Why the Euro Is in Peril

Commentaries on economics and technology.
Dec. 9 2011 11:56 AM

Why the Euro Is in Peril

Europe’s leaders are complaining about what went wrong instead of thinking about what they can do right.

The euro
The euro

Photograph by Samuel Kubani/AFP/Getty Images.

Just when it seemed that things couldn’t get worse, it appears that they have. Economists on both sides of the Atlantic are now discussing not just whether the euro will survive, but how to ensure that its demise causes the least turmoil possible.

It is increasingly evident that Europe’s political leaders, for all their commitment to the euro’s survival, do not have a good grasp of what is required to make the single currency work. The prevailing view when the euro was established was that all that was required was fiscal discipline—no country’s fiscal deficit or public debt, relative to GDP, should be too large. But Ireland and Spain had budget surpluses and low debt before the crisis that quickly turned into large deficits and high debt. So now European leaders say that it is the current-account deficits of the eurozone’s member countries that must be kept in check.

In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the United States, which has had an enormous current-account deficit for years. So, how will the European Union distinguish between “good” current-account deficits—a government creates a favorable business climate, generating inflows of foreign direct investment—and “bad” current-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euro’s founding would imply.

Advertisement

In Spain, for example, money flowed into the private sector from private banks. Should such irrational exuberance force the government, willy-nilly, to curtail public investment? Does this mean that government must decide which capital flows—say into real estate investment, for example—are bad, and so must be taxed or otherwise curbed? To me, this makes sense, but such policies should be anathema to the EU’s free-market advocates.

The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong, or at least inadequate. The 1980s Latin American crisis was caused by excessive borrowing, but that could not explain Mexico’s 1994 crisis, so it was attributed to under-saving.

Then came East Asia, which had high savings rates, so the new explanation was “governance.” But this, too, made little sense, given that the Scandinavian countries—which have the most transparent governance in the world—had suffered a crisis a few years earlier.

There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: Financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.

These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment—the interest rate and the exchange rate—and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition—a race to the bottom to attract investment and boost output that could be freely sold throughout the European Union.

Moreover, free labor mobility means that individuals can choose whether to pay their parents’ debts: Young Irish can simply escape repaying the foolish bank-bailout obligations assumed by their government by leaving the country. Of course, migration is supposed to be good, as it re-allocates labor to where its return is highest. But this kind of migration actually undermines productivity.

Migration is, of course, part of the adjustment mechanism that makes America work as a single market with a single currency. Even more important is the federal government’s role in helping states that face, say, high unemployment, by allocating additional tax revenue to them—the so-called “transfer union” so loathed by many Germans.

Even if those from Europe’s northern countries are right in claiming that the euro would work if effective discipline could be imposed on others (I think they are wrong), they are deluding themselves with a morality play. It is fine to blame their southern compatriots for fiscal profligacy, or, in the case of Spain and Ireland, for letting free markets have free reign, without seeing where that would lead. But that doesn’t address today’s problem: Huge debts, whether a result of private or public miscalculations, must be managed within the euro framework.

Public-sector cutbacks today do not solve the problem of yesterday’s profligacy; they simply push economies into deeper recessions. Europe’s leaders know this. They know that growth is needed. But, rather than deal with today’s problems and find a formula for growth, they prefer to deliver homilies about what some previous government should have done. This may be satisfying for the sermonizer, but it won’t solve Europe’s problems—and it won’t save the euro.

This article comes from Project Syndicate.

TODAY IN SLATE

Sports Nut

Grandmaster Clash

One of the most amazing feats in chess history just happened, and no one noticed.

The Extraordinary Amicus Brief That Attempts to Explain the Wu-Tang Clan to the Supreme Court Justices

Amazon Is Officially a Gadget Company. Here Are Its Six New Devices.

How Much Should You Loathe NFL Commissioner Roger Goodell?

Here are the facts.

Amazon Is Officially a Gadget Company

Science

The Human Need to Find Connections in Everything

It’s the source of creativity and delusions. It can harm us more than it helps us.

Food

How to Order Chinese Food

First, stop thinking of it as “Chinese food.”

Scotland Is Inspiring Secessionists Across America

You Shouldn’t Spank Anyone but Your Consensual Sex Partner

Moneybox
Sept. 17 2014 5:10 PM The Most Awkward Scenario in Which a Man Can Hold a Door for a Woman
  News & Politics
Jurisprudence
Sept. 18 2014 10:42 AM Scalia’s Liberal Streak The conservative justice’s most brilliant—and surprisingly progressive—moments on the bench.
  Business
Business Insider
Sept. 17 2014 1:36 PM Nate Silver Versus Princeton Professor: Who Has the Right Models?
  Life
Outward
Sept. 18 2014 11:25 AM Gays on TV: From National Freakout to Modern Family Fun
  Double X
The XX Factor
Sept. 18 2014 11:40 AM Where Pregnant Women Aren't Allowed to Work After 36 Weeks  
  Slate Plus
Slate Fare
Sept. 17 2014 9:37 AM Is Slate Too Liberal?  A members-only open thread.
  Arts
Brow Beat
Sept. 18 2014 11:48 AM Watch the Hilarious First Sketch From Season 4 of Key & Peele
  Technology
Future Tense
Sept. 18 2014 10:07 AM “The Day It All Ended” A short story from Hieroglyph, a new science fiction anthology.
  Health & Science
Bad Astronomy
Sept. 18 2014 7:30 AM Red and Green Ghosts Haunt the Stormy Night
  Sports
Sports Nut
Sept. 18 2014 11:42 AM Grandmaster Clash One of the most amazing feats in chess history just happened, and no one noticed.