THE EURO: THE HOPE AND THE REALITY - EUROPE IN CRISIS - Summary and Analysis of The Euro: How a Common Currency Threatens the Future of Europe - Joseph E. Stiglitz

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



The euro was founded with three hopes: (1) that it would bring Europe ever closer together, and was the next step in Europe’s integration; (2) that the closer economic integration would lead to faster economic growth; and (3) that this greater economic integration and the consequent greater political integration would ensure a peaceful Europe.

The founders of the euro were visionaries who tried to create a new Europe. They were argonauts in uncharted waters, traveling where no one had ever been. No one had ever tried a monetary union on such a scale, among so many countries that were so disparate. So it is perhaps unsurprising that matters turned out so different from what these visionaries must have thought.

I shall argue in this chapter that even with the best-designed euro project, the benefits of a single currency would have been more limited than its advocates claimed, that its impact on overall economic integration was likely to have been ambiguous, and that one should not have been surprised that the euro was more divisive than unifying—thus setting back political integration. The very reason that the euro was an incomplete project was the reason that it was likely to prove divisive. Far from being an important step in the creation of a united Europe that would play a critical role in today’s global economy, it should have been expected that the euro would have an opposite effect.

Political integration, like economic integration, was not just an end in itself but a means to broader societal objectives—among which was strengthening democracy and democratic ideals throughout Europe. I conclude this chapter by observing that the construction of the euro has instead increased the perceived democratic deficit in Europe, the gap between what Europe does and what its citizens want.

We have commented repeatedly on the link between politics and economics. As we have noted, one of the reasons for the failure of the eurozone is that economic integration has outpaced political integration. The hope was that the politics would catch up with the economics. But as divisiveness and the democratic deficit has grown, the likelihood that that will happen has diminished.

The euro was born with great hopes. Reality has proven otherwise.


Those strongly supportive of the euro make a few points—points I’ve encountered repeatedly in the years I have worked with European leaders, politicians, and economists.


Euro supporters observe that successful large countries, like the United States, share a common currency. It follows, in this reasoning, that if Europe is to play a role on the global stage similar to the United States, it, too, must share a common currency. Could one imagine, they ask, an America with multiple currencies? Many Europeans, noting that if the countries of Europe were united, Europe would be one of the two largest economies,1 worry that Europe does not pull the weight it should in the global economy, simply because it is politically divided.

But this begs several critical questions: What are the prerequisites for playing the kind of global role that the United States plays? Will having a monetary union move Europe closer to attaining those conditions? Is having a monetary union necessary for achieving such a goal? And how important is it for Europe to play that role?

The counterargument

In earlier centuries, the ability to exercise “power” on the global scene mattered a great deal. The wealth of nations depended to a large extent on military power. The conquest of colonies was how a relatively small island, Great Britain, became a dominant global power. Fortunately, we have a new balance of power that greatly circumscribes the exercise of military power. Even when a country wins a war, its ability to receive the spoils of war are limited. For example, American oil firms may receive slightly favorable access in Iraq because of the war, but the cost of the war far outweighed any possible benefits.2

Even the United States, which spends an order of magnitude more on its military than any other country in the world, cannot impose its will on others under the new rules of the game. Its attempt to do so in Iraq, against enemies with a small fraction of the population and resources of the United States, has been thwarted. It could not halt Russia’s attacks against Ukraine. Whether a united Europe would have changed the picture much is arguable—and at the very least, if Europe were to pursue such influence, it would require massive increases in military spending.

If there is European consensus, Europe’s influence will be heard—even without a monetary union

Conversely, if there were massive increases in military spending and agreement about military objectives, then even without full political unity, the weight of Europe would be larger, but as in the case of the United States, hardly decisive. The problem is more that it is difficult to reach a consensus about military objectives: another aspect of the diversity across Europe. With Germany so strongly dependent on Russian gas, it might be expected to be more reluctant to support strong measures against Russia.3

The world would not have been a better place if the UK, Poland, and others who joined the “coalition of the willing” in support of America’s war against Iraq, in violation of international law, had had enough clout within a “united” Europe to force Europe as a whole to join in that war.4 If there had been unanimity among the European countries, then of course their united view would be heard more loudly. But the lack of political integration is not the source of the problem: it is the lack of consensus. If there had been a consensus, there are already the institutions within Europe that would have allowed coordinated action and a coordinated effective “voice.”

In this perspective, Europe’s influence can and will be heard in those arenas where there is a European consensus.5 The major challenge in enhancing Europe’s influence is to strengthen common understandings; if, as this book argues, the euro leads to more divisiveness, then the euro is in this respect counterproductive.

The role of rules

What decisions a united Europe might take would, of course, depend on the political rules that defined the union. If there had to be unanimity among the countries within Europe, then in the absence of a broad consensus about policies, the likely result is gridlock. If the political system gave disproportionate power to Europe’s corporate interests, what Europe would “bargain” for in trade agreements would be rules that advance those corporate interests. While those interests would like to see a more united and powerful Europe, it is not obvious that the potential outcomes would serve the interests of the citizens well.

