Summary and Analysis of The Euro: How a Common Currency Threatens the Future of Europe - Joseph E. Stiglitz (2016)
Part IV. A WAY FORWARD?
Chapter 11. TOWARD A FLEXIBLE EURO
Looking at Europe today, we might say that it is in a pickle. It wants to preserve the euro, even though the euro has not been working. It would like to pretend that if only member countries had obeyed the rules, if only there had not been that American-made financial crisis, all would have been well. But in its heart of hearts, Europe must know that this is not true. Countries that obeyed the rules also went into crisis. It was not just countries of the southern periphery but also Ireland. Even virtuous Finland is having trouble adjusting, and has had unacceptably high unemployment—9.3 percent in early 2016.
The nature of the market economy is that “stuff happens.” And the stuff that happens affects different countries differently, and requires large adjustments. The euro makes those difficult at best.
While northern Europe castigated the countries of the south for the fiscal profligacy of the so-called garlic belt, troubles in Finland showed that the problems were deeper and different. Finland had been one of the success cases of Europe. After having been a near-vassal of Russia, its GDP per capita in 1960 was but $10,500 (adjusted for inflation), 68 percent of that of the United States at the time. Then, through heavy investments in education, it grew to the point that by 2007 its per capita income was $42,300, or 93 percent of that of the United States. But then a series of problems befell the country: in the fast-changing world of hi-tech, its leading company, Nokia, lost out to competitors. Finland had close ties with Estonia, which was badly hit by the 2008 crisis. And after the fall of the Berlin Wall, Finland had profited by strong trade with Russia. But sanctions with that country hurt Finland as well as Russia, which also suffered from the decline in oil and gas prices.
Finland’s GDP shrank by 8.3 percent in 2009, and in 2015 it was still some 5.5 percent below its 2008 peak. In the absence of the euro, Finland’s exchange rate would have fallen, and the decrease in imports and increase in exports would have stimulated the economy. In the absence of the fiscal constraints imposed by eurozone membership, it might have borrowed to finance government expenditures that would stimulate the economy. Instead, it got caught up in the wave of austerity afflicting Europe. Divisive cuts in wages of public sector employees were somehow supposed to mysteriously increase the competitiveness of Finland’s exports. Instead, the wage cuts decreased demand, deepening the downturn. In short, the euro-medicine worked little better in well-behaved Finland than it did in the more recalcitrant patients of the south.
The alternative entailing “more Europe,” creating a eurozone that works, is almost surely the best path forward for Europe, but it appears too much for at least some of the countries in the eurozone to stomach. On the other hand, the alternative discussed in the last chapter, the amicable divorce, is equally unpalatable. For those who saw the euro as the next, and critical, stage in European integration, divorce would be a sign of giving up, of resignation. I argued that this view was misguided—sharing a common currency is not, or should not be, at the heart of the European project—but perception is, at least to some extent, reality: if significant numbers of people within Europe see even an amicable divorce as at least a temporary surrender, then it could set back the agenda for European integration.1
Here, I want briefly to discuss one last alternative, which I call the “flexible euro.” It entails recognizing that there has been some progress in creating eurozone institutions since the euro crisis broke out, though not enough to make a single-currency system work. The flexible euro builds on these successes, in the hope that one could create a system in which different countries (or groups of countries) could each have their own euro. The value of the different euros would fluctuate, but within bounds that the policies of the eurozone itself would affect. Over time, perhaps, with the evolution of sufficient solidarity, those bounds could be reduced, and eventually, the goal of a single currency set forth in the Maastricht Treaty of 1992 would be achieved. But this time, with the requisite institutions in place, the single currency might actually achieve its goals of promoting prosperity, European solidarity, and political integration.
THE BASIC IDEA
The basic idea draws upon chapters 9 and 10: recognizing the gaps in the eurozone structure that exist now and are likely to persist in coming years, we can use some of the tools that we would use in the case of an amicable divorce to arrange for sufficient policy coordination so that the fluctuations in the various euro-currencies would be limited.
We make use of the observation made in the last chapter that by and large, in the 21st century, we have moved to a digital economy—and accelerating that process would increase efficiency and facilitate tax collection. Rather than a single currency for the entirety of what is now the eurozone, there would be several groupings, each with their own currency. Each country or country grouping would create an electronic currency—along the lines described in chapter 10. Money could be easily transferred from one person’s account to another, for instance, upon the purchase of goods and services. Firms would pay into these accounts their workers’ wages; they would similarly pay their suppliers and be paid by their customers. I described in chapter 10 how money could be added to or subtracted from within the electronic system—for instance, through the creation of new credit or a decrease in the supply of credit.
