our ideas with experiments that nature—or politics—throws up. The euro, I believe, has taught us a lot. It was conceived with a mixture of flawed economics and ideologies. It was a system that could not work for long—by the time of the Great Recession, its flaws were exposed for all to see. I believe that the underlying deficiencies had been evident from the start for anyone willing to look. These deficiencies had contributed to a buildup of imbalances that played a central role in the unfolding crises and will take years to overcome.

This experiment was especially important for me, since I had been thinking and writing about economic integration for years, and especially since I had served as economic adviser to President Bill Clinton, as chairman of his Council of Economic Advisers, in the 1990s. We worked on opening up borders for trade between the United States, Canada, and Mexico through NAFTA, the North American Free Trade Agreement. We worked, too, on creating the World Trade Organization, launched in 1995, the beginning of an international rule of law governing trade. NAFTA, launched in 1994, was not as ambitious as the European Union, which allows free mobility of workers across borders. It was much less ambitious than the eurozone—none of the three countries shares a currency. But even this limited integration posed many problems. Most importantly, it became clear that the name “free trade agreement” was itself a matter of deceptive advertising: it was really a managed trade agreement, managed especially for special corporate interests, particularly in the United States. It was then that I started to become sensitive to the consequences of the disparity between economic and political integration, and to the consequences of international agreements made by leaders—as well-intentioned as they might be—in the context of far-from-perfect democratic processes.

I went from working with President Clinton to serving as chief economist of the World Bank. Here, I was confronted with a new set of issues in economic integration that was out of kilter with political integration. I saw our sister institution, the International Monetary Fund (IMF), try to impose what it (and other donors) viewed as good economic policies on the countries needing its assistance. Their views were wrong—sometimes very wrong—and the policies the IMF imposed often led to recessions and depressions. I grappled with trying to understand these failures and why the institution did what it did.⁹

As I note at several points in this book, there are close similarities to the programs that the IMF (sometimes with the World Bank) imposed on developing countries and emerging markets, and those that have been imposed on Greece and the other afflicted countries in the wake of the Great Recession. I also explain why there are marked similarities in the reasons these programs continue to disappoint, and the widespread public opposition to them in the countries they have been imposed on.

Today, the world is beset by new initiatives designed to harness globalization for the benefit of the few. These trade agreements, which reach across the Atlantic and the Pacific, called the Transatlantic Trade and Investment Partnership and the Trans-Pacific Partnership (TTIP and TPP) agreements, respectively, are once again being crafted behind closed doors by political leaders, with corporate interests at the table. The agreements evidence a persistent desire for economic integration that is out of sync with political integration. One of their most contentious features would enable corporations to threaten countries with lawsuits when their expected profits are adversely affected by any new regulation—something that no government would countenance within its own borders. The right to regulate—and to change regulations in response to changes in circumstances—is a basic aspect of the functioning of government.

The eurozone project was, however, different from these other examples in one fundamental way: behind it was a serious intent to move toward more political integration. Behind the new trade agreements, there is no intent of having harmonized regulatory standards set by a parliamentary body that reflects the citizens of all those in the trade area. The corporate agenda is simply to stop regulation, or, even better, to roll it back.

But the design of the “single-currency project” was so influenced by ideology and interests that it failed not only in its economic ambition, bringing prosperity, but also in its ambition of bringing countries closer together politically.

Thus, while this book is aimed at the critical question of the euro, its reach is broader: to show how even well-intentioned efforts at economic integration can backfire when questionable economic doctrines, shaped more by ideology and interests than by evidence and economic science, drive the agenda.

The story I tell here is a dramatic illustration of several themes that have preoccupied me in recent years—themes that should have global resonance: The first is the influence of ideas, in particular how ideas about the efficiency and stability of free and unfettered markets (a set of ideas sometimes referred to as “neoliberalism”) have shaped not just policies but institutions over the past third of a century. I have elsewhere described the policies that dominated the development discourse, called the Washington Consensus policies, and shaped the conditions imposed on developing countries.¹⁰ This book is about how these same ideas shaped what was viewed as the next step in the tremendously important project of European integration, the sharing of a common currency—and derailed it.