Greater power for a united Europe would translate into greater well-being for European citizens only if the political system was truly democratic. There are good reasons to be concerned about this, given the current political structure of Europe.


The second argument for more political integration focuses on the role that the EU has played in sustaining peace within the core of Europe. Given the destruction of the two world wars of the previous century, it is understandable why this should be of paramount importance. Some observe the absence of war within the core of Europe over the past 70 years and give the European Union credit. That may well be the case, though there are many other changes that have occurred as well—the creation of the UN, nuclear deterrence, and changes in attitudes toward war. Our question, though, is a narrower one: There is no evidence that sharing a single currency, or the closer integration resulting from sharing a single currency (if that actually happened), would reduce the probability of conflict; no evidence to suggest that it would make a difference either directly or indirectly. Even supposing that adopting a common currency promotes integration, it’s not clear that, where economic integration and increasing peace coincide, the former is the cause of the latter. This book will argue that the currency union may actually run counter to the cause of greater economic integration.6


There is a quite different set of arguments for a single currency, perhaps better reflecting the political drive for it: Every day when individuals use the currency, they are reminded of their identity as Europeans. As this identity gets fostered and strengthened, further political and economic integration might be possible. The importance of this has almost surely been diminished as we have moved to electronic money and the use of debit and credit cards. Young people seldom make use of those funny pieces of paper we call cash.

But it should have been clear at the onset that such psychological benefits, if they exist, would be overwhelmed if the euro failed to deliver on its main promise of furthering prosperity. Indeed, if it actually led to worsened economic performance, one might have anticipated a backlash, not just against the euro but against the entire European project.


The previous section explained why the simplistic arguments for the euro—that it would lead to a more powerful and influential Europe through a more united Europe and that it would enhance the ability to sustain peace—are unpersuasive. Here I take a broad perspective on economic integration, explaining why the euro (by itself) was unlikely to have promoted the kind of economic integration that would enhance growth and societal welfare, and why it should have been expected that the euro might actually impede further economic and political integration.


There is a long-standing argument that closer economic integration would lead to faster economic growth, based on the idea that larger markets lead to increases in standards of living as a result of economies of scale (that is, unit costs of production decrease as the scale of production increases) and taking advantage of comparative advantage (that is, there are efficiency gains from having each country specialize in the country’s relative strengths).

These notions date back to the late 18th and early 19th centuries, in the works of two of the great classical economists, Adam Smith7 and David Ricardo.8 But there are several flaws in applying Smith’s and Ricardo’s analyses of largely agrarian 18th- and early 19th-century economies to Europe at the beginning of the 21st century. First, tariff and trade barriers are already low; the law of diminishing returns suggests that the relative benefits of further reductions may be fairly small. Most importantly, there is already free movement of goods, labor, and capital within the EU: the euro is irrelevant for this analysis.

Secondly, Smith and Ricardo ignored the benefits of tailoring policies, including regulations and the provision of public goods,9 to local differences in tastes and preferences. Some societies may prefer more stability and better systems of social protection, and greater expenditures on public education and health; others may be more committed to preserving existing inequalities.

Greater economic integration—or, I should say, certain forms of economic integration—may, as we shall see later, impede the ability of different countries to realize societal well-being by advancing their own conceptions of what the state should do and how it should do it.10 In the days of Adam Smith and David Ricardo, the economic role of the state was very limited; today, it is far more important—partly because of changes in the structure of the economy itself, and partly because increases in standard of living have led some societies to demand more of these collective goods provided by government.

Indeed, advances in our standards of living largely result from our creation of a learning society11—of advances in technology and knowledge—which themselves are in the nature of public goods, goods that have to be collectively provided: all individuals can benefit from such advances.12 Markets by themselves will not result in efficient levels of investment in research and learning; they may not even result in learning and research going in the right direction. There will be too little basic research and too much research figuring out how to increase the market power, including that derived from patents.

I stress these changes in our economy and our economic understanding partly because they are at the root of the failure of the euro experiment, which was influenced by ideas about the functioning of the economy that, even as the euro was being designed, were being discredited and were badly out of date. In the world of Smith and Ricardo, there was little role for the state—though, as I have said, even Smith recognized that there was a far greater role than his latter-day devotees. In their world, since there was little need for collective action, it would have made little difference whether the collective action that was undertaken was done at the level of the nation-state or the European-wide level. Differences in views about what the government should do or how it should do it, too, would not have mattered much. Today, they matter a great deal. That’s why today, those in one part of the eurozone, such as Greece, are so unhappy about being told what to do by others with different views of the nature of society and the role of government; and with close economic integration, they can even be significantly affected by what the governments of other eurozone countries do—especially when, as in the case of Germany, government decisions have major effects on smaller countries. As we shall see in later chapters, Germany’s decision to constrain wages was a form of competitive devaluation that disadvantaged other countries in the eurozone, especially those with less pliant workers.


