The Future of the EuroOxford University Press, 2015, 337 pp., $29.95 (paperback)
Ambrose Bierce once observed that war is God’s way of teaching Americans geography. In that spirit, the career of Europe’s common currency, the euro, may be said to be Providence’s way of reminding the world of the pervasive presence in human affairs of unintended consequences. The euro has produced, on a great and damaging scale, the opposite of what its architects and champions sought to accomplish.
Their goal was to make Europe more prosperous; the continent as a whole has become, as a result of the common currency, poorer. They also sought, as was the case for every previous step in Europe’s post-World War II process of economic and political integration, to reinforce democracy. Instead, the crisis of the euro, which began in 2010, has strengthened political parties and political forces with questionable commitments to democratic values and procedures. The creation of a consortium of countries using the same currency—the “eurozone”—was supposed to promote economic “convergence” in Europe, narrowing the gap between the richest and poorer countries. Instead, that gap has widened.
The political leaders who established the euro believed that it would enhance Europe’s political and economic role internationally by equipping the continent with a currency to rival the American dollar, but the disruption it has caused has reduced Europe’s global power and influence. The partnership between two former enemies, France and Germany, served as the engine of European integration for six decades, culminating in the adoption of the euro, and brought benefits to both countries. It had something in common with an earlier, cinematic partnership, the one between Fred Astaire and Ginger Rogers, of which it was said that he gave her class and she gave him sex appeal. Similarly, France conferred political legitimacy on Germany, helping the Germans recover from the disgrace they incurred during World War II, while through close association with an economically resurgent Germany, France exercised more influence than it could have done alone. The impact of the euro, however, has reduced not only Germany’s standing but also France’s influence in Europe.
The euro and its troubles have, in sum, re-created what the Franco-German partnership and European integration as a whole were designed to end. Between 1870 and 1945 what became known as “the German problem” consumed Europe and ultimately much of the world. This boiled down to the problem of fitting a late-unifying Germany into the European state system on terms acceptable both to the Germans and to the other countries of the continent. Its association with France within a steadily integrating Europe seemed to have solved that historic challenge. The euro crisis has revived it, although not, fortunately, in its previous form, when it gave rise to three destructive wars. The present crisis has thrust Germany into the role of Europe’s sole and undisputed leader, but this has turned out to be a role that Germany, although the most powerful country on the continent, lacks sufficient power to play effectively. Moreover, the Germans did not and still do not wish to play that role, and have not, in fact, played it successfully. They have alienated many of their fellow Europeans whenever, and however reluctantly, they have attempted to take the lead in Europe.
The process of European integration, which began with the formation of the European Coal and Steel Community in 1951 and has led, over the decades, to the formation of the European Union and the establishment of the euro, has coincided with and contributed to an unprecedented era of peace and prosperity in what was once the most violent region on the planet. The crisis of the euro risks undoing much of what Europe has accomplished over the past 64 years. It is, therefore, no small event, and its implications reach far beyond the Eurozone.
The Future of the Euro, a new collection of 12 essays edited by Matthias Matthijs and Mark Blyth, provides a very useful perspective on this crisis. The book avoids the pitfalls that are inherent in the subject it addresses and in the manner in which it does so. That subject is a moving target. The crisis of Europe’s common currency is far from settled. Indeed, as of this writing, in July 2015, it is not clear whether Greece will remain a part of it, let alone what the consequences of a Greek withdrawal—or ejection—would be. Because it deals with the underlying and enduring causes of the euro’s troubles, however, the book’s essays will repay close attention no matter what happens to the eurozone’s southernmost and most troubled member.
In addition, volumes of collected essays with multiple authors such as this one almost always have an uneven quality. By contrast The Future of the Euro’s selections are sufficiently well coordinated to present and elaborate on a single, powerful argument. That argument makes it easier to understand what has gone wrong in European monetary affairs, but at the same time hard to muster any optimism about the prospects for fixing it.