Today, the same battle of ideas is being fought in myriad skirmishes. Indeed, in some cases, even the arguments and evidence presented are fundamentally the same. The austerity battle in Europe is akin to that in the United States, where conservatives have attempted to downsize government spending, including for badly needed infrastructure, even while unemployment remains high and resources remain idle. The fights over the right budgetary framework in Europe are akin to those that I was immersed in with the IMF during my tenure at the World Bank. Indeed, understanding the global reach of these battles is one of the reasons I have written this book.

The ideas wielded in these battles are shaped by more than just economic interests. The perspective I take here is broader than narrow economic determinism: one cannot explain an individual’s beliefs simply by knowing what will make him better off economically. But still, certain ideas do serve certain interests, and we should thus not be surprised that by and large, policies tend to serve the interests of those who make them, even if they use more abstract ideas to argue for them. This analysis leads to an inevitable conclusion: economics and politics cannot be separated—as much as some economists would like them to be. A key reason that globalization has often failed to produce benefits for large numbers in both the developed and less developed world is that economic globalization outpaced political globalization; and so, too, for the euro.

A further theme is related to my more recent research on inequality.¹¹ Economists, and sometimes even politicians, focus on averages, what is happening to GDP or GDP per capita. But GDP can be going up, and most citizens nonetheless could be worse off. That has been happening in the United States for the last third of a century, and increasingly, there are similar trends elsewhere. Economists used to argue that how the fruits of the economy were shared did not matter—that was an outcome that might be of concern to a political scientist or a sociologist but not to an economist. Robert Lucas has gone so far as to say, “Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution.”¹²

We now know that inequality affects economic performance, so that one cannot and should not just shunt these matters aside.¹³ Inequality also affects how our democracies and our societies function. I believe, however, that we should be concerned about inequality not just because of these consequences: there are fundamental moral issues at stake.

The euro has led to an increase in inequality. A main argument of this book is that the euro has deepened the divide—has resulted in the weaker countries becoming weaker and the stronger countries becoming stronger: for instance, German GDP going from 10.4 times that of Greece in 2007 to 15.0 times that of Greece in 2015. But the divide has also led to an increase in inequality within the countries of the eurozone, especially in those in crisis. And this is so even in those European countries that were making progress in reducing inequality before the start of the euro.

This should not come as a surprise: high unemployment hurts those at the bottom, high unemployment puts downward pressure on wages, and the government cutbacks associated with austerity have particularly negative effects on middle- and lower-income individuals that depend on government programs. This, too, is a cross-cutting theme of our times: the neoliberal economic agenda may not have succeeded in increasing average growth rates, but of this we can be sure: it has succeeded in increasing inequality. The euro provides a detailed case study on how this has been accomplished.

Two other themes relate more directly to work on economic systems in which I have long been engaged. It is now (finally) widely recognized that markets on their own are not efficient.¹⁴ Adam Smith’s invisible hand—by which individuals’ pursuit of self-interest is supposed to lead, in the aggregate, to the well-being of the entire society—is invisible because it is simply not there. And far too little attention has been paid to the instability of the market economy. Crises have been part of capitalism since the beginning.¹⁵

The standard model used by economists simply assumes that it is in equilibrium; in other words, if there is ever a dip in the economy, it quickly reverts to its normal path.¹⁶ The notion that the economy quickly converges to equilibrium after an upset is key in understanding the construction of the eurozone. My own research has explained why economies often do not converge, and what has happened in Europe provides a wonderful if sad illustration of these ideas.

The role of the financial system is also integral to the story told here. Financial systems are obviously a necessary part of a modern economy. But in other work I have described how, if not carefully regulated, financial systems can and do lead to economic instability, with booms and busts.¹⁷ What has happened in Europe again provides an illustration of these issues—and of how the design of the eurozone and the policies pursued in response to the crisis exacerbated problems that are ever-present in modern market economies.