If collective action is, today, far more important than it was in Smith’s and Ricardo’s day, differences in views about what the state should do can be, in turn, of first-order importance. This has two important implications—one that Europe has recognized, the other which it has not. The first is the principle of subsidiarity discussed earlier: public decisions should be taken by the lowest level of authority possible. Decisions about local highways, local schools, local police and fire departments, even the local environment should be made by local communities, not by national or supranational authorities. The problem is that there are often spillovers from the action of one local community (or one national government) to others, in which case there needs to be at least some coordination and some actions taken by higher-level authorities.

At the creation of the euro, there were worries that with the euro, there would be significant externalities—instances in particular where the action of one country had adverse effects on others. In setting the rules and regulations governing the euro, they had thought that they had focused on constraining the most important spillovers. They had not.

The externalities upon which the euro’s designers focused arose when countries borrowed excessively. If such borrowing was somehow “monetized” (converted to money by the central bank), there would be inflation, and Germany had had a long-standing concern about inflation. They took pride that the Bundesbank (their central bank) had maintained tight control over their money supply, and that Germany for decades had not faced high inflation.13They were worried that in giving up their own central bank and joining others, some of whom had not demonstrated such discipline, that would no longer be true. That is why the countries that belonged to the euro had to commit themselves to low levels of deficits and debts.

The obsession with deficits was, however, largely a matter of pure ideology: there is little if any evidence that such deficits and debts (at least at moderate levels—levels still substantially higher than the 3 percent deficit/GDP limit to which Europe agreed) would have significant spillover effects to others.

On the other hand, wage policies such as that of Germany, where until recently there was no minimum wage and in which there was a concerted effort to lower wage levels in the 1990s to make the economy “more competitive,” do have significant spillover effects. Such policies are, as I explain in chapter 4, another version of competitive devaluation, or “beggar-thy-neighbor” policies that played out so disastrously in the Great Depression. With the “fixed exchange rate” of the euro, Germany couldn’t lower the value of its currency. But it could lower its cost of production by enacting policies that lowered wages. For a variety of reasons, these are policies that Germany could undertake much more easily than could other countries of the euro, which made them particularly attractive to German policymakers as instruments for gaining an advantage relative to the country’s neighbors. Sadly, the creators of the euro paid absolutely no attention to this far more important externality.

The second implication was that if there were significant differences in economic structures, values across countries, or views about the functioning of the economy, the scope for welfare-increasing collective action at the European-wide level would be limited. Consider the simplest task of a central bank—setting interest rates to balance the risk of inflation versus unemployment. If the circumstances of the countries for which the central bank is responsible are different, then a policy that might be appropriate for a country fighting inflation would be totally inappropriate for one worried about unemployment. Sharing a common currency and a central bank—a shared public good—could be a disaster. A democratic compromise might be bad for both: unacceptable inflation in one, coupled with unacceptable unemployment in the other.

But even if the economic structures across countries were the same, views about the appropriate policy course could differ absent a broad agreement about how the economy functions. People in one country might believe that if the unemployment rate drops below some threshold, inflation would break out. Such a country would want the unemployment rate to be pushed down to that level but no further. Other countries might hold that one could push the unemployment rate down further. To put a floor on the unemployment rate would impose unacceptable costs on workers. To force countries with such differing perspectives to accept the same policy would be foolish. Again, compromise would leave both unhappy.

Finally, even if the economic structures were the same, and their understandings of how the economy behaves were the same, as we’ve seen, different countries could have different values. One might be more concerned about inflation and its effects on bondholders, the other about unemployment and its effects on workers. These different sets of values would imply quite different monetary policies.

In each of these instances, unless one could show a compelling reason for the countries to have the same policies—to have the shared currency—it would seem to make little sense to do so. There are large costs, and these costs have to be compared to the benefits.


The benefits of integration depend on the form of integration—and there are many different forms of economic and political integration. This multiplicity is already evident in Europe. There is free migration among many but not all of the European countries. Within the Schengen area, individuals can move freely practically as if there were no borders at all.14 The Schengen area includes most of the EU countries, but not the UK and Ireland, and includes some countries that are not part of the EU, namely Iceland, Norway, and Switzerland.15 With the migrant crisis, the boundaries across which free migration should be allowed are being debated—and even what should be meant by free migration.

There is a free trade area. Switzerland, Norway, Lichtenstein, and Iceland are part of the European Free Trade Association but not of the EU. There are courts that address disputes between, say, Iceland on the one hand and EU members (like Netherlands and the UK) on the other. This court, the European Free Trade Association Court, ruled that Iceland did not have to compensate UK and Dutch savers after the Icelandic banks in which they had put their money went bankrupt, beyond the amount that was in the deposit insurance fund. There are courts, too, that rule on human rights issues anywhere in Europe (for example, the European Court of Human Rights). The EU is unusual in having taken some forms of integration quite far—and yet gone slowly in others. For instance, as we have noted, the EU central budget—analogous to the federal budget of the United States—is very limited, only about 1 percent of EU GDP, with the largest share of the funds going to provide agricultural subsidies.16

There is a rich agenda of programs that could enhance economic and political integration. The Erasmus program, which facilitates students studying in other European countries, is an example of a program that strengthens the identity and integration of the continent. An EU-wide tax on high incomes, to be used for redistribution, would be another important step in furthering economic integration and enhancing EU economic performance by addressing the region’s increasing inequality. (We will discuss this further in later chapters.)