I described, too, a system by which net payments to and from abroad could be kept balanced: exporters would receive chits in addition to payments in the local-euro into their account, and those who wanted to import would have to buy a corresponding number of chits, in addition to making payments out of their accounts. The system of marketable trading chits would ensure that the value of exports equaled the value of imports—there would be no net flow in or out of the payments system. As we saw in chapter 10, countries could decide to allow a trade deficit or insist on a trade surplus, simply by changing the ratio of chits one received for a euro of exports relative to those needed for imports.
In this system, the value of one country’s euro could vary relative to that of another’s (and even more, the value of that country’s euro plus the associated value of a chit). This is the flexibility in exchange rates that the current system lacks. At the same time, I explained how the system of chits would likely limit the variability of the value of one euro-currency against another.
STABILIZING RELATIVE EXCHANGE RATES
There are many ways that Europe could, collectively, work to limit the extent of the movements in exchange rates in our system of flexible euros. I discussed these in chapter 9, so I shall be brief here.
LIMITING SURPLUSES
First, the countries (most especially Germany) that have traditionally run trade surpluses—imposing large external costs on their European neighbors and global economies through the resulting imbalances—could commit to reducing those surpluses. They would do this by the same chit system. Not only would this reduce global imbalances, but the same reasoning that suggested that the Greek-euro will be stronger than it otherwise would have been (with chits limiting trade deficits) implies the German-euro will be weaker than it otherwise would be with chits limiting the magnitude of the surplus.
Eurozone leaders, if they wished, could thus achieve close to parity among the different national or regional euros simply by adjusting the chit system.
MORE EFFICIENT SHARING OF THE BURDEN OF ADJUSTMENT
Earlier chapters noted that trade imbalances were caused by the rigidity in real exchange rates that follows from the rigidity in nominal exchange rates. The eurozone approach of trying to achieve the desired real exchange rate adjustments through magical productivity adjustments (for example, in structural reform programs) or through internal devaluation simply has not worked—and has been very painful.
Part of the reason for the failure of adjustment is that Germany has insisted on an asymmetrical adjustment process, that the burden of adjustments be borne by the deficit countries (through lowering wages and prices)—this in spite of all the evidence and theory that downward adjustments are far more costly than the reverse. It would be far better if Europe could commit itself to an asymmetrical process, but this time, with the opposite bias: the surplus countries should follow policies (for example, fiscal and wage policies) that lead to upward adjustments of wages and prices.
PRODUCTIVITY CONVERGENCE
We have seen, too, in previous chapters how Europe has put in place a process of productivity divergence, as the sources of finance in weak countries sour and as public investments in infrastructure, education, and technology plunge.
Europe already has some institutions in place to do the opposite, and it says it is committed to doing more. For instance, the European Investment Bank can strengthen investment in weak countries. If the eurozone follows through quickly on its commitment to create a real banking union, with common deposit insurance, it would do much to prevent the extremes of divergence in access to private finance. But small and medium-size enterprises in weak countries would still almost surely be at a competitive disadvantage. Again, a eurozone SME lending facility, directed especially at weak countries, could help rectify these disadvantages. If Europe created a solidarity fund for stabilization or assumed more responsibility for social expenditures like unemployment in afflicted countries, it would free up the budgets of these countries to make more of these forward-looking investments.2 So, too, if Europe were to encourage industrial policies, rather than proscribe them, the lagging countries would have a better chance of converging toward the leading ones.
THE ECONOMIC RATIONALE
Previous chapters have explained the problems with the single-currency system of the eurozone. Large trade imbalances on the part of the periphery countries built up in the years before the crisis—and the system did nothing to stop the buildup. It then imposed a painful and costly adjustment in the aftermath of the crisis—where the costs were typically borne by the deficit countries. If we look inside the countries, matters are even worse: workers and small businesses are paying the price of this asymmetric adjustment process; but it was others who benefited in the creation of the earlier imbalances—in the case of Spain, for instance, construction firms and real estate speculators. We are asking innocent bystanders to pay for the mistakes of others.
The system is rife with macroeconomic externalities—where the actions of some individuals and firms impose high costs on others. Whenever there are externalities, there is a need for public action. That is obvious in the case of environmental externalities like pollution; public action in response has led to cleaner air and rivers. It has worked. But America’s banks polluted the global economy with toxic mortgages: regulators should have done something about this, but they didn’t. Within the eurozone, something similar occurred. In some cases (Ireland and Spain), there was a real estate bubble; in others, the excesses took different forms.