What happened to the countries using the euro is plain enough. The establishment of the common currency created a version of a classic financial bubble in the public debt of some of the countries that adopted it. Demand for their bonds soared, driving down the interest rates required to sell them and thus encouraging borrowing on a large scale. Then investor psychology changed, the bonds of the “peripheral”, largely southern European, members of the euro became harder to sell, and the difference between their interest rates and the rates on the most credit-worthy bonds (those of Germany) increased sharply.
This put considerable strain on the southern economies. Greece went effectively (if not formally) bankrupt. Other countries seemed to be sliding toward default. This posed an acute economic danger not only to the distressed countries themselves but also to the northern Europeans, whose banks had purchased the bonds of the peripheral countries in large quantities. Default would have ruined these banks and brought about a financial crisis potentially as damaging as the one initiated by the failure of the American investment bank Lehman Brothers in September 2008. In response, the countries of the Eurozone took ad hoc, delayed, and indecisive steps to rescue—bail out—the afflicted countries. These measures have, thus far, prevented the worst case—something like a repetition of the events of 2008—but they have not ended the economic troubles of the peripheral countries or the general weakness of the euro.
The larger question of why the euro has produced such severe difficulties, and the closely related question of what should be done about them, has evoked two responses. One of them has determined the policies that Europe has adopted since the onset of the crisis. The other is the theme of The Future of the Euro.
The northern Europeans, and especially the Germans, who did not suffer the international bond market’s loss of confidence, consider the cause of Europe’s current economic problems to be the irresponsible fiscal conduct of the countries whose difficulties that loss of confidence triggered. They have diagnosed the malady as a case of fiscal profligacy: The afflicted countries spent beyond their means.
From this diagnosis followed the prescription: These countries must reform their economic practices to make themselves more competitive, and reduce their current account deficits. Since they cannot do this by devaluing their national currencies, having given them up when adopting the euro, they must do so through what has come to be known as austerity: a drop in national economic activity occasioning sharp rises in unemployment.
The northern Europeans succeeded in getting the southerners to adopt this prescription because of the economic version of the Golden Rule: He who has the gold makes the rules. The southerners required financial support from the northerners to avoid default and the northerners, having become their bankers, were in a position to impose conditions on their loans. Austerity as the condition for their support commended itself to the Eurozone’s northern core countries for several reasons. The chapter by Abraham Newman of Georgetown University explains how Germany’s own recent history, in particular the high costs of unification, and the economic reforms the country undertook in the first decade of this century, predisposed the Germans to consider austerity the appropriate response to the crisis. The northern Europeans also wished to avoid the problem of moral hazard: If the southerners suffered no adverse consequences for their fiscal fecklessness they would have no incentive to mend their ways.
Finally, the policies that the northern Europeans preferred placed the burden of reducing the southerners’ deficits entirely on the countries running those deficits, and not on those accumulating the surpluses that are the inevitable complement of deficits. Were Germany to pump up its own economy, it would import more from the peripheral countries and export less to them, easing the economic pressure on them. This the German government, with the support of the German public, has refused to do. Although they seldom put it in precisely this way, the northern Europeans regard the euro crisis as stemming from the economic sins of the southern countries, for which these countries must atone. If atonement has turned out to be economically painful, so be it—or rather, so much the better, since this will discourage sinning in the future.
This diagnosis of the euro crisis has two problems. The first is that it is not wholly accurate. It does apply to Greece, which accumulated consistently high deficits in its government budget. Spain and Ireland (the latter an economically peripheral although not geographically southern country), however, which have also had to undergo austerity, had practiced fiscal responsibility before 2010. They fell victim to the collapse of their private banks when real estate bubbles burst, as occurred in the United States in 2008, and the public authorities were left to pick up the pieces. It was the banks, not the politicians or the citizens of these countries, that caused the crisis; but the public has had to pay the price of coping with it. Secondly, austerity has not improved economic conditions where it has been practiced: Debt has increased, growth has stalled or stopped altogether, unemployment has soared. Thus far the cure the northern Europeans have prescribed has proven, if not worse than the disease, then certainly no better.