The European integration project saw integration being accomplished in a step-by-step fashion, gradually, over a long period of time. This book is about only one such step—what I have described as a misstep: the creation of the euro, a single currency, done prematurely before the requisite conditions were satisfied, and in ways that have pulled Europe apart.


The previous section explained that there are many different forms of economic integration, and that in some instances, closer integration, of at least some forms, may not be desirable.

Close economic integration can be achieved without sharing a currency. The United States and Canada have had a free trade agreement since 1988. Canada, too, has, I believe, benefited from not sharing a common currency with its southern neighbor. Currency flexibility strengthened its ability to adapt to the multitude of shocks that a natural resource-based economy inevitably faces. The flexibility of its currency played an important role in enabling exports to substitute for government spending as Canada put its fiscal house in order in the early 1990s.

Some of the countries in the EU are members of the eurozone, but many (Denmark, Sweden, UK, Bulgaria, Croatia, the Czech Republic, Hungary, Poland, and Romania) are not. Sweden, for instance, has grown faster than almost all the countries of the eurozone, and later chapters will argue that its success is because Sweden is outside the eurozone. Chapter 3 will explain that the eurozone as a whole has been performing more poorly than those countries in the EU that are not part of the eurozone—and I believe that the single currency is one of the important reasons that this is so.


Among the architects of the euro, there appeared to be simply a presumption that sharing a common currency would promote every aspect of economic integration. There was no general theory upon which the advocates of monetary union could draw, not even historical experiences that they could cite. There had never been an experiment quite like this.

Having a common currency eliminates one major source of economic risk—the risk of changes in the exchange rate.17 Exchange-rate risk is one of the important risks that firms have to manage. How they manage that risk—both through decisions in financial markets and about the structure of production—can in theory have important effects on the extent of real economic integration, including diversification of production throughout the region. It turns out that the establishment of a currency area (such as the euro) may actually lead to greater concentration of economic production in a few countries within the area. The hope, of course, was otherwise: that having eliminated one important source of risk, firms would be more willing to produce in different countries.

To understand the effects of changes in an exchange-rate regime, one has to understand the variety of ways that firms cope with exchange-rate risks. One of the ways that firms manage such risks in the short-term is through buying and selling foreign exchange forward, trading in futures markets, “locking in” the exchange rate at the time a transaction is made. Thus, if a firm in the United States is producing widgets to export to Canada in six months’ time, it does not know what the value of the Canadian dollar (relative to the US dollar) then will be. But it doesn’t really have to worry: it can sign a contract to deliver the goods in six months’ time with payment in Canadian dollars, and it can convert those future Canadian dollars now into US dollars. There is, of course, a cost to this financial transaction (which can be viewed as a kind of insurance against exchange-rate fluctuations). In well-functioning markets, however, the cost of such insurance is relatively low.

But these mechanisms do not work very well for long-term investments, partly because the necessary markets do not exist or have high transactions costs.

There is an alternative way of managing such risks: diversifying production across the markets in which one transacts, in which one buys and sells. The American firm might set up part of its production process in Canada, and as it does so, America’s and Canada’s real economy becomes more integrated. When a firm does that, the variability in its costs of production and in its profits is reduced.

However, once there is a currency union, this argument for diversification of production no longer applies. If there are advantages in concentrating production in one or a few locales, as is often the case, then production may get more concentrated. It may move, for instance, to a country with better infrastructure, enabling the richer country with better infrastructure to get an increasing share of production, enhancing their tax base and allowing them to invest in even better infrastructure.


In analyzing the benefits of a single currency, one cannot escape a fundamental incoherence in the European project: The design of the euro was predicated on a belief in well-functioning markets. But with well-functioning markets, the costs of managing exchange-rate risks should be low. With well-functioning markets, the realignments in exchange rates would reflect only changes in fundamental information, information that is typically revealed gradually. Thus exchange-rate adjustments would be slow and gradual. Adjustments in exchange rates (prices) are, in turn, an important mechanism by which well-functioning economies adjust to events that may affect one country differently than they affect another (economists refer to such events as “shocks,” with no intimation that they are cataclysmic in nature). For instance, an increase in the demand by China of the goods produced by Germany and a decrease in demand for goods produced by Italy could easily be managed by an increase in Germany’s exchange rate and a decrease in that of Italy. This will enable Italy to sell more, bolstering its economy.

There is a strong presumption then that taking away price adjustment mechanisms leads to a more poorly performing economic system. When a group of countries choose to have a single currency, they effectively fix their exchange rates. They take away this adjustment mechanism. That should imply a more poorly performing economy.

What should have underlain the design of the euro was a recognition of market failures and imperfections; an acknowledgement of the lack of robustness of the standard competitive model discussed earlier, which played such an important role in the “conception” of the euro—slight market imperfections can lead to the system behaving differently than the way it would with “perfect markets”; and an understanding of the theory of the second best discussed in the previous chapter. Much of the high level of volatility we observe in exchange rates is evidence of market irrationality and imperfections. At one moment, there may be euphoria about the prospect of, say, America’s economy; shortly later, sentiment changes.