A final theme with which I have been long concerned, but which I can only touch upon in this book, relates to values that go beyond economics: (a) economics is supposed to be a means to an end, increasing the well-being of individuals and society; (b) the well-being of individuals depends not just on standard conceptions of GDP, even if that concept were broadened to include economic security, but on a much wider set of values, including social solidarity and cohesion, trust in our social and political institutions, and democratic participation; (c) and the euro was supposed to be a means to an end, not an end in itself—it was supposed to increase economic performance and political and social cohesion throughout Europe. This in turn was supposed to help achieve broader goals, including enhancing the well-being and advancing the fundamental values to which I have alluded. But it should be evident that everything has gone awry. Means have become ends in themselves; the ultimate objectives have been undermined. Europe has lost its compass. This waywardness, however, is not a uniquely European phenomenon. It has happened so often in so many places: it seems almost to be a global disease of the times.

In a sense, then, the story of the eurozone is a morality play: It illustrates how leaders out of touch with their electorates can design systems that do not serve their citizens well. It shows how financial interests have too often prevailed in the advances of economic integration and how ideology and interests run amok can result in economic structures that may benefit a few, but put at risk vast parts of the citizenry.

It is a story, too, of platitudes, uttered by politicians unschooled in economics who create their own reality, of positions taken for short-run political gain that have enormous long-term consequences. The insistence that the eurozone should not be designed in such a way that strong countries would be expected to help those having a temporary problem may have a certain appeal to selfish voters. But without a minimal degree of risk-sharing, no monetary union can possibly function.

For most Europeans, the European project, the further integration of the countries of the continent, is the most important political event of the last 60 years. To see it fail, or to suggest that it might fail, or that one aspect of the project—its currency system—might fail, is viewed almost as heresy. But reality sometimes delivers painful messages: the euro system is broken, and the cost of not fixing it very quickly will be enormous. The current system, even with its recent reforms, is not viable in the long run without imposing huge costs on large numbers of its citizens. And the costs extend well beyond those to the economy: I referred earlier to the disturbing changes in politics and society, the rise of extremism and right-wing populism. While the euro’s failure is not the only reason for these trends, I believe that the huge economic toll that has been imposed on so many of its citizens is one of the more important causes, if not the most important one.

These costs are especially high for Europe’s youth, whose future is being put in jeopardy, whose aspirations are being destroyed. They may not understand fully what has happened, they may not fully understand the underlying economics, but they understand this: they were lied to by those who tried to persuade them to support the creation of the euro and to join the eurozone, who promised that the creation of the euro would bring unprecedented prosperity and that, so long as countries stuck to basic strictures keeping deficits and debts, relative to GDP, low, the poorer countries of the eurozone would converge to the richer. They are now being told, often by the same politicians or politicians from the same parties: “Trust us. We have a recipe, a set of policies, which, while it may inflict some pain in the short run, will in the long run make all better off.”

Despite the dismal implications of my analysis for what will happen if the eurozone is not changed—and the even worse implications if the eurozone is changed in ways that many in Germany and elsewhere are now arguing for—this book is, in the end, hopeful. It is a message of hope that is especially important for Europe’s youth and for those who believe in the European project, in the idea that a more politically integrated Europe can be a stronger and more prosperous Europe. There is another way forward, different from that which is currently being pushed by Europe’s leaders. Indeed, there are several ways forward, each requiring a different degree of European solidarity.

Europe made a simple and understandable mistake: it thought that the best way toward a more integrated continent was through a monetary union, sharing a single currency. The eurozone and the euro—both the structure and its policies—have to be deeply reformed if the European project is to be saved. And it can be.

The euro is a manmade construction. Its contours are not the result of inexorable laws of nature. Europe’s monetary arrangements can be reconfigured; the euro can even be abandoned if necessary. In Europe as well as elsewhere, we can reset our compass, we can rewrite the rules of our economy and our polity, to achieve an economy with more and better-shared prosperity, with a strengthened democracy and stronger social cohesion.

This book is written in the hope that it provides some guidance on how Europe can do this—and that it provide some impetus to Europe’s undertaking this ambitious agenda quickly. Europe must restore the vision of the noble ends it sought at the inception of the European Union. The European project is too important to be destroyed by the euro.