The system described here provides a simple framework within which macroeconomic externalities are better addressed. It is almost surely not a panacea. There will still be macroeconomic fluctuations; but if well managed, they will be less severe and so will their consequences. This system would enable Europe to emerge from stagnation.
Some might complain: Aren’t we interfering with the market? The eurozone itself is a massive interference with the market. It fixes a critical price, the exchange rate. It says that there has to be a single interest rate for the entire region, set by a public body, the European Central Bank. The question is, with this government-imposed rigidity, how well does the rest of the market perform? Can it assure stability? There is now more than a decade of evidence, and the answer is a resounding no.
This proposal entails minimal intervention in the market, and even in doing so, uses market mechanisms. It corrects for a well-recognized externality, the market externality associated with external imbalances. Europe has gotten itself into the current mess partly by assuming that markets are more perfect than they are. Markets exhibit enormous volatility in both prices and quantities: interest rates demanded of borrowers from different countries have moved violently in different directions, and capital and credit flows have fluctuated in ways that are virtually uncontrollable under current arrangements.
Workers are told that they should simply accept being buffeted by these maelstroms that are not acts of nature but the creations of irrational and inefficient markets. Workers should accept wage cuts and the undercutting of social protections, in order for the capital markets to enjoy their “freedom.” The flexible euro system is intended to bring a modicum of order to this chaos, which has not even produced the higher growth in GDP that was promised—let alone the social benefits that were supposed to accompany this higher GDP.
There are some fundamental philosophical differences between the flexible eurozone framework and that of today’s euro. The latter assumes that if the ECB sets the interest rate correctly and individual countries adhere to their debt and deficit limits, all will be well. It hasn’t been. There is an abstract theory (called the Arrow-Debreu competitive equilibrium theory) that explains when such a system of unrestrained competitive markets might work and lead to overall efficiency. It requires markets and information that are far more perfect than that which exists anywhere on this earth. And even then, these Nobel Prize-winning economists were unable to show that the economic system was dynamically stable. It was an equilibrium theory; there was no explanation of how the economy would get to that equilibrium.
In the real world in which we live, it is often better not to just rely on prices—to try, as our flexible-euro framework does, to control the quantity of credit and net exports, and to regulate the uses to which credit is put and the amount of foreign denominated debt. The management of the economy in our proposed framework relies, however, heavily on the use of prices, but not fully so; there is no micro-management, but more macro-management than exists today.
Decades ago, we learned that one could not let a market economy manage itself. That is why, for instance, every country has a central bank determining interest rates and regulatory authorities overseeing banking. Some arch-conservatives would like to roll back the clock, to a world without central banks and with free banking, with no restraints. Anyone who has read his economic history knows what a disaster that would likely be.
But anyone observing macroeconomic performance in recent years will see that things have not gone well. Chapter 3 showed the massive waste of resources. It would be wrong if we did not try to improve upon this sorry record. The framework provided here and in the previous chapters does this. These are modest reforms that would not upend the system. But they systematically address some of the major weaknesses of current economic arrangements, some of the major instabilities that have proven so costly to our economies and our societies.
There are, of course, a large number of details to be worked out. The system is surely not perfect. But almost as surely, it is better than the current system, which has imposed such high costs on so many within the eurozone. This framework of eurozone economic cooperation with the flexible euro could lead to greater economic stability and growth.3
THE NEED FOR EUROZONE COOPERATION
Just as European cooperation is required if there is to be an amicable divorce, European cooperation would be helpful to ensure smooth functioning of the flexible euro. Even if there is hesitancy on the part of some for this proposed alternative,4 the system is such that it can be undertaken by a “coalition of the willing,” any grouping within the eurozone could adopt the system; these countries could then work together to ensure the relative stability of movements in the local-euro exchange rates, in the manner that I described earlier in this chapter. Of course, if all, or even most, of the countries of the eurozone, with the exception of perhaps Germany, join this coalition of the willing, then de facto, Germany’s exchange rate itself would become flexible, for it would then be variable with respect to all of the other local-euros. It would then be in the interests of Germany to join the overall system, to help ensure stability of its exchange rate relative to those of the others.
Given sufficient European solidarity and cooperation, the framework would result in exchange rates moving within increasingly narrow bands. With sufficient success in exchange-rate coordination, in narrowing the band, it might, someday, allow Europe to move forward, toward a single currency.