Had there been a recognition of the limitations of markets, perhaps the founders of the euro would have been more cautious in its creation, paid more attention to the details, and put more emphasis on ensuring that the institutions that would have enabled it to work were simultaneously put into place.


There was, of course, a certain popular appeal to having a single currency. People could travel from one country to another without exchanging currency. Exchanging currencies was a bother—and often expensive. The fact that it was expensive should have said something about the functioning of financial markets: the costs of exchanging currencies should be extremely small, if markets actually functioned efficiently, as hypothesized in the standard models.

But while transactions costs are an annoyance for travelers today, they are not economically significant. Most transactions (both in numbers and value) are mediated electronically—through bank transfers and debit and credit cards. The costs for computers to move from one currency to another is negligible. (The prices charged by banks may be significantly larger, again testimony to market failures that are pervasive in the financial system. But the appropriate response is not to reconfigure entire currency arrangements but to regulate and reform the financial sector.)

There is another kind of transaction cost that sharing a currency may reduce: the exchange-rate risk going forward of longer-term investments that we discussed earlier in the chapter. But these costs have had at best a second-order effect in major production and supply chain decisions. China, for instance, has become integrally incorporated into the global supply chain, in spite of exchange-rate risk as well as political and supply-side risks. Of course, if the benefits of integration were small, then these costs might be an impediment; but by the same token, the welfare losses (for instance, from increased costs of production) arising from the lack of integration would also likely be small.

One economic risk totally overwhelms these small benefits. With flexible—fully or “managed” flexible exchange rates—exchange rates can be realigned as circumstances change. The adjustments may be daily or hourly or more infrequent. But they occur and are typically small, and firms and individuals have learned how to cope easily with them—sometimes with the assistance of financial markets.

But in the absence of these adjustments, the exchange rate eventually gets so far out of alignment that it cannot function.18 In the case of Argentina, which had fixed its exchange rate in 1990 to the dollar, the misalignment became intolerable by 2001—there were interlinked currency, financial, and debt crises that were very costly; but after the country abandoned the dollar peg, letting its exchange rate fall by some 75 percent, and discharged the debt that had accumulated in the era of its overvalued currency, it grew impressively: at the fastest rate, next to China, in the world.19 So far, all the countries within the euro have stayed in but at a great cost.

In short, the economic argument for having a single currency is far from compelling. The savings in transactions costs are not likely to be significant. The EU countries with differing currencies had already experienced significant economic integration with the formation of the European Union; we have seen how a single currency might, in some respects, even impede integration, say, of production across the region. The modest benefits that do exist are overwhelmed by the costs of the crises that so frequently arise as real exchange-rate misalignments emerge.


Those outside of Europe have been deeply interested in its “experiment” in integration. Europe’s earlier success as it eliminated barriers to the movement of goods, services, and capital served as an example to be followed; its current problems arising from the euro serve as a warning of integration gone awry. More broadly, Europe’s integration provides insights for globalization in general. Globalization is nothing more than the closer integration of the countries of the world—and nowhere has that integration been taken further than in Europe. There is an ongoing debate: What is required for globalization to succeed? What happens if globalization does not work well? What are the benefits and costs, and who receives those benefits? Who bears the costs? The successes and failures of Europe are seen as lessons for both regional integration and globalization. The problems in achieving a successful monetary union in Europe have dampened enthusiasm elsewhere, for instance in both Africa and Asia, for this form of economic integration.

The fundamental insight to glean is that economic integration—globalization—will fail if it outpaces political integration. The reason is simple: When countries become more integrated, they become more interdependent. When they become more interdependent, the actions of one country have effects on others. There is thus greater need for collective action—to ensure that each does more of those things that benefit the other countries in the union and less of those things that hurt others.

Moreover, most policies have ambiguous effects: some individuals are made better off, others worse off. With sufficient political integration, some of the gains of the winners can be transferred to the losers, so that all are made better off, or at least no one is much worse off. With sufficient political integration, those who lose in one policy reform can have the confidence that in the next they will win, and thus in the long run, all will be better off.

There are thus two problems: in the absence of sufficient political integration, an economic union lacks the institutions to undertake the requisite collective action to make the integration work for all; and in the absence of sufficient solidarity, certain groups will almost surely be made worse off than they would be in the absence of integration. Indeed, part of the objection to globalization has been that in some countries most citizens have actually been made worse off, even if it has led to better overall performance as measured by GDP.20

In chapter 4, we will explain the economic conditions necessary for a monetary union to work. In focusing, however, on the economic conditions, economists have neglected the far more important issues of the political and social conditions necessary for success. We note the failure to put in place the institutions that would have enabled the monetary union to work. But the failure to establish these institutions was not an accident. It was the result of a lack of sufficient political commitment to the European project. In the absence of solidarity, it is hard to have political integration, precisely because no one is confident that the system will work for them.