The contributors to The Future of the Euro believe, in contrast to the conclusion of the governments of the continent’s rich countries, that the common currency’s difficulties arise from a serious failure in its design. It lacks, they argue, the institutions that are necessary for any currency to function effectively. Without such institutions, it follows that, whatever Greece’s fate, the euro will remain crisis-prone—a point also made publicly, as it happens, by several prominent economists, most of them living in North America, before the currency was launched. Specifically, the authors of The Future of the Euro collectively insist that putting the common currency on solid footing requires the establishment of eurozone-wide institutions of three kinds.
It needs financial institutions. Indeed, in a provocative essay Erik Jones argues that because of the absence of such institutions, the degree of financial integration that Europe achieved even without a common currency would have provoked a crisis sooner or later, even if the euro had never been born. A banking union is needed to provide regulation, supervision, deposit insurance, and mechanisms for coping with failed banks across the Eurozone. The members of the common currency have agreed in principle to establish these, but they have not even been able thus far to issue a common debt instrument—a “eurobond”—that would enhance the euro’s stability. Nor do they have a central bank with the power to stop financial panics. The American Federal Reserve exercised this power in response to the financial crisis of September 2008. While it has widened the scope of its activities since 2011, Europe’s equivalent—the European Central Bank—still lacks the power the Fed deploys and so has been unable to act decisively to protect the European economy.
The long-term viability of the euro, according to the contributors to The Future of the Euro, also requires fiscal institutions with the power to act in “countercyclical” fashion: to obtain revenues through taxation across the Eurozone and to redistribute them to regions in the grip of economic downturns. States with their own currencies can lower interest rates in response to downturns. Members of a currency union—the American states taken separately, for example, and the countries in the Eurozone—cannot. They need other methods for relieving the economic distress that they will, at some point, inevitably experience. The American dollar functions effectively as a national currency because the United States can quickly implement fiscal policies for that purpose. Should economic conditions deteriorate in the Midwest, say, the Federal government pays unemployment compensation, drawing on taxes from all regions of the United States, to workers there who have lost their jobs. No institution has the authority to do this across Europe. (In the United States, moreover, workers who lose their jobs in one part of the country can move elsewhere to find employment. While laws support comparable labor mobility within Europe, cultural obstacles to it, not least language barriers, remain firmly in place.) If the members of the common European currency have at least made a start on establishing some elements of a financial union, they have done nothing to inaugurate a regime for common taxation and redistribution. Whether they prove able one day to do this depends on politics.
Third, therefore, the euro requires common political institutions. It needs them to impart political legitimacy to its financial and fiscal policies. Effective Eurozone-wide monetary and fiscal institutions would create the need for a political authority of comparable scope to administer them and carry out their decisions. The plain and compelling message of the book, one that monetary history supports, is that a successful currency requires a corresponding government; and this is the main reason for pessimism about the euro’s future.
For the crisis of the common currency has given the countries of the periphery a taste of what a euro-wide government would be like for them. The economic decisions that affect their well-being have largely been made, since 2011, not in their own capitals by their elected representatives but rather in Brussels and Berlin by people who are not accountable to them and who did not, on the whole, consult them. The people of southern Europe could expect to be able to vote for an all-European government, but they could not expect to exert anything like the kind of influence over it that they have normally had over their present, democratic, national governments.
Moreover, policies that have flowed from decisions made elsewhere have made the people of peripheral Europe poorer, which is the opposite of what they expected from membership in the euro. They will not be eager to make permanent the kinds of political arrangements that have produced the straitened economic circumstances in which they now live, and that leads to a final unintended consequence of the euro.
The euro’s travails have revealed, as the contributors to The Future of the Euro make clear, that a European government is necessary if the currency is to serve as the vehicle for prosperity across the continent. Those same travails, however, have made such a prospect extremely remote. European elites have initiated and managed most steps in the process of European integration, but the creation of an effective pan-European government will surely require the active support of European publics; yet, given their experience with the common currency, the people of the peripheral countries, at least, are hardly likely to give it. The most important question that the common currency’s troubles raise, therefore, is not how long and under what conditions Greece will remain in the euro, but how long, and under what conditions, the euro itself can endure. That is a question to which no one has the answer.