Conversely, when there is a high level of solidarity, then there will be more confidence in collective decision-making. With this higher level of solidarity, there will be a greater willingness to give up more degrees of political sovereignty and to have greater political integration. One is more likely to accept losses for oneself, if it contributes, in some way, to the general well-being.

In the list of economic conditions necessary for success of a monetary union, perhaps the most important is that there be enough economic similarity among the countries. When the countries are economically very similar, it is also the case that political differences are likely to be smaller and the policies will affect them all similarly. In such circumstances, creating common political institutions—political integration—is easier.21 But when economic circumstances differ markedly—when some countries are debtors and others creditors—then political integration, including creating the political institutions necessary to make economic integration work, becomes more difficult.

Having similar economic structures may make it more likely that two countries share common beliefs, but it far from guarantees it. There is ample evidence that countries with similar economic systems and at similar standards of living, at least today, can have quite different beliefs (though many economic historians trace these differences back to differences in economic structures in earlier times). Understanding the nature of these differences is critical for assessing the kind of economic and political integration that is desirable, or even feasible.

What is required then is not only that they have similar economic structures but also similar belief systems—beliefs about social justice and how the economic system works.

In the discussion in the following chapters, several sets of beliefs will play an important role—including some of the beliefs that we discussed earlier in this chapter concerning what makes for a good economy.


It is hard for an economic federation to work if the different members of the federation have different views of the laws of economics—and there are fundamental differences in conceptions about how the economy works among the countries of the eurozone that were present even at the time of the creation of the euro, but which were then papered over. These differences have impeded not just the formulation of appropriate programs in response to the euro crisis but have meant that programs designed by (or acceptable to) Germany, the country that has become the dominant power in the eurozone, have often been viewed as imposed on those accepting them.

Of course, the crisis country has “voluntarily” accepted the terms, but it has accepted the terms not because it believes that the “program” will solve the problems but because not accepting the terms would lead to intolerable consequences—including the possible departure from the eurozone. And those in the eurozone, as well as many economic pundits, have been successful in convincing the crisis countries that the departure from the euro would be extraordinarily costly.

That those in the crisis country do not believe in the economic theory underlying the “voluntary” programs has two consequences: the programs are unlikely to be effectively implemented, and they are likely not to be politically sustainable—especially if the programs are less successful than promised. In chapter 3, we will show that that has in fact been the case—not only less successful than promised but even worse than some of the harshest critics of the euro anticipated.

Perhaps the most obvious instance of such differences in conceptions of how the economy functions is “austerity,” the belief that by cutting spending or raising taxes a country in recession experiencing a fiscal deficit (an excess of spending over revenues) could be brought back to health. Modern scientific economics has refuted the Hooverite economics I discussed in the last chapter. The point I make here, though, is different: it is difficult for a group of countries to share a common currency and to work together when there is such a disparity in the views of the laws of economics. Decisions are going to have to be made in response to a myriad of unforeseen circumstances. There will never be unanimity, but when there are large disparities, it is inevitable that there will be considerable disgruntlement with whatever decision is taken.

There are a myriad of detailed issues in which different conceptions of how the economy functions play out, not just the macroeconomic issues of austerity and inflation previously discussed. One aspect of the neoliberal agenda entails privatization. There are strong arguments that governments should focus their attention on those areas where they have a comparative advantage, leaving the private sector to run the rest. Though this principle makes theoretical sense, in practice determining where the government has a comparative advantage is difficult.

Experiences around the world have shown a variety of outcomes. Perhaps the most efficient steel companies in the world in the 1990s were the government-run firms in Korea and Taiwan, and there is little evidence that the privatization of the Korean company, POSCO (demanded by the IMF in its 1997 financial rescue), led to improved efficiency. In Canada, there is scant evidence that the major national private railroad company is more efficient than the large public one; in Chile, little evidence that private copper mines are more efficient than public mines. In Latin America, the privatization of telecoms did not lead to greater productivity, at least in those instances where investments had not been overly squeezed by government budget constraints.22

Many of the government-run enterprises are in sectors where there are natural monopolies (for instance, because the economies of scale are so large that there should be only one firm), and with such monopolies, the issue is not whether there will be government intervention but the form that it will take. Both as a matter of theory and practice, well-run government monopolies may do just as well as government-regulated private monopolies.23

Thus, the demand of the Troika for privatization of certain Greek government-owned assets is dictated as much by ideology as by evidence and theory.

Again, our point here is simple: it is that there are deep divides across Europe about what gives rise to a well-functioning economy. So long as each country is allowed to choose for itself, matters are fine. But it is not so fine if economic integration entails giving one country (or group of countries) the power to dictate to others what they should do. That has happened across the eurozone, in matters concerning both macroeconomics and microeconomics, and especially in countries that are in crisis. It is especially troublesome when the policies foisted on the country don’t work—for the very reasons that the citizens of the country thought; the costs of the mistake, of course, are borne by the country upon whom they are imposed, not by those imposing them. This is the story of the eurozone.

Later chapters will explain why the policies being imposed on these other countries by the Troika are wrong, based on a flawed understanding of economics. But even if they were correct, one has to ask: Are the gains from this aspect of economic integration, the euro, great enough to justify the loss of self-determination? This chapter has argued that the benefits are at best questionable, and if that is the case, the answer to whether the benefits of the euro are worth the costs is unambiguous.


Some of the privatizations, such as those involving basic services, raise questions of values: a society may feel that there is a basic right to minimal access to water or electricity, rights and values that might be undermined by a profit-maximizing monopolist.

Labor rights and worker protections illustrate other aspects of the struggle over values. Some have questioned whether the programs that have been imposed on the countries in crisis have gone beyond those designed to increase economic performance. Not content with an approximately one-fifth decline in labor costs in Greece,24 it appears that the Troika wants to weaken workers’ bargaining rights, which would lead to still lower wages. The language of the programs is sometimes ambiguous and may obfuscate what is really being asked within the negotiations.25 There is a concern that what was being asked, say of Greece, may have violated the International Labor Organization’s core labor standards, to which almost all countries have agreed.26 But there is also a concern that, given the evidence that unionization may actually increase productivity, these measures will be counterproductive.27

Different societies have different values, different conceptions about how the economy works, and indeed, even different conceptions about democracy and what constitutes a well-functioning society. Germany’s finance minister, Wolfgang Schäuble, has repeatedly emphasized the importance of rules, and if there are rules, they must be obeyed. Of course, many of the most heinous crimes have been committed by those who simply said they were just obeying rules. For a society to function well, there must be the right rules, and the right degree of flexibility to deviate from the rules when appropriate. Given our limited knowledge, we can never be sure whether our model of the economy is right; there is always the possibility that rules that might have made sense were our model right are very wrong if our model is wrong. And when we discover that our model is wrong—even possibly wrong—perhaps because the world itself has changed, we have to have the flexibility of changing what we do. Different societies may, of course, come down with different views on striking the right balance between rules and discretion.28

Again, the key issue is the extent to which economic integration entails surrendering important aspects of a country’s ability to make its own decisions. If there is a broad consensus on these matters of values, there may be limited differences about what policies to undertake. But if some countries think minimal access to water or electricity is a basic right, or that workers should have certain basic rights to collective action, then they will be deeply unhappy if contrary policies are imposed on them—and they should be.


The European project was ambitiously aimed at bringing the countries together, but together in a political union that would reflect basic European values. Some of these values, however, are obviously not universally agreed to or respected, especially in certain countries or in certain parts of certain countries. A basic liberal value is respect for a diversity of views. There will and should be less tolerance for views that do not respect some of the core values. Far more problematic, though, is the right of one country to impose its values on others. Doing so can undermine another core European value, democracy—and this is of especial concern when what is being touched upon affects basic principles of social justice. Among the core values are the core labor standards—which, as we noted, some suggest were being undermined in at least one of the Troika programs. Again, the question is, are the benefits of this aspect of economic integration and monetary integration worth the costs? And this time, what is at stake is more than judgments about economic performance; it’s about more fundamental issues of social justice and democracy.

From the very start, the European project was afflicted with a democratic deficit. It was a top-down project, conceived by foresighted leaders, who were less successful as salesmen. In some countries—especially those emerging from fascism and communism—there was enthusiasm about being part of Europe. Indeed, the prospect of joining the EU provided a major impetus for institutional reforms that played an important role in the success of the countries in eastern and central Europe as they made a transition from communism to a market economy.29 But repeatedly, when various aspects of the European project were subjected to referendum—Denmark’s and Sweden’s referendums on the euro, France’s and Netherlands’s on the European Constitution, Norway’s referendum on joining the EU—anti-EU sentiments prevailed.30 Even when pro-EU forces won, there were significant votes on the other side.

One of the reasons is the construction of the EU itself—with the laws and regulations promulgated by a commission that is not directly elected. Not even the head of the European Commission is elected. Devising rules and regulations that worked for the entirety of the diverse region inevitably led to complexity. Of course, Europe has recognized this, and it has slowly but steadily been moving toward greater democratic accountability—except on one front: the monetary union.

If the euro is to be successful, it has to be an economic project that is consistent with, and even reinforces, other fundamental values. It has to strengthen democracy. But the euro has done the opposite.

The most powerful institution in the eurozone is the European Central Bank, which was constructed to be independent—not answerable to or guided by elected leadersanother neoliberal idea that was fashionable at the time of the construction of the euro. Though it remains fashionable in some quarters, it is increasingly being questioned. As we will see in chapter 6, the countries that performed best during the global financial crisis were those with more accountable central banks.

The actions of any central bank have large political and distributive consequences—seen most clearly in times of crises. Central banks are good at cloaking their decisions in jargon suggesting that they are simply implementing their mandate. But there are choices in how they implement that mandate. Though they would almost surely deny it, the ECB’s decision to shut off funds to the Greek banking system in the summer of 2015 was an intensely political act.

The growing democratic deficit is seen most obviously in the fact that when given the opportunity, the countries of Europe have repeatedly rejected the policies being imposed on them. In 2015, 61 percent of the electorate in Greece voted to reject the conditions imposed, and in Portugal and Spain similar proportions supported candidates opposed to austerity. But opposition is evident, too, in numerous other elections, including in Italy, where voters turned out the party supporting austerity; they elected parties calling for an alternative course.

In spite of these elections, the policies remained effectively unchanged. In Portugal, matters were even worse: the president initially refused to install the antiausterity coalition on the grounds that it contained anti-euro parties, even though, having won 62 percent of the votes, the coalition controlled the parliament.

In each country, the newly elected government was told in effect that they had no choice: accept the conditions or your banking system will be destroyed, your economy will be devastated, and you will have to leave the euro. What does it mean to be a democracy, where the citizens seemingly have no say over the issues about which they care the most, or the way their economy is run? This democratic deficit destroys confidence in democratic processes—and encourages the growth of extremist parties that promise an alternative.

But the lack of commitment to democracy has become increasingly evident as the programs that have been imposed on the countries in distress have evolved. This was seen most clearly in Greece. Early on, there were suggestions from Germany that Greece give up its vote as a member of the eurozone until it had been rehabilitated, until it was out of the “program.” It was reminiscent of the United States, unusual among democracies, where in most states those in prison cannot vote, and in others, people once convicted of a felony lose their right to vote forever. Greece had, evidently, in the eyes of Germany committed the crime of getting overindebted; and while it wasn’t being asked to permanently give up its vote, until its debt was at the level where Greece could manage on its own, it was suggested that Greece should be deprived of its voting rights.

The programs demanded of Greece have illustrated this profound lack of commitment to democracy in other ways. One demand was that Greece not submit any bill for public consultation until after it had been reviewed by the Troika.

When George Papandreou, prime minister of Greece, proposed a referendum in 2011 to get the support of his people for the program that was being demanded, the leaders of the Troika were genuinely offended. They acted as if they felt betrayed. What, ask the people? Ironically, Papandreou believed he would win support of the population for the program—so committed were the Greeks to the euro that they were willing to suffer the pain and indignities of the program in order to stay within Europe. He believed that with this affirmation, there would be more “country ownership” of the program, and with that greater commitment it would be easier to implement the program effectively. I agreed. As chief economist of the World Bank, I saw the big difference that it made when there was country ownership, and at the Bank, we worked hard to achieve this while I was there. We engaged with civil society, we explained the development strategies, we had seminars. By contrast, when the program is viewed as imposed from outside, there are widespread attempts to circumvent it.

Perhaps the worst instance of this “nondemocratic” stance became evident after Greece elected a leftist government in January 2015, headed by 41-year-old Alexis Tsipras, that had run on an antiausterity platform—not a surprise given five years of failed prior programs, with GDP falling by a quarter and youth unemployment peaking above 60 percent. Conditions and terms that had been proposed to the previous center-right government of Antonis Samaras (from the New Democracy Party, closely linked to the oligarchs, and a party that had been engaged in some of the deceptive budgetary practices that brought on the Greek crisis) were withdrawn. Harsher conditions were imposed. As support for Tsipras and his unconventional finance minister, Yanis Varoufakis (who is an excellent economist, having come from a teaching stint at the University of Texas at Austin), grew, if anything the eurozone negotiators took a still harder stance. It perhaps didn’t make things easier that he was probably the only economist among the finance ministers with whom he was supposed to “negotiate.”

In the end, Greece knuckled under. Germany refused to restructure Greek debt—even after the IMF said that that would have to be done. They refused to back off from a required primary fiscal surplus of 3.5 percent (the amount revenues would have to exceed expenditures, net of interest payments) for 2018—a number virtually guaranteed to continue depression.31

The Greek people had wanted two things and they could not have both: they wanted an end to austerity and the restoration of growth and prosperity; and they wanted to stay in the eurozone. Tsipras knew that the latter was, for the moment, more important than the former, and that’s what he opted for, as he acquiesced to the demands of the eurozone. For the moment, they have stayed inside the eurozone, and the eurozone has been kept whole—but at a great cost to European democracy (not to mention the cost to the Greek people, which we will discuss at greater length below).

When he turned, once again, to the Greek people for confirmation, they again resoundingly supported him. The Greeks had survived another assault from Berlin, but the government, and the Greek people, had had to sacrifice their economic agenda. As I have suggested repeatedly, no issue is of more concern to a nation and its people than the conduct of economic policy.

Within the EU and eurozone, governments were supposed to have retained large domains of sovereignty. What happened in Greece and what was happening elsewhere within the eurozone gave the lie to this idea. At least in some circumstances, economic sovereignty had been surrendered. In still others, key elements had been given up.

The eurozone institutions, such as the ECB, to which that economic sovereignty had been given up, were a far cry from democratic. The democratic deficit that had been apparent at the birth of the eurozone has grown ever larger. The deepest hopes of the euro—that it would bring stronger political integration based on a strengthening of democratic values—are thus just that: still hopes. The reality is otherwise.

The political and social costs of the euro are apparent. The question is, what have been the benefits? The statistics that lay bare the economic disappointment of the European project are presented in the next chapter.